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Posted on 22-Apr-2017 Comments  0

Banking Divergence


Not just PSU banks, but even private banks are diverging…



The banking results for the fourth quarter ending March 2017 have just about started coming, but the first signs of divergence are already visible. There has been a divergence between private banks and PSU banks for quite some time. That was on the parameters of growth,margins, profitability, NIMs and the quality of assets.


The divergence is evident from the fact that HDFC Bank alone has a market valuation that is higher than all the PSU banks (including SBI)combined. That gives you an idea of the amount of wealth that Private Banks has created in the past few years at the expense of the PSU banks. But now the divergence within the private baking space is becoming clearer.…


Legacy versus non-legacy assets…


This is where newer banks tend to have a distinct advantage. However, even within the private banking space, there are clear cases of legacy assets putting pressure. For example, IDFC Bank is up against a major problem of legacy infrastructure assets inherited from IDFC.Similarly ICICI Bank has a problem with its own legacy as a financial institution as well as its legacy of aggressive growth through the 1990s and 2000s. On the contrary, banks like HDFC Bank, Kotak Bank and IndusInd Bank have managed to overcome the legacy problem more successfully. This is only going to sharpen the divergence.


Quality of assets is the key…


Even within the private banking space, there are some banks that have managed the quality of assets much better. This has been done through a low risk focus, flexible allocations and tighter risk controls. An HDFC Bank, IndusInd Bank and Yes Bank have managed to rein in their Gross NPAs at below 2% and that has held them in good stead. On the contrary, Axis Bank, IDFC Bank and ICICI Bank have serious problems of asset quality. While it is partly to do with legacy assets, it is also to do with aggressive and target-based lending practices. It is hardly surprising that currently Kotak Bank commands a market cap that is higher than ICICI Bank despite being much smaller in size.


Divergence in NIMs…


The Net Interest Margins (NIMs) represent the gap between the yield onfunds and the cost of funds. Banks, within the private space, thathave built a strong retail franchise have managed to beat the slowdown in infrastructure sectors. Such banks have boasted higherNIMs and also better valuations. A look at the private banks pointstowards HDFC Bank, IndusInd, RBL Bank and Kotak Bank as the ones with attractive NIMs. They are also the ones to quote at a much richer P/BV and P/E. The divergence has been profound even within theprivate space. The writing is on the wall for the weaker banks


PSUD is investment


How to make a success of it in this financial year…



The government in its February Budget has again set an ambitious target for divestment of PSUs. Rs. 72,000 crore ($11 billion) may appear to be steep by historical standards, but it is not too hard to achieve.Two years back, the government could achieve just about 40% of its disinvestment target due to weak market conditions. A lot has changed since then. Here are 3 steps the government can focus on to make a success of divestment this year…


Focus on the stories that sell…


If the success of this financial year’s first divestment in NALCO is any indication, the government needs to focus on stories that sell.Consider a few samplers. No point in trying to divest oil producers like ONGC and OIL at a time when upstream oil is hardly attractive to investors. On the contrary, the focus should be on downstream stocks like IOC, HPCL and BPCL that can elicit demand considering the favorable regulatory environment. Similarly, power producers may not attract interest, but power aggregators like Power Grid and power financers like PFC and REC will definitely elicit interest from investors considering their low cost of funds. Metals and minerals is one more area that the government can focus on as investors will be keen to buy these stocks considering the strong metal prices in the global commodity markets. Of course, selling PSU banks may be the harder part of the challenge!


Give it an attractive pricing…


One of the key lessons that the government has learnt in the past is that attractive pricing is the key to making any divestment a success. In the early part of 2000s, the government divestment program began in right earnest with Maruti. The attractive pricing and the subsequent appreciation actually triggered off the massive buying interest in PSU stocks. That was followed by a series of PSU banks; each of them priced at an extremely attractive level. That, probably, holds thekey to the success of the program. The first divestment in NALCO was done at a discount of nearly 10% over the market price, which attracted a lot of retail and institutional interest.


Avoid bunching of divestments…


Back in 2004, the government had planned the divestment of ONGC along with a few others. The issue size was huge and sucked out most of the liquidity from the markets. This resulted in a fall in price post listing. This is a normal problem when too many divestments are bunched together. Markets in 2017 are substantially deeper and broader with greater participation. However, bunching should still be avoided in the larger interest of post-listing performance. The government has done the right thing by starting early this year. The trick now is to phase it out gradually through the year.


Telecom Worry


Why the RBI may have raised the red flagat the right time…



Recently,the RBI had raised red flags over the exposure of banks to the telecom sector. Like steel and infrastructure, banks have a massive exposure to telecom to the extent of almost $65 billion. The RBI’s contention was that the current provisioning policy for telecom sector does not reflect the risk in the sector. Therefore, the RBI called for higher provisioning for the telecom exposure. RBI is bang on…


Financially,they are jittery…


There are quite a few financial question marks over the telecom sector.Firstly, the debt levels are quite high. Bank exposure alone is quite high to the tune of almost $65 billion. With telecom companies looking for acquisitions, mergers, investment in spectrum,geographical expansion etc; the appetite for funds will only increase. Most of these are long gestation investments and are unlikely to generate returns in the medium term.


But above all, the financial solvency position is quite difficult.Interest coverage is an important measure for high debt companies.Telecom sector overall has an interest coverage of less than 1. That means, the Earnings before Interest and Tax (EBIT) is not even sufficient to cover interest payouts. Net profits are therefore likely to be illusory and hard to sustain. Hence, it is very difficult to justify valuations and risk is just too high to give comfort to banks.


Competition is intensifying…


That was always the case and the competition has become more intense after the entry of Reliance Jio. Let us look at the two principal businesses viz. voice and data. Voice has already been under pricing pressure for quite some time and the entry of Reliance Jio has also queered the pitch. Jio is virtually offering its voice services free of cost bundled with its data services. With Average Realization per User (ARPU) already low, free voice will only hit earnings further.Jio has also set new benchmarks in data pricing and other players have no choice but to follow suit. The pressure on the financial health of telecom companies is intense and is only likely to worsen.


What will be the impact?


Unlike infrastructure sector and steel lending, the exposure to telecom is more evenly dividend across banks. Even private banks like IndusInd,Kotak and Yes Bank have a large exposure to telecom in percentage terms. The next 2 quarters could show pressure on the balance sheet of banks and further provisions have to be made. The tougher call could be for the telecom companies. Many of them will face similar problems like the infra sector which saw bank funding dry up beyond a point of time. From the RBI’s point of view, they are bang on target and this could not have come a day earlier!


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