PSU Banks: Is it time to buy? Not yet

  Ex-SBI, PSU banks’ valuations have corrected 30% below 5-yr average since Dec-14, in-line with their fundamentals  Near term outlook remains stressed, spike in bond yields and monsoon uncertainties will add to the stress  Remain cautious on PSU banks; SBI remains our preferred pick among them Steep correction looks justified: Since Dec-14, our covered PSU banks’ valuation (ex-SBI) has declined to 0.8x P/AB, correcting over 30% below their 5-year average. We believe the correction was warranted, given these stocks were trading at 5-yr average valuations, while their RoA corrected ~42% below the 5-yr average, driven by continuing asset quality stress, leading to higher credit costs and weaker margins. SBI is the only exception, which saw 17% correction in valuations, in sync with its RoA decline. 1H performance crucial, more correction could be in store: With regulatory forbearance ending on restructuring loans, asset quality trends in 1H will be very crucial. While 5/25 refinance has taken off and could provide relief to operational infra and core sector project loans, stress formation outside these sectors remains elevated. In addition, with monsoons still in early days, uncertainty remains, which coupled with rural slowdown, agri NPLs could rise. Similarly, bond yields have shot up the past fortnight and are likely to incur losses to PSU banks in 1Q. We suspect most PSU banks might have shifted meaningful quantum of SLR securities from HTM to AFS as well as parked incremental purchase in AFS category, which could result in higher MTM losses. This is crucial as in 4Q, excluding treasury gains, most PSU banks’ PBT dropped sharply. Remain cautious: We continue to remain cautious on PSU banks as macro outlook remains subdued along with weak capital adequacy for most banks. We cut earnings estimates between 4% (SBI) and 13% (BoB) as we reduce treasury gains and margins and increase credit costs for most banks. Versus consensus, our estimates are lower by 10-20% on most stocks. We maintain a Hold on BoI and UNBK as they continue to trade at 0.5-0.6x P/AB, while we remain Reduce on BoB, PNB and CBK, where valuations are still out of sync with RoA. We remain Hold on SBI, given its better top management, good capitalisation levels and relatively better profitability. FIG India Banks India Financials PSU Banks: Is it time to buy? Not yet India Banks (INR) _Target price__ Upside/Company Ticker New Old Rating Price DownsideCanara Bank CBK IN 269 313 Reduce 301 -10.6Punjab National PNB IN 112 123 Reduce 133 -15.8Bank of India BOI IN 160 173Hold 174 -8.0State Bank of India SBIN IN 281 305Hold 255 10.2Bank of Baroda BOB IN 127 159 Reduce 142 -10.6Union Bank of India UNBK IN 144 150Hold 149 -3.4Source: HSBC estimates, priced as of 16 June 2015 17 June 2015 Tejas Mehta* Analyst HSBC Securities & Capital Markets (India) Private Limited +9122 22681243 tejasmehta@hsbc.co.in Sachin Sheth* Analyst HSBC Securities & Capital Markets (India) Private Limited +91 22 2268 1224 sachinsheth@hsbc.co.in This report replaces the one of the same title and date to correct the Basel III CAR and Tier I ratio chart on pg 8. View HSBC Global Research at: http://www.research.hsbc.com *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations Issuer of report: HSBC Securities and Capital Markets (India) Private Limited Disclaimer & Disclosures This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it 2 FIG India Banks 17 June 2015 abcDichotomy between price performance, valuations and RoA PSU banks’ share prices have corrected quite sharply since Jan-15. Barring SBI, which corrected by ~18%, our covered PSU universe corrected by ~38%. Despite this, since Feb-14, when the current rally started, our covered PSU bank stocks are still up by ~28%, while SBI is up by 72%. In contrast, ex-SBI, RoA of PSU Banks have declined over the past 4 quarters, mainly driven by higher credit cost as asset quality continued to worsen. This is despite most PSU Banks booking significant treasury gains during FY15. In fact, in 4QFY15, excluding treasury gains, PSU Banks PBT as % of assets declined to 30-50 bps. This implies there is a clear dichotomy between the price performance and RoAs of these banks. PSU banks price performance* since Feb-14 PSU banks price performance* YTD (since Jan-15) Source: Thomson Reuters DataStream, HSBC Source: Thomson Reuters DataStream, HSBC RoA continues to slide for most PSU Banks Source: Company data, HSBC Research