Public Sector Banks

Stock Analysis & Valuation
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It is the daily news of rising PSU Banks which is giving me heartache. CNBC TV 18 said they have risen more than 40% this month.

There could be two approaches to this news. One way is to join the crowd. Many investors have, I am sure, made money in the rush. The other way is asking “Why they are sudden darlings of the investors?”

Every time I look at the financials of a PSU bank, I wonder what is in them. In many cases, their PE is more than the ROE/ROCE. Take BoB for example. The PE is 8.78, while the ROCE is 4.02%. Yet it is continuously rising. In June it was ₹96, today it is ₹166.75. Yes, its Net Profit has increased from ₹1942 cr in the June 22 ending quarter to ₹3392 cr in the Qtr ending Sept 22.

Canara Bank, another example. PE is 6.16, and the ROCE is 4.49%. To my uneducated eyes a company with that sort of ROCE would be a basket case! You don’t get even what you would get from its savings deposit. Yet, in September this year it was ₹210, today it is ₹318. In the June Qtr its Net Profit was ₹2193 cr. In the Sept '22, the Net Profit is ₹2730.

Of course the case of Book Value is different in many cases. The Book Value of Canara Bank is ₹ 386. This is higher than the price. For BoB the Book Value at ₹ 178 is again higher than the price.

But doesn’t the book value include a lot of inert assets? Or at least assets which have not been monetised. In the case of many PSUs, they have enormous land banks.

I wanted to make a point that in the case of the private banks it was different, but the statistics is again startling. The PE of ICICI Bank is 21.7. The ROCE is 5.59%. To a naked eye it seems to be doing worse than the PSU Banks. Its price by the way was ₹678 in June, and today it is ₹923.
Taking this yardstick, I should reject the ICICI Bank too.

My question then to the community is: if you do not want to blindly join the race, how do you assess stocks, specially bank stocks?

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From what little I know, banking is a complex business, and I don’t think looking at financial metrics is not the correct approach. Unlike with a lot of businesses, where we could asses the businesses by first looking at the metrics, banking should be looked at the business first. Also PE is not the default metric used while analyzing financial businesses, it is PB.

A basket approach can be followed, if one is sure about a sector’s performance. ETFs are another option.

Not invested in banks.

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Maharatna PSU company declares 30% dividend, record date falling next week.

https://www.google.com/amp/s/www.livemint.com/v/s/www.livemint.com/market/stock-market-news/maharatna-psu-company-declares-30-dividend-record-date-falling-next-week/amp-11668868506178.html%3Famp_js_v=0.1&usqp=mq331AQKKAFQArABIIACAw%253D%253D#ampf=

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With very limited knowledge I have, I feel that PE and ROCE are not right metrics to asses a bank, as a bank’s capital base is different than other companies. Even if this is wrong, it is a fact that most of the folks prefer to use ROE and PB ratio and in the end, consensus drives the stock price!

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ROA is more like it.

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Another important data point to consider would be GNPA and NNPA. What is pertinent more so is the trend of these over last 2-3 years. COVID would have resulted in a spike. A lot of them now have shown the peak NPA crisis is behind them so things should improve. Improvement in these metrics could possibly be a driver for the stock price eventually.

Metric wise, yes, RoA is useful. Also important is what leverage is bringing the bank that RoA. RoE is basically RoA * Leverage.
Bank of Baroda - RoA = 0.62%, Lev = 13.8, RoE = 9.0%
Canara Bank - RoA = 0.5%, Lev = 17.4, RoE = 9.23%

In hindsight over 1Y, stock market says BoB is better than Canara Bank as it generates higher RoA with lower leverage though RoE for Canara Bank is higher. Improving NPA numbers would bump up the RoA and in turn RoE.

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Look at this video by @Worldlywiseinvestors on what metrics to track for banking and NBFC companies.

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How do you find the leverage? Does the NPA equal leverage?

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Accordingly to me, ROCE is a useless matrix for banks. Inherently, banks are highly geared. If their RoA is better than cost of fund, after adjusting for statutory reserves, it is value accretive for shareholders. So, a better matrix to look for is RoE.

If their lending is secured / to high rated clients, there will be lower credit cost (lower provision / write off) which will help in improving PAT and thus RoE. However, this comes at cost of RoA (higher rated customers will give lower RoA).

Consequently, if banks want to earn more RoA (leading to higher NIM), they will have to tap risky customers, increasing there credit cost. In good times, such credit cost (if properly secured against assets), can help improving RoE. But in bad times, it can even lead to bankruptcy.

If their cost of borrowing is lower (e.g. CASA), they can lend at competitive rates to high rated clients and earn better NIM which will improve PAT and RoE.

If lending is spread across multiple borrowers (lower ticket size), there is less risk of asset going bad, thus lower credit cost (lower NPAs). Which is why retail lending is considered safer, compared to wholesale lending.

If lending is secured (with backing of assets), there will be lower losses in case loan goes bad. Thus supporting profitability and RoE. This is why a vehicle financing is more safer than credit card (100% unsecured).

Cost-to-income ratio also play important role, specially for growing bank / NBFC as initial set up cost (incl. fixed cost) is higher, which will generate steady income only in future.

As Warren Buffett says " Banking is good business, unless you do dumb things".

Banking is very simple (and boring). you borrowing at lower cost and lend at higher rate, thereby earning the spread (NIM in industry parlance). But greed (of banking employees) make them do dumb things (like risky lending), which back fires and hurt badly.

@meekinvestor With all due respect, I would suggest please enroll for some banking course to understand the basics. You can learn from various threads here. You can also explore Youtube.

To answer your question, leverage is found on the balance. Below is the latest BS of Canara Bank. On an equity base of Rs. 66111 cr, they have borrowing of Rs. 11,32,694 cr. i.e. leverage of 17x. Part of this borrowing is CASA which is the best form of borrowing for banks.

NPA (Non Performance Assets) are the loan given out to customer but now highly unlikely to be collected. So, as per RBI guidelines, such loans are classified as NPAs. GNPA is gross amount which is unlikely to be collected. NNPA is the net amount after adjusting for provision. A higher provision means lower net NPA (which is good), but lower profitability to show (which is bad). So, NPA pertains to asset side of BS (Asset going bad). leverage pertains to liability side.

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Thanks for the pains you have taken to educate me.

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In PSU banks, it could be compulsion more than greed.

Thanks for writing that very educative post.

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