Private banks, once considered growth engines across various metrics including loans, revenues, profits, and book value per share (BVPS), are now labelled as “ex-growth”, according to a new Emkay report.
“Our Gordon Growth model analysis indicates that the intrinsic multiples for private banks have collapsed by 4-63% over the last 10 years. Lower growth and moderating ROEs have depressed fair values, and we find that the near-halving of multiples for some leading banks (HDFCB, KMB, IIB), is supported by the deterioration of underlying fundamentals. Historical P/BV ranges for private banks now have little predictive value. The derating should continue, in our view, and the valuation ranges for private banks would now settle at 1.5-1.7x (P/BV) with further time correction,” its Waiting for Godot – The Elusive Turnaround report said.
The transformation
Several factors contribute to this transformation. Firstly, extreme risk aversion among both corporate borrowers and lenders has dampened demand for wholesale loans, a trend exacerbated by the aftermath of the credit cycle between 2015 and 2020. Additionally, corporates are increasingly turning to the bond market, leading to disintermediation and further reducing lending opportunities for private banks.
The competition landscape has also evolved, with public sector banks (PSUs) becoming more competitive post-Covid, eroding the easy market share gains traditionally enjoyed by private banks. Cyclical factors such as liquidity constraints and concerns over retail asset quality further compound the challenges faced by private lenders.
For PSU banks the trade has largely played out. At 1-1.2x PBV, there is limited rerating scope as growth tapers and ROEs are at risk from capital raising, it said, adding that there are attractive bottom-up opportunities but no compelling top-down case. We have no clear preference between private banks and PSUs.
Regulatory pressures
Regulatory pressures add another layer of complexity. The Reserve Bank of India (RBI) has intensified scrutiny on lenders in recent months to curb retail credit build-up and address challenges arising from the rapid growth of digital payments. While this move is viewed positively from a systemic stability standpoint, it poses challenges for banks, including slower growth in profitable segments like unsecured retail and increased investments in technology.
The shrinking fair value of private banks underscores the broader trend. Intrinsic multiples have declined significantly over the past decade due to lower growth and moderating returns on equity (ROEs). Historical price-to-book value (P/BV) ranges for private banks now provide little predictive value, with a further derating and a settlement of valuation ranges at 1.5-1.7x P/BV with time correction.
In response to these shifts, Emkay advocates for a bottom-up, absolute-return approach for stock picking among lenders, focusing on intrinsic value mismatch, turnarounds, and earnings momentum. They advise against relying on historical valuation metrics and benchmark weights, instead emphasising the importance of large, liquid names in the portfolio.
As part of these strategic adjustments, the weightage of financials in the model portfolio has been reduced to 15% from 30%, with significant cuts in index heavyweights such as HDFC Bank, ICICI Bank, and State Bank of India (SBI). AXSB has been added to the portfolio, with the redistributed weightage across other sectors.
