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Make hay while the sun shines. Investors in shares of State Bank of India (SBI) and Bank of Baroda (BoB) seem to be doing this. The street gave a thumbs up to the solid September quarter (Q2 FY23) earnings of these public sector lenders announced on Saturday. Robust loan growth, better asset quality and improving net interest margins (NIMs) were the common positive factors in their Q2 earnings.

Loan growth momentum is likely to be sustained aided by strong tailwinds across segments, the SBI management said in an earnings call. The BoB management shared the optimism and said traction in loan book is expected to continue with the bank’s FY23 loan growth projected to be in line with the industry’s credit growth.

Sharp upswing
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Sharp upswing

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On Monday, both the stocks hit 52-week highs on NSE. Shares of SBI and BoB closed 3.4% and 9.5% up, respectively. A slew of brokerages have upgraded FY23/FY24 earnings estimates for these banks.

So far, so good. However, investors should not get carried away. The benefit of lower cost of funds may last for another quarter, as loans get repriced faster and deposits with a lag. However, tightening systemic liquidity and increasing competition for deposits pose a downside risk to margins, making the way ahead challenging.

“SBI has delivered a bumper quarter in Q2, largely aided by a benign credit cycle and a blue-sky environment. However, this is not sustainable," said Krishnan ASV, senior vice-president, institutional research, HDFC Securities.

A U-turn in the credit cycle will impact all banks, but there are company specific factors as well, which investors should take a note of. SBI has more elbow room than large private sector lenders, given its relatively better loan-to-deposit ratio, according to Krishan. Thus, SBI can enjoy the benefit of cheaper funds a little longer. Nonetheless, investors would do well not to extrapolate the Q2FY23 earnings performance. “Upgrades for FY23 have happened for SBI, but don’t overlook these risks. Once they begin playing out, the scope for incremental earnings revisions for FY24/FY25 is negligible," he said.

For BoB, the Q2 earnings beat came as a shot in the arm for its valuations. “Until Friday, SBI was trading at FY24 price-to-book of 1 time and BoB was at 0.7 times. After Monday’s rally in BoB, the valuation gap between BoB and SBI has narrowed," said Abhinesh Vijayaraj, director, equity research, Spark Capital Advisors (India).

Even so, BoB’s Q2 had some dampeners such as the rising share of the low-margin accretive overseas loan book and moderation in the CASA ratio. BoB’s return on asset (RoA) hit a multi-quarter high of 1.01% in Q2, but that may not hold for long.

“With impending wage hikes and some normalisation of credit costs, RoA over the medium to long term can be around 90-100 bps in our view and we don’t see a possibility of RoA structurally normalising above 100 bps," said analysts at Macquarie Capital Securities (India). One basis point is 0.01%. Further, analysts at Macquarie believe that BoB still carries the risks of being an acquirer of weaker public sector banks over the medium-term.

Meanwhile, so far in CY22, shares of SBI and BoB have significantly beaten Nifty Bank, rising by 33.4% and 93.2%, respectively. “SBI is the sector leader. The improvements/positives seen in SBI reflect with a lag of 12-24 months in other PSU banks. The sharp rally in BoB seen in recent months is a reflection of that and also signals that BoB is fast catching-up. That said, we believe SBI is likely to command a premium valuation over other PSU banks," Vijayaraj said.

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