Morgan Stanley on Wednesday said the potential impact of Expected Credit Loss (ECL) guidelines on its covered PSU banking universe could range from 1 per cent to 2.5 per cent of loans. The brokerage said it has become more selective on state-run banks and downgraded Punjab National Bank (PNB) to underweight. It prefers Bank of Baroda (BOB), Bank of India (BOI) and State Bank of India (SBI) with better balance sheets over Canara Bank and PNB.
The brokerage said the three bank may have greater upside on a relative basis.
"We get more selective on SoE banks after strong performance over the past month and likely peaking of rates: Banks that face greater impact from ECL norms are likely to see a delay in the re-rating cycle, even as earnings estimate upgrades are set to continue," it said in a note.
Morgan Stanley has downgraded PNB to underweight from equal weight. It noted that the stock is up 56 per cent over the past year relative to 25 per cent for the BSE Bankex and 13 per cent for the Sensex.
"We believe the potential impact from ECL provisioning will be relatively higher for the bank and this will weigh negatively on the stock, hence our downgrade to Underweight," it said.
For PNB, it cited relatively lower coverage ratios, relatively higher gross and net NPL formation and credit costs historically, and relatively lower capital ratios. BOI, it said, has a weak asset quality track record like PNB and Canara Bank, but better capital and coverage provide some relative comfort.
"BOB has good capital and coverage, plus a better asset quality track record compared to BOI, PNB, and Canara Bank," Morgan Stanley said.
The foreign brokerage said SBI has relatively lower capital, but better coverage and asset quality track record. Moreover, its share of retail loans has increased where asset quality performance has been better, it said.
Morgan Stanley expects consensus earnings estimate upgrades to continue and said banks will go through a benign credit cycle; NPL formation is running below normalised levels, it noted. It prefers BOB, BOI and SBI over Canara and PNB to play this theme.
"We expect banks with better balance sheets to see further increases in valuation premium within SoE banks as the concerns around ECL sustains. As the cycle remains benign, they should be able to build more buffers and see lower dilution over the cycle. Further, these banks trade at better valuations and hence the potential dilution from any capital raise will be lower. Our UWs have low absolute downside, reflecting that the benign credit cycle should support earnings and valuations," it said.
Meanwhile, its key picks in Indian banks are ICICI Bank and Axis Bank where the potential ECL deficit, adjusted for contingency provisions, is likely to be negligible. In fact, they could still do a write-backs, Morgan Stanley said.
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