banks hammered

We have been witnessing bank stocks getting hammered by the day. In fact, the bank Nifty is quoting at its lowest point for sometime. 

The public sector bank stocks are quoting at 52-week low points.

There is a good reason for this to happen. Banking is a tough business; and this is not well understood by many. We can be cautious about investing in highly leveraged firms, and choose to invest only in businesses that have low debt or capacity to service debt comfortably. Yet, this comfort is limited when we deal with banks. 

Banks are inherently risky because they have no option but to be highly leveraged. They have to raise debt which is disproportionate (in size compared to any other business) to their equity. Their investments are actually loans that they make to the borrowers, both retail and corporate. Because their assets are largely funded by debt, a small percentage loss on loans becomes a large portion of equity. 

If equity is not adequate, the bank can possibly go under; if not, the equity erosion can be stressful enough. The option then is to either raise more equity capital or lower growth. Both can become double-edged swords. Stressed assets lead to lower equity and returns, which lead to lower stock prices. Low stock prices hamper efforts in raising new equity. Lower growth also suppresses the already low stock prices. The vicious cycle for banks is painful. 

It is always better to be prudent when dealing with loans. A loan that is not recoverable is actually not worth making in the first place. Furthermore, if for some reason a loan becomes difficult to recover, it makes sense to acknowledge it and provide for it. Don't surprise markets at the wrong time. However, most banks do not follow this policy for the fear of lower stock prices. Little do they know that eventually what has to happen shows up. 

I have noted earlier how HDFC bank is treated by the market the way it is. Not much has changed. Markets continue to treat it well. Of course, it is managed much better than its peers. Yet, its pricing has always been at large premiums. 

For the investor, it is: for low long this premium will continue?

Another private sector bank, ICICI bank has been treated pretty badly. Its stock price is at a year low, and has been like that for sometime. 

It was trading at Rs.242 in May 2013 and at Rs.393 in January 2015. As of 10 February 2016, it is at Rs.207. Considering it was priced at Rs.192 in February 2014, one can still argue for a short call. 

HDFC bank is worth more than twice ICICI bank now. For the investor it is: for low long this discount will continue?

ICICI bank has not had good numbers in its operations. Its non-performing assets are increasing, which only tells how they were initiated. We cannot put the blame on commodity prices and commodity businesses. There must be something wrong in the process out there. 

Yet when we want to make an investment decision, both HDFC bank and ICICI bank pose different perspectives: The large premium and large discount. Which is true?

As of December 2015, ICICI bank had equity of Rs.896 b and loan book of Rs.4,348 b. It had Tier 1 capital of Rs.700 b, which is adequate. Its risk-weighted assets were Rs.5,934 b. About 79% of its loans were financed by debt. Its gross and net NPAs were Rs.213 b and Rs.100 b respectively. Provision for NPA has been increasing each quarter which is worrying the market. The bank has said it would continue in the coming quarter too. The equation is: every 1% loss in loans erodes 4.85% of its equity. How long will this continue, and does the bank have the capability to bring it down?

Markets may not strengthen its stock price significantly in the next three months at least. Well, that's not the point right? We don't care what markets think in the short term. My question is: given the hammered down prices for ICICI bank, or the stretched prices for HDFC bank, how large is the gap between their value and price?

When I think about HDFC bank and ICICI bank, I think that if one is long, the other is short. Heck, which one is it?

I know that markets can remain irrational longer than investors can remain solvent. I also know that markets have the tendency to force investors to be irrational.