SBI Or HDFC Bank? Time To Switch To Public Sector Undertakings (PSUs)?

Can the stock of SBI continue to outperform HDFC Bank?

SBI Or HDFC Bank? Time To Switch To Public Sector Undertakings (PSUs)?

Public sector banks in India have suffered poor valuations for decades.

Has A Bank Ever Told You Its Deposits are Riskier than Stocks?

These Should Have...

I shared this bold warning with Equitymaster readers in 2018.

I was concerned that banks in India, particularly public sector ones, weren't being completely honest.

This was a time when they had steep non-performing loans. Yet, the banks gave no warnings to their depositors. Depositors were unaware that more than half the public sector banks did not have the capital to redeem deposits.

Believe it or not, the losses of these banks were several times the value of the deposits they owed back then. And if they had to shut down, they couldn't repay depositors.

But then, as is always the case with PSUs, the government came to their rescue.

Armed with emergency capital infusions from the government, the banks managed to honour deposits. This certainly did not mean better quality lending or higher provisions.

So, left on their own, the PSU banks might have had to mark down the value of deposits by 90-100%. But with the bailout neither the banks not depositors suffered. Only the taxpayers and shareholders did.

The PSU banking stocks languished for years and traded at steep discount to private sector peers.

Public sector banks in India have suffered poor valuations for decades. At the turn of every economic cycle, these entities are forced to lend vigorously. They even lend to corporates with poor balance sheets.

As a result, a fresh wave of NPA clouds the profits of these entities every few years.

On the other hand, private sector lender HDFC Bank is among a long-term investor favourite stocks.

The consistency in the lending quality, the NPA provisions and profit growth has always kept the bank ahead of the pack in valuations. When compared to even larger peers like State Bank of India (SBI), HDFC Bank's valuations are, on average, at least 3 to 4 times higher.

Of course, banking stocks globally are subject to pessimism from time to time. As I write this, pessimism about China's banking sector has reached an unprecedented level. Their valuations are even approaching the depths of US banks during the 2008 financial crisis.

China's four biggest banks, including Industrial & Commercial Bank of China are currently priced at near record low valuations (about 0.4 times book value). This depressed level roughly matches where investors priced JPMorgan and Bank of America during the depths of the 2008 crisis.

The constant Covid-lockdowns, departure of businesses from Chinese shores and exit of foreign investors have taken a toll. Only a sharp economic revival can turn the fortunes of the Chinese banks like they did for the American ones.

PSU banks in India, on the other hand, are all geared up to lend more. The third quarter of 2022 saw them grow their loan book at 18% per annum, one of the highest in decades. With lots of capex coming on stream, the banks have mandate to offer the necessary capital.

Moreover, nearly 60% of the deposits are low-cost CASA (current and savings accounts). So, with bulk of rural and semi urban deposits, PSU banks, especially SBI, have a clear cost advantage over private sector peers.

So, is this the best time to switch from private sector to PSU banks?

Would it be better to ditch the likes of HDFC Bank in favour of SBI, that can without doubt reap the benefit of India's economic revival?

Can the stock of SBI, which has gained 253% since 2020, continue to outperform HDFC Bank (up 53% since 2020)?

Well, SBI and its PSU peers are currently not as much at peril as they were in 2018. And their potential to keep lending at healthy rates is real.

However, it would be foolish to assume that the government will keep perpetually bailing out the banks every few years. Or that the NPAs will be soon forgotten.

So, do not make the decision to switch, from say HDFC Bank to SBI, based on the stocks' performance in recent months.

Rather take a closer look at the capital adequacy, quality of lending, and return ratios.

Even the private sector has several banks that have potential for significant upside. Do not ignore them just because PSU stocks are going up.

(Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.)

Featured Video Of The Day

NDTV Ground Report: What's In Store For Farmers This Budget
.