PSU BANK STOCKS

PSU Bank stocks are starting to look somewhat like the Indian cricket team after they ran into Mendis in the Asia Cup. Battered and bruised. But these stocks, currently out of favour could provide a mix of steady income and capital growth to investors' portfolios. Let's look at some reasons as to why PSU Banks are now discarded by the public.

1. It is felt that PSU Banks' profit margins would be eroded due to mark to market losses on their treasury holdings. While this is true, banks generally hold these bonds to their maturity. So while mark to market losses could dent their margins in the short run, these would provide above normal profits when interest rates cool off. Even if interest rates do not ease, these bonds would continue to provide interest at the coupon rates and on maturity the entire principal would be received by the bank.
2. Due to rising interest rates demand for loans would decrease. Again PSU banks are not aggressive in their approach to giving out loans to people. In fact this conservatism was said to be one of their drawbacks when the going was good. With the current scenario, where private sector banks are being downgraded because of NPA fears, PSU banks are relatively well insulated from NPA'. Though demand growth may slow down somewhat, PSU banks are well equipped to handle this because of their diverse clientele and their reach in rural areas. Since it is expected that agricultural growth will be better this year, PSU banks are well poised to capture a part of this growth to make up for demand slowdown from cities and corporate.
3. Rising interest rates would put margins under pressure, because of higher cost of funds. This would also work to the advantage of PSU banks because of their larger base of CASA (Current And Savings Accounts) deposits. Here banks have access to a large pool of funds at extremely cheap rates. This would partly offset the higher cost of funds, at which they borrow for term deposits and other longer term borrowings.

Now for some reasons, as to why PSU banks are excellent investment candidates at current levels.

1. Most of these banks are available at or below their book value. These businesses are not going to disappear from the Indian markets in a hurry. Then why give them such abysmally low valuations? Most of them own huge pieces of real estate, in prime locations. These are generally being carried on the books of the banks at cost price. So, if the treasury holdings of banks are marked to market, then the real estate should also reflect current market prices. If this is done then the disparity between book value and market price could widen further.
2. The current dividend yield on PSU bank stocks works out to anywhere between 4 to 6%. This is one category which offers the highest dividend amongst all the available sectors in India. Although, if profits decrease, the banks might lower dividends, but in the longer term they have a history of paying out a large portion of their profits in the form of dividends. So eventually the dividend payouts ought to revert to their mean. In fact the high dividend yields give investors some kind of protection against further sharp downsides in stock prices.
3. Most banks have modernised their operations, downsized excess staff and improved service levels. Gone are the days when they operated from dingy branches with grumpy clerks. The PSU banks of now are the match of their private counterparts in terms of ambience and ease of banking. Not only that, they also have a human interface for customers who are not comfortable with handling computers and ATM', unlike private banks.
4. PSU banks are being discounted at 4 to 5 times past year' earnings. Although earnings are expected to come down in the current year, as discussed above, this is likely to be a temporary phenomenon. Since markets have a tendency to discount the future by about 6 months, the stock prices of these banks could rise well before interest rates start easing.

Then again there are some intangible factors which work in favour of PSU banks. Customer loyalty is one of them. Then the low cost of operating accounts unlike private banks which charge customers for every small service. According to a Assocham survey in 2006, 60 % of Indian businessmen prefer PSU banks for sourcing credit cards and 80 % of them approach PSU banks for personal and educational loans. As mentioned above their rural reach, access to cheap funds via CASA and diverse client base give PSU banks an invaluable brand equity.

Future prospects include disinvestment by the Government, which could provide a real trigger to stock prices. Consolidation among banks is likely to take place in 2009, when several PSU banks are expected to merge to acquire size and financial muscle to take on foreign banks

Risks associated with PSU banks include Government interference in the form of farm loan waivers and tendencies to favour political constituencies through banks. Inability to face competition from foreign banks, which are expected to hit Indian markets due to opening up of the banking sector in 2009 could be a negative. Even the larger PSU banks are considered miniscule when compared to their global counterparts. This lack of size could hamper the growth of these banks. Lack of autonomy in incentivising employees to improve productivity and retention of key employees could be a concern.