We see some early signs of abatement in impaired loan accretion for the larger PSU banks. Our analysis of five key loan-intensive sectors shows that the average size of stressed corporates doubled in the past two years, with persistently high interest rates a bigger determinant of stress than their operating performance. With uncertainties around interest rates ebbing and GDP growth picking up from here, we expect lower net impairment into FY15F (forecast). While we retain our preference for private sector banks given their structural advantages, we think the valuation comfort offered by some large PSUs offers interesting near-term opportunities.
We highlight how improving macro, better trends in agri and retail and the recent discom restructuring offers comfort on incremental delinquencies.As well, we analyse the interest coverage trends across five other key sectorstextile, metals, E&C (engineering & construction), chemicals and food processingwhich make up for 30% of incremental impairment over last two years.
Despite operating margin uptrend, high interest costs drive higher delinquencies: Our analysis of companies with ICR (interest coverage ratio) less than 1x points to high interest rates being a key factor behind higher delinquencies despite export-driven sectors (textiles, metals, chemicals) showing improvement in their operating margins. The food processing sector (e.g., sugar) has been hit by pricing disputes impacting supply; but we expect some resolution given its political sensitivity. Continued stress for E&C is likely until the capex (capital expenditure) cycle revives but some large restructuring done recently would ease delinquencies.
The increasing size of stressed corporates could drive larger and lumpy recoveries: Average annual turnover of stressed companies rose to R4 bn from R2 bn three years ago driving up the ratio of stressed loans in the system. This implies potentially large and lumpy recoveries for the PSUs with any turn in macro.
While PNB and a few mid-size PSU banks offer valuation comfort, tight co-movement between impairment accretion and valuation for PSUs indicates strong potential for re-rating on any trend improvement.
Implication for coverage stocks: While we continue to like private sector banks over a longer horizon given their structural strengths, we believe asset quality trajectory would offer tactical opportunities into PSUs.
How does the valuation stack up for large PSU banks? We have seen tight co-movement between valuation of PSU banks and their incremental impairment. Within our coverage, SBI and BOB are yet to report a meaningful turn in their asset