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In Part-I, I shared my preliminary analysis of PSU banks loan book. Even if the PSU banks overcome the bad assets and recapitalization woes, its future growth potential appears less than optimistic due to the recent advances in the technological innovation around banking industry.

Broadly there are 3 vital pillars in managing financial services and each of them undergoing profound changes:

  1. Facilitating Transactions – Fintech companies will make this vertical more and more commoditized. Most manpower in PSU banks are dedicated to this vertical whose relevance will wane in future.
  2. Pricing ‘risk’ – Fintech companies are trying to break open this vertical with models, artificial intelligence, data analytics etc. However, we all know what happened last time when financial world used models to price the risk [Hello 2008 :-)]. They have to undergo atleast one financial cycle to prove its worth. Local knowledge and real world judgement on pricing the risk will still be crucial.
  3. Workforce skill-set – Managing human resource, providing training in evolving technologies to improve customer service and to manage risk are very important. This is an area where large private sector banks has an definitive edge over PSU banks and even some of the smaller old-age private sector banks.

Private sector banks: 

Lets first look at the loan books of private sector banks and weed out poorly-managed banks to arrive at the shortlist for further analysis. As i said in part-I, I considered Net NPA’s and restructured standard assets net of provision as bad assets. 

Larger Private banks:

Large Pvt - NW and Bad assets


Screen Shot 2016-01-17 at 4.26.02 AM
We can clearly see why HDFC bank always trades at premium. It has got ultra-clean loan book with paltry bad assets. Bad assets of ICICI and Axis bank constitutes approximately 25% of its Net Worth. Quality difference in the loan book between HDFC bank and ICICI & Axis is clearly visible.

Smaller private banks:

Small Pvt - NW and Bad assets

Small pvt - bad assets to advances

Small pvt banks - NW to bad assets[Note: For example, in the case of Federal Bank, bad assets constitutes 42% of its entire Net Worth].

Debacle of Dhanlaxmi bank is well-known and hence lets exclude it. Except, City Union bank and DCB bank most of them are afflicted with bad loans problem. Barring these exceptions, bad assets constitutes 6-8% of the bank’s loan advances. It will hobble them for a while and higher than usual equity dilution can’t be ruled out.

Key points from long-term investing perspective:

  1. Better not to look at the PSU banks further, except SBI. In addition, probably SBI is the only PSU bank that has strong presence in asset management, insurance and investment banking vertical. Added it to watchlist.
  2. Among larger private sector banks, HDFC, Kotak, IndusInd, Yes bank needs to be delved deeply.
  3. Although Axis and ICICI bank are hobbled by bad assets, they have excellent retail banking franchise. Added both of them to watchlist – will closely monitor developments on asset quality front.
  4. Given the huge potential of financial sector in India, couple of smaller private banks may break out from the pack. DCB and City union bank needs to be analyzed further.

I attached private sector bank’s data excel sheet. Feel free to download and play with the numbers. Let me know if you come across any mistakes or interesting observations [Note: All the numbers are collected from individual bank’s FY 2015 annual report. I used only standalone numbers for comparable purpose. For Kotak-ING combined, i took FY’15 Kotak bank standalone + FY’15 Kotak Mahindra Prime subsidiary (which does car financing) +  FY’14 ING Vysa (FY’15 annual report is not available due to merger)].

Looking forward to your thoughts. Cheers 🙂