My
last month's column for Wealth Insight:
While private banks are part of any investor’s portfolio, PSU banks have to remain a trading play
While private banks are part of any investor’s portfolio, PSU banks have to remain a trading play
By Anand Tandon | Nov 24, 2012
The
year 2012 has been and continues to be an election-heavy year – with 7
state assemblies completing their terms. Elections are a time when
politicians are at their “promising best” – often promising voters
rewards in the form of lower power tariffs, waiver of farm loans, and
nowadays computers, TVs and other goodies. It is common knowledge that
elections spoil rural credit culture: farmers wait for elections for
waiver of overdue credit, and are too often rewarded with it. I recently
came across a working paper published by Harvard Business School which
offers some interesting insights. Authored by Shawn Cole
(http://www.hbs.edu/research/pdf/09-001.pdf), the paper establishes some important points which have implications for investing in bank stocks.
Higher credit, but no increase in production
Using data for 32 elections conducted across 19 states over 8 years,
Cole establishes that in an election year, agri-credit portfolio of
state owned banks (PSU banks) increases 5-10 per cent. Private sector
banks, on the other hand, do not reveal any such increase. This increase
cannot be attributed to rainfall, population or any productivity-linked
variable. Importantly, the paper establishes that increased credit does
not result in increased output.
Higher defaults, and write-offs
Another related observation is that while the average increase in credit
is 8 per cent, the increase (peak to trough) in defaults increases 16
per cent. While it should be expected that an increase in credit will
lead to higher bad loans, the increase of 16 per cent is too high to be
explained by just the rise in credit.
Data also reveals that post the election, the bad-loan percentage falls
quickly. This is not because recoveries increase – the author suggests
that the drop is a result of write-offs that the banks undertake to live
up to the pre-election promises made by the politicians.
Higher benefits to areas where election results are uncertain
The areas that seem to get the largest bump up in credit are those that
are viewed as being at the margin with regard to the ability of the
ruling party to win elections. The study revealed that areas where the
ruling party/coalition won by a margin of 15 per cent or more, received
almost 5-6 per cent lower credit than those areas where the voting was
closer. In other words, bank loans were being used as a means to “buy”
votes in “swing” districts.
The “committed” voter received a different reward: he had his loans
written off! Where the margin of victory exceeds 15 per cent,
“forgiven” loans increase, leading to an almost 27 per cent drop in
figures of delayed loans. Other areas, where the ruling party lost, do
not witness such largess. The formula seems to be inducement before and
reward after.
Implications for investing in banks
The paper re-establishes the notion that politicians will use whatever
resources they can to win elections. It also explains why government of
the day does not wish to reduce its investment in state owned banks to
lower than 51 per cent, despite facing the daunting prospect of having
to invest between Rs 1 trillion and Rs 2.5 trillion over the next ten
years. This, despite the investment yielding poor returns – dividends to
shareholders are lower than borrowing cost; capital gains are notional
since policy does not allow equity to be sold since government holding
is already near the 51 per cent threshold in many cases. After all, who
would voluntarily wish to give up the means of “purchasing” voter
goodwill.
Without going into the moral or ethical dilemma that this poses, what does this imply for the average investor?
It has long been known that whenever a new chairman takes charge, there
is a sudden jump in the non-performing assets of banks. This is
particularly true for state owned banks. SBI offered a great example at
the last change of guard. Consequently, investing just after a new
chairman takes over is hazardous for investors. Better to wait a couple
of quarters for the “clean-up” to be visible.
To this, we now add another tool – whenever an election is due, state
owned banks operating in that state will likely witness a sharp increase
in agricultural credit in the year prior to the election, followed by
increased write-offs. Consequently, investment in such banks is best
avoided till atleast 6 months after the elections to enable the
write-offs to work through the system.
The current year has seen a revival in the stock market. However, state
owned banks have significantly underperformed. A combination of
inadequate capital, larger exposure to poorly performing sectors, and
consequently, higher re-structured loans have driven valuations to below
stated book in most cases. In addition, it is possible that the market
is already factoring in the decline that is likely in agri-credit
portfolio for reasons stated earlier.
Inefficient capital allocation increase societal costs in many ways.
Taxes have to increase to pay for government spend; including the
capital required to be infused in banks. This is an indirect transfer
from urban to rural India since farmers are not directly taxed. Another
impact is lack of accountability of state owned banks for their
performance resulting in below par customer experience and higher cost
ratios. In a perverse way, the private banks benefit, since they gain a
greater share of the market due to better product and service, despite
having to work harder to raise capital which is “freely” available to
their state owned competitors.
While private banks will form part of any investor’s portfolio, state
owned banks have to remain a trading play. Consistent performance for
state owned banks will have to wait till the level of government
ownership and control falls to lower levels. However, given that
politicians across the world attempt to use public institutions for
private ends, it will be a long time coming.
