In a recent analysis of the banking industry, InCred Equities has forecasted a potential decline in profitability for public sector banks (PSBs) as we enter a new cycle of interest rate cuts. This anticipated shift is largely attributed to increasing pressure on margins and a downturn in non-core income. Despite these challenges, the brokerage has highlighted Punjab National Bank (PNB) and Canara Bank (CBK) as top picks within the PSB sector due to their solid liquidity positions and attractive valuations.

Public Sector Banks Under Pressure

InCred’s report indicates that PSBs may experience a structural margin reduction of 5 to 10 basis points even by the end of FY27, particularly in light of a potential 50 basis point cut in the repo rate. For FY26, the brokerage anticipates margin compression of 15 to 20 basis points. A significant factor contributing to this outlook is the limited repricing ability of savings account deposits, which make up about 30% of interest-earning assets for PSBs.

• Key Insights:
  • Limited downward repricing potential for savings accounts.
  • Heightened competition affecting MCLR cut benefits.
  • Need for banks to enhance loan-to-deposit ratios and increase high-yield asset shares.

Favorable Picks: PNB and Canara Bank

Among the state-owned banks, InCred has voiced a preference for PNB and Canara Bank, assigning an ‘ADD’ rating to both. The brokerage appreciates their robust balance sheet liquidity and lower expected credit costs. Notably, PNB could see gains from recovering written-off accounts and potential advantages from tax rate adjustments. Canara Bank, on the other hand, is noted for its declining credit costs and favorable valuation metrics.

Conservative Stance on Other PSBs

InCred has taken a more cautious approach to other state-run banks, maintaining a ‘HOLD’ rating on State Bank of India (SBI), Bank of Baroda (BoB), and Bank of India (BoI). While recognizing SBI and BoB as strong entities, the brokerage points out that their current valuations limit further upside potential. BoI faces challenges due to low liquidity and weak profitability, which has influenced InCred’s conservative outlook.

The Future of PSB Valuations

Reflecting on the PSB stock rally between March 2021 and July 2024, InCred notes that this surge was driven by improved stressed loan coverage, reduced credit costs, and effective liquidity management. During this period, PSB valuations saw a substantial increase from 0.6x to 1.3x forward price-to-book (P/B) ratios. However, the firm warns that such a positive trend may not be sustainable moving forward, as PSB stocks have seen a nearly 15% decline over the past six months.

• Future Considerations:
  • Future rerating of PSB stocks will depend on volume growth and margin trends.
  • As of Q3FY25, PSBs reported a healthy 14% year-on-year credit growth, but sustaining this growth hinges on effective deposit mobilization and liquidity management.

Conclusion: A Preference for Private Sector Banks

In summary, InCred Equities has expressed a clear preference for private sector banks, highlighting their stronger liability franchises, better growth dynamics, and favorable valuations. While PNB and Canara Bank emerge as strategic choices within the PSB landscape, the overall state-owned banking sector faces significant hurdles in maintaining profitability amidst an evolving rate cut cycle. InCred has also begun formal coverage of BoB, BoI, CBK, and PNB, signaling a comprehensive approach to analyzing the banking market.

For those interested in the banking sector, it’s crucial to stay informed about these trends as they will significantly influence investment strategies and market dynamics.