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PSU bank stocks are rallying, but don’t miss the red flags

public sector banks have brought down their bad loan pile with the help of write-offs. In FY20, nearly a quarter of the bad loans were written off. (File Photo: Mint)Premium
public sector banks have brought down their bad loan pile with the help of write-offs. In FY20, nearly a quarter of the bad loans were written off. (File Photo: Mint)

The rally is outsized also because they were the most beaten down stocks last year when the pandemic struck. That said, with the second wave impacting the real economy, lenders cannot be expected to go unharmed

Public sector banks (PSBs) have had their best ride in the stock market since the government proposed to fix their legacy bad loan problems through a bad bank in February. The Nifty PSU Bank index has surged more than 32% since budget day, outshining the broad market and private sector peers.

Several factors apart from the bad bank announcement have come together to give a boost to the valuations of PSBs. Lenders have fixed their capital and hacked away at their corporate toxic loan load. Mergers have given balance sheets more heft to handle additional stress.

Investors have got another reason to rejoice. The largest lender, State Bank of India (SBI), showed a reduction in its gross bad loan pile and reported a record quarterly profit for the March quarter. The Nifty PSU Bank index gained 2.4% on Monday with hopes of its peers mimicking this performance being triggered.

However, there are several red flags that investors risk missing in this rally. The jury is still not out on asset quality, despite early signs that the health of the loan book has turned for the better for public sector lenders.

Satish Kumar/Mint
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Satish Kumar/Mint


The second covid wave is causing greater stress for SBI in smaller towns, which may increase the bank’s delinquencies, analysts at Nomura Financial Advisory and Securities (India) Pvt. Ltd pointed out. This may apply to most PSBs because of their large presence in these areas.

A look at the special mention accounts (SMAs) of big lenders indicated that new stress is building up. Notwithstanding the handholding during the first wave of the pandemic, small businesses are finding themselves challenged yet again on revenues and margins. This puts pressure on their repayment capacity. SBI’s SMA accounts where repayments are overdue more than a month totalled 11,519 crore. In their disclosures during a qualified institutional placement of shares, Bank of Baroda and Punjab National Bank also showed a considerable build-up of these accounts for the December quarter.

Credit growth, the backbone of a bank’s business, has been decelerating fast over the past decade. Before the pandemic, loan growth had dropped to 6.02% for FY20 from double digits in previous years. In FY21, loan growth was a mere 5.58%.

What’s more is that much of this loan growth has been cornered by private sector banks. Public sector lenders have seen a sharper drop in growth.

For some lenders, it has been a year of loan book contraction. This trend is expected to reverse in the current year, against a low base. Even so, the share of these lenders in overall disbursements during the year needs to be watched.

The other factors that contributed to improved asset quality for lenders also needs to be scrutinized. Write-offs have played a key role in bringing down bad loans for PSBs. In FY20, nearly a quarter of the bad loans were written off. The recovery from such written-off accounts is less than 30%, barring a few stray cases where the loss is lower. SBI wrote off loans worth roughly 32,000 crore in FY21, which was 23% of its bad loan pile. Its peers may have a similar experience.

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