After big bang PSU banks merger, what should investors do and which stocks to buy?

The government is taking steps to accelerate the pace of reforms in August to address the slowdown in the economy. The highlight, of late being, the long-awaited decision of merger of PSU banks taken by Finance Minister Nirmala Sitharaman on August 30.

This follows the successful merger of Vijaya Bank and Dena Bank with Bank of Baroda and five associate banks with State Bank of India in the past two years.

As many as 10 banks have been merged into a pack of 4 now which has brought down the total count of PSU banks to 12 from 27 two years ago, 8 of whom will be large banks with national presence, while 4 banks will have regional focus.

In addition, the government also announced capital infusion of Rs 55,250 crore for 10 banks including the newly merged four banks, which is 79 percent of total budgetary allocation of Rs 70,000 crore for FY20.

The intention behind this merger is to increase productivity, reduce asset quality pressure, improve credit flow, operating efficiency and corporate governance, make maximum use of technology and make PSU banks stronger etc. The effective date of this merger is likely to be April 1, 2020.

Experts believe it is definitely a good step towards growth, but most of them are not convinced enough to invest in PSU banks and they still favour private banks barring a few banks among PSUs.

SBI, the country’s largest lender, is most experts’ choice but among these new banks, they advise to remain selective till the current dust settles in terms of asset quality and feel it is a long way to go.

“This is a positive step forward for the long-term growth as it reduces the inefficient capital use that is provided every year by the government. This will reduce operating expenses along with increase the efficiency per employee over the longer term,” said Sameer Kalra, Founder & President (Research) at Target Investing who has a buy rating on Canara Bank (merged).

Kalra has a sell rating for other flagship merged banks as in short term he believes there will be a negative impact on the flagship-merged banks due to the recognition of higher provisions needed to address the asset quality of the banks being merged with.

It will impact the credit cost and lead to a reduction of NIMs that is already facing pressure due to two reasons: the rate cut benefit which needs to be passed on to the customer and the increased stress from Agri & SME clients, he said.

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Hemali Dhame, Research Analyst at Dolat Capital feels the merger bringing together Punjab National Bank, OBC and United Bank is hugely positive for PNB. Hence it has upgraded its rating on PNB to Buy.

“It improves PNB’s capital position materially even before the capital infusion. OBC and United are on a relatively stronger footing on asset quality and capital in comparison to PNB. We change our view on PNB and increase our target to Rs 80. With an upside of 23 percent, we upgrade PNB to a buy. It is currently trading at 0.7x FY21E P/ABV,” she explained.

Canara Bank + Syndicate Bank is likely to be one of the most comfortable mergers, largely as the presence of both the banks in the same state, and Syndicate Bank has relatively benefitted from this merger, she said, adding Union Bank is the clear winner in the merger of Andhra Bank and Corporation Bank as three banks are very similar in its deposit and advance mix.

Dhame is not convinced with Indian Bank and Allahabad Bank merger as synergy is likely to be tedious due to varied cultures.

Abhimanyu Sofat, Head of Research at IIFL Securities also said that the merger of relatively better run Indian Bank with Allahabad Bank is disappointing. It may be lack of appetite for some of the weak banks that they were left out of this merger exercise, he added.

He cited the example of the earlier merger of Bank of Baroda. “Except for growth on CASA, and reduction in cost to income ratio, the previous merger of Bank of Baroda with Vijaya Bank and Dena Bank did not get appreciated by the market. We have not seen any significant fall in the credit cost leading to continued pressure on the stock price of Bank of Baroda,” he explained.

Bank of Baroda shares fell more than 30 percent in last three months against 10 percent fall in Nifty PSU Bank index.

But considering that still three fourth of saving accounts are with PSBs and that there could be significant cost savings, he sees this merger exercise to be positive for the sector on a long-term perspective. Immediate release of funds for growth will ensure improvement in loan growth for the banks, he said.

Mustafa Nadeem, CEO, Epic Research also said since the merger has been announced and synergy that will be created, it should result positively for investors in the longer term. The investors in these stocks should rather extend the time horizon in these stocks, he advised.

He feels these measures are focused on a few important things. “First, it is the growth that is majorly outlined by the FM. Second, this consolidation is to scale up the potential of PSU banks and this consolidation should result in inorganic growth that was need of the hour for the PSU banks space. Thirdly, technological advancement is sought to improve as the appointment of the executive director that is done now is focussed on the same,” he explained.

Nadeem is upbeat on the private space for a long time but feels PSBs still have a long way to transform themselves to be competitive to private space.

Mona Khetan, Banking Analyst at Reliance Securities said a big positive from the FM’s address was the recruitment of Chief Risk Officer (CRO) from the market at market-linked compensation for PSBs, which could improve the underwriting standards at these banks, a long-time concern.

“On valuations, given their weak return on assets and interim profitability pressure, we do not expect a significant catch up unless one sees a sharp improvement in risk practices,” she added.

Deepak Jasani, Head of Retail Research at HDFC Securities said more work needs to be done on changing the compensation structure, work culture and governance.

Tough calls should be taken to ensure cost rationalisation/reductions and operational efficiencies/synergies assumed for the consolidation.

“While the usefulness of a common technology platform as a starting point for consolidation cannot be disputed with, more work will be required to bridge geographical gaps / close overlapping branches and overcome cultural differences. All these will help PSU banks to compete effectively against the Private Banks and SFBs in creating a robust profitable credit book and building up fee businesses,” he added.

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Author: Ayaan