Banks - Bonds have larger impact on MCap than NPLs - Avendus

The turmoil in the bond market has had a far larger impact on new banks. The six weeks after mid-Jul13 saw MCap of new banks fall by up to 11x the erosion in bond values compared with only 1.0x to 1.1x erosion in MCap of PSU banks. The recovery in bond values has seen MCap of new banks recover much more of the lost ground. In the near term, bond yields may have the stronger influence on bank valuations, relative to asset quality. Outperformance by new banks may extend if yields revert quickly to 'normal' levels. We expect larger returns from PSU banks over the next 12 months. The recent downgrades to FY14f earnings reflect the risks from a rise in stressed assets, and others. Our top picks are AXSB among new banks, and BOB and PNB among PSUs. Key risk to valuations remains a prolonged high-interest rate regime.

Yield volatility has larger impact on new banks than PSU banks

The spike in GOI bond yields after 12Jul had a disproportionate impact on new banks with the erosion in their market capitalisation being c6x-c11x the estimated erosion in the market value of their bonds. In contrast, the erosion in market capitalisation of PSU banks was close to the fall in the value of their bonds. During 1HSep13, there has been a reversal of this process with the rebound in market capitalisation of new banks between c8x and c18x the rise in their bond values.

Large downgrade in two months may have factored recent risks

The 16% cut in FY14f net profit of PSU banks since end-Jun13 nearly equals the large downgrade during the 12 months ending Sep12, led by the sharp rise in the stressed assets. While the outlook for FY14f net profit remains weak, recent downgrade may have factored the risks emanating from rise in bond yields, increased asset quality concern and the pressure on NIM due to cost of funds inching upwards. While the FY14f net profit growth forecast for new banks stay significantly higher, the trajectory has been trending down.

PSU banks resilient to adverse forces

Despite superior earnings and asset quality in the Jun13 results, new banks had a larger contraction in their valuation during the two months ending Aug13. Their P/B fell from 2.10x to 1.60x before rebounding to 1.82x on 10Sep13. However, even after large erosion in valuation and possible de-rating, new banks trade above their low in c4.5 years. The discount of PSU banks in Jul13-Aug13 increased 3% to 74% after 30Jun13 compared to 8% rise in the preceding five months.

Prefer new banks in near term; large upside for PSU's over 12-months

We prefer new banks in the near term. The trend of large absolute rebound in Mcap seen after 28Aug13 may extend. However, there may be a larger potential upside on PSU banks over the 12 months, even if we apply the depressed valuation in the last 12 months as a benchmark. Our blended TP is based on the P/E, P/B and DCF methods. We prefer AXSB among new banks, and BOB and PNB among PSU banks over the 12-months.

Source : Equity Bulls

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