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Earnings and the CNX PSU Bank index rally

LiveMint logoLiveMint 25-05-2014 Ravi Krishnan

The almost 10% gain in State Bank of India’s (SBI’s) stock after its earnings announcement caps a season in which state-owned banks have become investor favourites. The CNX PSU Bank index on the National Stock Exchange has gained 55.3%, overshadowing the 16.9% rise in the benchmark CNX Nifty.

The reasons for this rally are not hard to find. One, the valuations of state-run banks had been beaten so badly that most were trading below their book values before the rally started. Even now, valuations are approximately 40% below peak level and 20% below the long-period average, Motilal Oswal Financial Services Ltd said in a 22 May note.

Secondly, there is new-found optimism that asset quality deterioration has stabilized.

A quick look at the aggregate bad loans of all state-run banks shows that it has indeed reduced by `15,319 crore from a quarter ago to `2.03 trillion. State-owned banks have also posted a combined operating profit growth of 17% in the three months ended March after two quarters of decline.

Yet, the figures hide more than they reveal. The fall in gross non-performing assets and increase in recoveries in some cases is for the large part owing to sale of bad loans to asset reconstruction companies after the Reserve Bank of India prodded them to do so. Slippages have shown no sign of abating for a large number of banks. For 15 large state-run banks, whose data has been compiled by Emkay Global Financial Services Ltd, slippages amounted to `23,922 crore in the March quarter, up 32% from the three months ended December.

Restructuring has also helped banks push loans out of the bad loans bracket. SBI, for instance, recast `7,636 crore loans in the March quarter, almost double that of the previous months.

Moreover, as continuing net profit decline shows, operating profit growth of state-run banks is not enough to make bad loan provisions. The provision coverage ratio of many banks is still languishing at around 60% levels. Taking SBI's example again. The lender’s provision coverage levels worked out to 62.86% at the end of March compared with 66.58% a year ago.

In the final analysis, the performance of state-run banks is closely tied to the fortunes of the economy. While valuations have climbed up from rock bottom, there is nothing to indicate the economy is on its way up.

The last time stressed assets had climbed to 10% of advances was in 2002-03. By the end of that year, the cycle started turning, but the conditions for recovery were far different.

In September 2003, the economy bounced back and logged a growth of 8.5%. Interest rate cuts were starting then and banks had resources to lend; the credit-deposit ratio was about 57%.

These preconditions to earnings growth are not visible now. Thus, the rally in the stocks of state-controlled banks boils down to the hope the new government will boost growth, a tough ask.

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