Stock Fundamentals

Slipping on bad loans

Radhika Merwin | Updated on January 23, 2018 Published on May 17, 2015

Rising NPAs and restructured assets have eaten into the bank’s earnings



With markets cooling off and corporate earnings dodgy, it may be time to take stock of your portfolio and exit stocks that are likely to see more earnings pressure. Banking stocks, in particular, had an excellent run from the start of 2014 until the new government’s maiden Budget in July that year.

But the optimism in public sector banks soon fizzled out as the poor financial performance returned to haunt stock prices.

A case in point is Punjab National Bank. The stock rallied 45 per cent from the beginning of 2014 till last July, but then lost steam. The bank’s increasing pile of bad loans and restructured assets have eaten into its earnings.

The stock now trades at 0.7 times its one-year forward book, which may appear cheap when compared with private banks that trade at four-five times PNB’s valuation.

But the discount is perfectly justified. PNB’s non-performing assets (NPAs) and restructured book have gone up significantly in the past few quarters. Accounting for this, the stock trades at 1.2 times its one-year forward adjusted book, which is its long-term historic average.

Given that PNB’s stressed assets are now about 16 per cent of loans, one of the highest among public sector banks, risks to earnings remain high and the book could erode higher provisioning for bad loans.

Investors can book profits at current levels.

Challenging year

PNB’s latest March quarter results highlighted the bank’s weak core performance and deteriorating asset quality. The bank’s net profit declined 62 per cent during the March quarter over the year ago period despite a tax write-back of ₹938 crore.

For the full year 2014-15, the bank’s net profit is down 8 per cent on the back of 76 per cent increase in provisioning for bad loans. If not for the strong growth of 86 per cent in treasury gains, the fall in earnings would have been much steeper.

The bank’s core net interest income grew just 2 per cent in 2014-15 due to muted credit offtake and a 30-basis-point fall in net interest margin (NIM).

The domestic loan book grew about 6 per cent over last year, far lower than the already sombre 10 per cent industry growth.

While the high-yielding retail loan book fared better, growing at 24 per cent, it constitutes only 14 per cent of total loans, and has not helped margins.

Causes for concern

About 44 per cent of PNB’s loans is from the large and mid-corporate segment.

Of the total restructured assets, 41 per cent is in the infrastructure space, and 15 per cent in iron and steel.

The gross NPAs have gone up sharply from 5.97 per cent of loans during the December quarter to 6.55 per cent in the March quarter (5.25 per cent in March 2014).

Aside from bad loans, the bank’s restructured loans, or loans which can slip into the NPA category, are also a cause for concern. Restructured loans are about 10 per cent of loans.

Asset quality for the bank depends a lot on the pace of revival in the infrastructure, mining and power sectors.

PNB’s return on assets has slipped to 0.2 per cent during the March quarter.

Given its high leverage (the ratio of assets to net worth) of about 15 per cent, the bank has not generated commensurate returns for shareholders.

The return on equity fell to 3 per cent during the March quarter. The bank’s Tier I capital has gone up from 8.5 per cent in the December 2014 quarter to 9.3 per cent in the March quarter, thanks to the capital infusion of ₹870 crore by the government and the bank raising ₹1,500 crore through issue of Basel-III compliant additional Tier 1 bonds.

Given that the government has adopted a new criterion by which only banks that are more efficient would be rewarded with additional capital, the bank’s performance needs to be watched closely.

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