Whalesbook
Valuation Gap Widens
Market data shows a growing difference in how private and public sector banks are valued. Large private banks are currently trading at price-to-earnings (P/E) multiples of about 15x-16x, which is lower than their average over the last three to five years. This contrasts sharply with public sector banks, whose valuations have surged in the past 18 months. Public banks rallied due to balance sheet improvements and loan growth, pushing their price-to-book values to more than one standard deviation above their long-term averages. This suggests that public banks may have already seen their valuation gains, making private banks, which have declined in value despite steady profit growth, potentially more attractive.
Earnings Drivers Shift
The focus in banking is moving from fixing balance sheets to core profitability. Public sector banks have historically used non-core income, like treasury gains and recovered bad loans, to hide shrinking profit margins. However, with rising bond yields and fewer easy recovery opportunities, the sustainability of these earnings is now questioned. In contrast, large private banks have focused on building stronger deposit bases and managing funding costs. Projections indicate that private lenders could maintain stable net interest margins (NIMs) through FY27, benefiting from a better mix of loans and less aggressive lending than public banks.
Risks for Private Banks
Despite positive prospects for private lenders, investors should consider potential risks. A key concern is the recent increase in private banks' exposure to high-yield, unsecured retail loans and microfinance. While these areas fueled growth from FY22 to FY25, they are the most susceptible to economic downturns. Rating agencies have noted that if oil prices remain high or geopolitical instability leads to stagflation, private banks with significant unsecured retail lending could face larger earnings downgrades compared to public banks with more collateralized loans. Additionally, attracting deposits remains a challenge across the sector, with intense competition likely to keep funding costs high for all banks and potentially limit NIM expansion.