Ability of smaller banks to withstand coronavirus shock key for investors

In this backdrop, investors are recommended to stay away from small private banks until the situation improves
There is little doubt that the negative impact of coronavirus across sectors would take a toll on the banking industry, in terms of asset quality, higher credit cost, and growth. However, the Street seems to have even less confidence in smaller (small- and mid-sized) banks if their stocks' recent underperformance versus large banks is anything to go by. Federal Bank, DCB Bank, and RBL Bank, among others, are down up to 59 per cent in the last 10 trading sessions versus a 30 per cent fall in the Nifty Bank index during the same period.

First, with uncertainty over the duration of the coronavirus pain and its impact on the overall economy, the ability of smaller banks to withstand the shock has become a key for investors.


Krishnan ASV, lead analyst at SBICAP Securities, believes: “Large banks with high capitalisation and a strong deposit franchise have greater ability to absorb the economic growth shock, which investors are looking for in light of the current situation.” In fact, a moratorium-like episode at a private sector bank is often followed by a temporary crisis of confidence for depositors of other private banks, which demands a slew of confidence-restoring measures by policymakers and other stakeholders, says Krishnan, adding that banks collectively investing in YES Bank was one such measure.


Having said that, the write-off of YES Bank’s tier-1 bonds would make fundraising difficult, especially for smaller private banks.


Second, according to analysts at Dolat Capital, besides growth and asset quality concerns, high exposure to small and medium enterprises (SMEs) has led to a correction in mid-sized banks. The SME sector is expected to be more vulnerable to the current crisis as the lockdown could wipe out a sizeable chunk of their cash flow in the near term. Lenders like Bandhan Bank and RBL Bank also have a high segmental concentration in microcredit and personal loans, respectively, which could see pressure if there are any job losses or pay cut, say analysts.

Finally, though secured loan books of many small private banks indicate good recoveries in the event of default, valuations are a hurdle. After the sharp correction, large and strong banks like HDFC Bank and ICICI Bank are available at a reasonable valuation of 2-3 times trailing 12-month book value; it is about 1-2 times for small privates banks. “Buying interest is likely to be limited (for mid/small banks) when large private banks are available at a significant discount,” say analysts at Dolat Capital in a report.


In this backdrop, investors are recommended to stay away from small private banks until the situation improves, select stocks like Federal Bank could be a good option to bottom fish.

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