Why PSBs still offer value

Summary: Public sector banks still trade at steep discounts to private banks, even though much of the damage from the old bad-loan crisis has been repaired. This story explores why cleaner balance sheets, improved profitability and lower concentration risk could gradually force investors to rethink how PSBs are valued.

Summary: Public sector banks still trade at steep discounts to private banks, even though much of the damage from the old bad-loan crisis has been repaired. This story explores why cleaner balance sheets, improved profitability and lower concentration risk could gradually force investors to rethink how PSBs are valued. Public sector banks (PSBs) have had a strong run. In the last three years, the Nifty PSU Bank index has doubled as investors rediscovered them after years of neglect, helped by cleaner balance sheets and stronger profits. However, even after this rally, they continue to trade at a discount to private banks. The top 10 private banks trade at a median P/E of about 17.6 times. The 12 public sector banks trade at about eight times. On price-to-book, private banks are at 1.6 times, while PSBs are close to 1 times. That discount was defensible a few years ago. PSBs were still carrying the scars of a long, bad-loan crisis. And investors, owing to the old memory, distrusted their lending discipline. But that old story now needs a second look. PSBs have repaired much of the damage. Their asset quality has improved sharply. NPAs are now broadly comparable to those of private banks. Profits have recovered, and sectoral concentration has diluted. So if the operating gap has narrowed, is the valuation gap justified? A different diagnosis of the old crisis The usual story is that PSBs lent badly and private banks were better run. There is truth in that. But it is not the full story. A paper from the Centre for Social and Economic Progress, a think tank, on the 2010s NPA crisis shows that the banking system’s gross NPA rose from 2.5 per cent in FY11 to 11.2 per cent in FY18. PSBs were hit much harder. Their gross NPA shot up to 14.6 per cent, while private banks reached only 4.7 per cent. The damage was severe. But the causes were broader than mere careless lending. Commodity prices crashed. Regulatory constraints delayed stress recognition. Public-private partnership projects, espe