The pitch is a bit long and has some formatting issues due to the numebr of graphs. Please use the below dropbox link to see the full pitch and let us know of any issues with the link. We have included the thesis here so that you can get a sense before committing to reading the whole pitch.
Short: State Bank of India (50% downside playing out over next 1-2 years).
India is expected to grow at a 7-8% clip over the next 3 years and credit usually grows as a 2x multiplier to GDP growth. However, public banks are currently growing at mid-single digits while private banks are growing at ~20% - a theme of divergence we expect to continue
We believe there is a chance to take advantage of this trend occurring in the India financial system where private banks are taking share from public banks that are weighed down by NPLs and uncompetitive banking offerings.
Further, we believe that between restructured loans that have little provisioning and the Reserve Bank of India (RBI) being too lenient on ensuring public banks correctly recognize NPLs, we are only in the middle innings of the credit cycle turning for these public banks – most of these public banks will need fresh equity capital from either the govt or public markets to fully clean balance sheets and recapitalize.
Unfortunately, most public sector banks have now traded down so far that only the most pessimistic expectations are built in – BOI at ~0.3 P/B, Union Bank at ~0.4x P/B, and Canara Bank at ~0.4x P/B
We believe the best way to play this theme is to be long the best-in-class private bank, HDFC Bank, and to be short the only public bank with bullish street expectations, State Bank of India (SBI). SBI has a large portion of loans on its balance sheet that are probable to go bad, well in excess of what investors are discounting.
We are new to looking into opportunities in India, but were intrigued by the real GDP growth rate and the new investor friendly Modi government voted into office in 2014. We found the financial sector a very compelling investing ground given the thematic shift occurring – the system once dominated by public banks, is now seeing private banks and non-bank financial companies rise to the top. We believe we are only in the middle innings of this shift and expect a further divergence between the private banks and the public banks to occur in terms of market share, profitability and asset quality.
**Given the financial system is just a multiplier of GDP growth, we have included our view of the Indian economy and financial system (for background on the shift occurring) and would love to hear the thoughts of others who have been following this situation for a longer time. Feel free to skip those sections and go right to the long / short pitches. Again, would love to hear which banks others would be long or short to help buildout our view of the situation on the Indian credit system**
I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise do not hold a material investment in the issuer's securities.
- PSBs start to recognize NPLs over the course of the next 1-2 years. Particular emphasis on the next few quarters as they should "true-up" to the RBI and investors the true level of distress currently on their loan books
- Time on restructured assets runs out and banks have to MTM losses / provisison for NPLs.
- Acceleration in consumer debt levels, especially in commercial vehicle and credit card loans provides outsized retail loan growth compared to system
- HDFC Bank engages in higher levels of corporate debt lending at the trough of the credit cycle for that sector and gains market share just as the cycle turns upwards - corporate loans have higher margins, leading to better RoEs when underwritten prudently.