PNB: Hold

M.V. S. Santosh Kumar

Shareholders of Punjab National Bank (PNB) can stay invested in the stock. Though the stock trades at an attractive valuation, it may under-perform in the near term, given the uncertain interest rate scenario. The current macro environment is not favourable for the banking sector and is making investors wary of the stocks, though they trade at attractive valuations.

At the current market price of Rs 480, PNB trades at 7.3 times its FY-08 earnings and about 1.3 times its latest (June 2008) book value. The current price is also 5.8 times the estimated FY-10 earnings and almost the same as the estimated book value

In the current market of rising interest rates and cost of funds, PNB is better-placed among the public sector banks to deliver reasonable growth, with higher net interest margin (3.23 per cent), high proportion of low-cost current account and savings account CASA (41 per cent) and low exposure to retail loans (a slowing segment). The risk of mark-to-market losses on its bond portfolio is also low due to a smaller proportion of loans in the AFS (available for sale) category.

Business and financials

PNB, the third largest bank in terms of balance-sheet size, is Basel II-compliant, in line with the RBI’s deadline of March 31, 2008 for banks with an international presence. PNB has made the necessary provisions for the risks. Ninety one per cent of its branches are core banking-enabled. With most of its business concentrated in the high-yielding northern States of Punjab, Haryana, Uttar Pradesh, and Delhi, any hike in lending rates may be absorbed without a significant slowdown in growth.

PNB is also well-placed in terms of AS-15 retired employee provisions (AS-15 is the additional provision that the bank is required to make for the retirement benefits of its employees; this will either be made in a phased manner or a one-time provision can be set aside). PNB made a one-time provision last year which helped it take lower provisions this quarter, even as other banks have spread these provisions over a period of five years.

The bank’s net profit rose 20.5 per cent year-on-year in the June quarter, helped mainly by lower provisioning; there was no major increase in the operating income (decrease in treasury profits hit operating income).

Expenses have risen in line with the increased cost of funds, which stood at 5.26 per cent (4.78 per cent in June 2007 quarter). The proportion of CASA has also come down from 43 to 41 per cent and is expected to moderate further in coming quarters. Deposits in the same period grew 21.3 per cent.

Contrary to the broader trend, the bank’s NPAs for the quarter have fallen because of write-backs taken on reimbursements for the farm loan waiver and provisions towards AS-15.

The bank’s gross NPA-to-gross advances is still high at 2.86 per cent, but NPA provision coverage of 78 per cent may make PNB less vulnerable to deterioration in this ratio.

The bank’s advances grew 20 per cent year-on-year, though the debt waiver reduced advances growth on a sequential basis. A lower proportion of retail loans (16.5 per cent) may lead to better asset quality for PNB, but SME loan (7 per cent in June quarter) delinquencies could offset these benefits. The net interest margin was under pressure (apart from cost of funds) because of a 50 basis point reduction in the lending rate in February, higher CRR requirements and a trend of depositors shifting from low-cost to term deposits. The recent hike of 1.50 percentage points in months of July and August in the bank’s PLR may help stabilise NIMs in the months ahead.

PNB has managed to contain the impact by reducing the proportion of securities held in the AFS category. Last year, it transferred Rs 5,331 crore to the held-to-maturity (HTM) category, resulting in a lower mark-to-market loss (Rs 151 crore) on its trading portfolio this quarter.

The bank has also transferred Rs 2,105 crore to the HTM category in the June quarter. Ninety per cent of the total Government Securities are in the HTM category.

Outlook and Risk

Interest rates are expected to decline in the next six-eight months as the measures taken by the RBI might bring down inflation, there might be better crop productivity, global prices may cool off and aggregate demand might moderate but if the high interest scenario still prevails (due to inflation remaining persistently high), there is a risk of further tightening in policy rates. PSU bank stocks, in particular, may be more impacted by the rate environment, due to the ability of the government to exert moral pressure on lending rates.

With the government shareholding in PNB standing at 57.8 per cent, there is sufficient room to raise further capital, though capital adequacy is now at a comfortable 12.96 per cent (Basel-II). PNB’s debt waiver write-backs may have to be reversed next quarter, consequent to the RBI guidelines suggesting that banks can write-back only after the amount is received from the government. Banks might get interest payment on the debtwaiver. PNB targets 18-20 per cent growth in various areas which it can achieve if it increases its non-interest income (the bank is planning to enter merchant banking business) and focus on areas such as SMEs, agriculture and financial inclusion. The bank’s international presence will help boost its profitability and is a positive upside for the bank.

The IPO of UTI AMC (this has recently been put off) and the sale of the bank’s stake in PNB Gilts, have the potential to generate one-time gains for the bank, should they materialise. Recent JV with IL&FS for industrial infrastructure financing may also add to the already diversified loan book.