pnb equity

Punjab National Bank stock is trading at Rs.97 per share. In January 2018, it had a high of Rs.194.  Oh yeah, it was priced Rs.231.45 on 26 October 2017. What happened? Well, this happened, and was explained here. $1,771.69 m is about Rs.115 b; that's the amount the bank is likely to be liable to the counter parties in case of full default. And later an additional Rs.13 b fraud was detected. 

So how much PNB's liability in this fraud is depends upon how much is the default going to be. SBI is already confident that PNB will make good all of its dues. PNB is in a slippery lane as of now. Until how much can be recovered from borrowers is known, all numbers are estimated in speculation. And the market says, so be it, if the price has to fall in speculation.

PNB equity was priced by the market at Rs.560 b in October 2017. It was Rs.392 b on 13 February 2018 just before the fraud detection, and has fallen 40% (Rs.156 b) since then. That raises question to the rational investors as to whether the stock is a buy now. After all, 40% fall is unprecedented, or is it?

Before the analysis, we have to begin with an understanding of the banking business. Core banking is after all raising equity and debt, the operating capital, at a lower rate in order to lend it to the borrowers at a higher rate. The difference in interest rates is the margin, and the difference in the amount of interest earned on lending and that incurred on borrowing is the operating profit earned by the equity shareholders. Ignoring the nuances of the banking regulation, it is a simple business at its core. 

A bank's borrowings include customer deposits and its bond raising. Debt for banks is actually the main feed for their lending business. Because banks are heavily leveraged, it is imperative that they exercise extreme caution on their operations. Otherwise, its shareholders will have to pick up the tin cups. Here's is how enormous its impact can be.

Suppose that a bank's equity is $10 and its debt is $90, and suppose that $100 is fully lent to the borrowers. Now, if only 1% of total loans turn non-performing, $1 of bad debt erodes 10% the bank's equity. Bad debts of 5% clears 50% of equity. Now we get the point how leverage plays on the bank's balance sheet. Nevertheless, banking is a business where debt is like oxygen; you need it to function. That said, extreme caution is imperative for banks.

Lending business is actually an investment operation. Investment in pure debt instruments requires both skill and caution. What is the point in lending for the sake of increasing the size of advances when its recoverability is in question? Be it businesses or individuals, there have to be sufficient free cash flows, both in size and consistency, available to service their debt; if not, they do not deserve debt. Banks will have to grasp this before lending.

Our definition of non-performing asset is one that bank is unable to recover. Let's see what the RBI guidelines say about NPA. 

Generally, the guidelines say that banks will have to classify assets as non-performing if principal or interest remains overdue for more than 90 days. That means, if a bank takes a view on a loan and before it becomes 90 days overdue concludes that it is not recoverable, it need not classify it as non-performing. That's the leeway banks take anyway which is legit, though not correct. However, after it becomes 90 days past overdue, the bank will have to classify it as an NPA. Do banks do that all the time? That's the question which remains a question. When a loan becomes NPA, bank's assets and income reduce due to provisioning and loss of income. That's bad for the banks, and they don't want to look bad. And that's why they take recourses to not to classify as NPA; and this ain't legit. 

Have a look at the RBI guidelines for provisioning.

The guidelines say that banks will have to provide 100% if the loan remains overdue for more than 3 years. While the call has to be taken by the individual banks as to whether a loan has become bad or remained doubtful, what is clear is that not providing for an unrecoverable debt does not make it recoverable over the period. One day the true picture will emerge. The credibility of a bank is built upon how it deals with its bad assets. The quality of a bank is built upon the levels of its non-performing assets; the lower the levels, the higher the quality, and of course, the safer its equity.

Coming back to PNB, as of December 2017, it had total equity (standalone, as we don't have consolidated numbers) of Rs.489,970 m; and shares outstanding of 2,425.587 m. That gives us a book value of Rs.202 per share. At the current market price of Rs.97, it appears to be a steal for an investor. But not so soon. As we have learned before, we need to know how good is this book value of Rs.202. 

As of December 2017, PNB had gross NPA of Rs.575,190 m (12.11%), and net NPA of Rs.340,760 m (7.55%). Its reported provision coverage ratio was 60.78%; whereas, our calculation suggests that just over 40% of gross NPA were provided for. The bank had stressed assets of Rs.671,290 m. There is an overlap between the gross NPA and stressed assets, and the stressed assets outside of NPA are estimated to be Rs.96,100 m. These are only estimates, still. 

The math then comes to this: Net NPA of Rs.340 b, fresh NPA of Rs.128 b, both of which call for higher provisioning if not 100%. Then the stressed assets of Rs.96 b. PNB is planning to go ahead with its Rs.55 b equity raising through issue of 334.9 m shares to the government at Rs.163.38 per share. After this, the total number of shares outstanding will be 2,760.487 m, and the new book value will be Rs.197 per share. 

Against its total equity of Rs.545 b, PNB is staring at NPA of Rs.468 b, and stressed assets of Rs.96 b. How much of PNB's equity is good depends upon how much of its loan assets will turn 100% bad. 

If all of its NPA turn bad, the bank will have to frantically look for fresh equity; or else...well, there won't be any equity left. That will not be good for a going concern operation.

If we estimate a loss 50% on NPA and none on stressed assets, the book value per share reduces to Rs.112. 

Loss of 50% on the existing NPA and 75% loss on the fraud assets will lower the book value to Rs.101 per share. 

A 75% loss of its NPA and none of stressed assets, and the book value will be Rs.70 per share.

We will have to take a pick based on our judgment. 

In fact, 75% loss on NPA and 25% on stressed will bring the book value to Rs.62 per share. What it means is, if the market wants it, it can bring the stock price to any level it wishes.

As of December 2017, PNB had return on assets of 0.12%, and return on equity of 2.03%. Its reported Tier 1 capital ratio stands at 9.15%; but the moment further provisioning is made, it will fall, and the bank will be much starved of equity capital.

It will be interesting to see if the government will buy the stock at Rs.163.38 per share as scheduled. The movie is unfolding for the public sector banks, surely.