SBI chairman Rajnish Kumar has rolled out his plan for the next two years, through which the bank will hack through its pile of bad loans and bring in virtuous business growth (Photo: Bloomberg)
SBI chairman Rajnish Kumar has rolled out his plan for the next two years, through which the bank will hack through its pile of bad loans and bring in virtuous business growth (Photo: Bloomberg)

Investors wary of loans amid SBI’s higher valuation call

  • SBI chairman is confident of delivering a return on assets of 1% by FY21 by bringing down credit costs and focusing on borrowers who will behave
  • Uncertainty on asset quality and recoveries is deterring investors from taking a big bite of SBI

Mumbai: The country’s largest lender, State Bank of India (SBI), believes it deserves a higher valuation from investors than what is ascribed to it at present.

It has a tough fight ahead to get this love from investors, though.

Chairman Rajnish Kumar has rolled out his plan for the next two years, through which SBI will hack through its pile of bad loans and bring in virtuous business growth. Kumar is confident of delivering a return on assets of 1% by FY21 by bringing down credit costs and focusing on borrowers who will behave.

He reminded investors of the vast network of branches the bank has and its balance sheet heft that will act as a springboard for further growth. The impressive 10% jump in the stock following this presentation is proof enough that Kumar has got the attention of investors.

But investors aren’t willing to take a big bite of SBI yet and not all analysts, who have a buy rating, are jacking up their target prices. Here is the single overwhelming reason for it: uncertainty on asset quality and recoveries.

Analysts at Morgan Stanley sum it up thus in their note: “In our view, NPL (non-performing loan) formation will remain high unless the economy rebounds sharply. Coupled with the continued struggle for banks to recover old bad loans, this implies that credit costs stay high. The other risk with SBI, being the largest state-owned bank, is that it is asked to help stressed borrowers."

Kumar’s targets depend heavily on how quickly insolvency cases get resolved and how fast new stress can be stemmed.

For SBI, 272 such cases are grinding in courts at present, and the most high-profile of them, Essar Steel, has been dragging on for quite sometime. Kumar has been running after his cheque from Essar Steel, only to see it fly from one date to another. The delays are not giving investors much hope.

Another factor key for SBI to meet its targets is how quickly its peers agree on resolution plans through inter-creditor agreements. Already, one case involving a power company has failed in the past.

To its credit, SBI has taken a conservative approach in setting targets. For instance, Kumar has warned that credit costs could go up to 2% if stress escalates and if SBI’s exposure to troubled Dewan Housing Finance Corp. Ltd decays even further.

Of course, no bank draws up targets without increasing the probability of meeting them. In that, SBI is clearly doing its bit. Its provision coverage ratio is 81%, the highest among banks. Considering its size, insurance is critical. That said, the coverage ratio draws strength from loans worth 1.04 trillion that have been written off.

Analysts at Jefferies India Pvt. Ltd noted that the bank is battling 650 overdue accounts through its stressed asset resolution department accounting for nearly 2 trillion.

But it would be unfair to ignore the big benefits of size. A 12% loan growth target on an asset size of 30 trillion is no chump change. Indeed, faster loan growth will not only bring income, but also tamp down on toxic loan ratios.

Then there are the more valuable subsidiaries that ride on SBI’s vast network. “SBI has a huge opportunity to leverage its huge existing customer base of 438 million customers to cross-sell its retail assets products (especially in life and card where only 3.6 million and 3.3 million, respectively, are SBI customers)," said analysts at JM Financial Institutional Securities Ltd.

SBI group’s life insurance arm has shown strong profitability over the past quarters with a promise of more. “Furthermore, expected IPOs (initial public offerings) in a couple of subsidiaries could unlock value like in the case of the life insurance business; hence, we remain bullish on the increasing subsidiary value contribution in our SOP (sum of parts)," wrote analysts at Nomura Securities.

SBI’s pitch for more premium is well founded. As proof of the pudding is in the eating, investors would wait for recoveries to materialize before bingeing on SBI shares.

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