Be smart with banking funds

For an understanding of the bifurcated nature of the funds in the “Equity: Banking” category, take a look at the 1-year returns generated by Kotak PSU Bank ETF and ICICI Prudential Banking and Financial Services.

With ICICI Prudential Banking and Financial Services (7%), Banking looks like a good sector to bet on. With the other (-20%), it appears appalling. But a closer look at the funds in this category throws up some clarity: The winners are the ones casting their lot with private banks.

Public sector banks are suffering from an NPA overdose and investors would do well to keep their distance. When State Bank of India (SBI) recently announced its quarterly results, its non-performing assets (NPAs) were 2.22% of total loans for the latest quarter, up from 1.6% a year ago. And there is no denying the fact that this is only expected to go up over the next few quarters. In fact, according to a report in the Economic Times on August 7, 2012, Reliance Communications approached SBI to restructure its short-term borrowing worth Rs 3,000 crore into long-term debt with a tenor of 3-5 years. It is not just small and medium enterprises facing the heat, even the big players are getting their debt restructured.

SBI is not a stand-alone example; all public sector banks are sailing in the same boat. And while alarm bells may not be ringing right away, it has certainly made investors uncomfortable.

Then there are the new corporate debt recast (CDR) norms issued by the Reserve Bank of India (RBI) that are projected to have a negative impact on the profitability of state-run banks. According to a report by Standard Chartered Securities, if the new CDR guidelines are followed, net profit of state-run banks will most likely decline to the tune of 6-18%.  The impact on private sector banks will be in the 0.2-2% range.

Does that mean Banking should be avoided from an investor’s point of view? No. It means certain banks should be.

Franklin India Bluechip, has a 24% exposure to Banking with almost the entire exposure to private banks. Portfolio manager Anand Radhakrishnan explains: “At this juncture, systemic risks on restructured loans/NPA are largely concentrated in capital-intensive sectors of the economy. At the retail level, we are not seeing the kind of stress that is being witnessed within these segments at the corporate level. Private sector banks’ relatively higher exposure to the retail space therefore has them well-placed vis-à-vis public sector banks. In some private banks, there may be stress on the asset quality front but it is not structural in nature.”

A number of the NPAs faced by PSU banks are structural in nature. An unviable project cannot become viable if it is structurally in bad shape. But an NPA caused because of the cyclical nature of an industry (such as automobile lending) will not be taboo. And that is the predominant difference between NPAs of the public and private sector banks.