What is causing PSU banks to rally?

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A look at the way PSU Banks are moving may give an indication that the worst is over for these banks. In the last one month alone, the NSE PSU Bank index has jumped by 18.85% while the NSE Private Bank index has moved only 5.61% and the broad Nifty has gained only 5.28%.

But according to experts, PSU banks have a lot of catching up to do with the private sector cousins, and the rough phase is perhaps not over yet.

First is the continued issue of toxic assets which the PSU banks have been carrying for the last few years. Though a major portion of these assets has been declared and taken off the books, there is still enough pending to impact profitability.

In a report on banking sector, India Ratings and Research  (Ind-Ra) expects ageing of non-performing assets to keep credit costs for PSBs at elevated levels of 170-180 basis points in FY17 (280 bps in FY16) which in turn will result in losses for some PSU banks in FY17.

Numbers for the current quarter too are expected to be subdued. Kotak Securities in a result preview has said that the sector continues to face an environment of slow growth. Banks are expected to report 40% YoY decline in earnings on the back of weak revenue growth of 7% YoY and provisions rising by 70% YoY. Kotak expects private banks to report a decline of 7% and public banks 80% YoY.

Markets have perhaps discounted the quarterly numbers and also the year end numbers but what about growth. India Ratings report says that credit growth from PSU banks will be the lowest in the last two decades. The reason for this is not only the quality of assets which is preventing banks to lend but also lack of capital.

Ind-Ra points out that limited availability of growth capital for public sector banks (PSBs) could pull down their loan growth trajectories to a CAGR of 9% over FY16-FY19. This is the bare minimum growth needed to generate sufficient spreads that can absorb operating and credit costs over this period. Even to achieve this bare minimum growth, Ind-Ra estimates the average Tier-1 capital needed during FY17-FY19 to be around 22% of FYE16 common Tier I equity (36% for mid-sized PSBs). This estimate is over and above the capital committed under Indradhanush programme.

Macquarie in its recent visit with banks also points out the lack of growth opportunities for banks. Every bank we met talked about retail, led by mortgages and auto loans, as the key growth driver, says the Macquarie report. The space seems to be getting crowded with PSU banks also concentrating their efforts to milk their retail clients.

What then is the market factoring that analysts are missing out as far as PSU banks are concerned?

One reason, as mentioned earlier is a bridging of the valuation gap between public and private banks, now that most of the toxic assets issues are out in the open and being addressed. Bulk of Rs 25,000 crore of recapitalisation of PSU banks is expected to be completed this week. Finance ministry has made it clear that they will be willing to increase allocation for capitalisation if it is needed.

Second is a possibility that government will increase its allocation for capitalisation which will help infuse. And finally is the opportunity of being part of a larger, healthier bank which will be formed post-merger of the smaller ones as envisaged by the government.

Government’s intention of supporting the PSU banks is clear. This is what is probably keeping interest in PSU banks alive. As has been seen in the case of sugar and steel sector, if government decides to support a sector, its revival, though temporary is assured.

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