Would PSU bank reap the benefits of reversal in rate cycle

Post cut of 50 bps in interest rate by US Federal Reserve, which came as a surprise, markets have started pencilling further decline of 50 bps till December 2024. Following the suit factoring beginning of reversal in rate cycle, 10-year G-sec yields in Indian debt market have declined 25 bps to 6.75% in last 3 months.

While the timing of rate-cut may vary, consensus remains on trend of rate cycle which is expected to be partially beneficial for the financial domain. While accretion in book value (owing to MTM gains) is seen to benefit PSBs, falling rates could keep momentum in credit demand intact.  

Earlier, PSBs were biggest beneficiaries owing to treasury gains, amid decline in interest rates. However, with recent change in accounting policies, MTM gains are to be adjusted in networth by-passing P&L. Thus, fall in interest rates is seen to accrue book value, specifically for PSBs.

On the other hand, substantial proportion of loans linked to external benchmark (~57.5% of advances linked to EBLR) and continued intense competition on deposits increases probability of continued pressure on margins. A back of the envelope calculation shows that impact on margins could be offset by MTM gains on investments, thus safeguarding valuations. Thus, we prefer PSBs and large private banks in the current environment.

For a broad understanding, consider Bank of Baroda wherein MTM gains (calculated) is estimated at ₹627 crore (assuming AFS book at ₹77940 crore, duration of 3 years and 25 bps decline in G-sec) while impact on NII (owing to reduction in rates) is estimated at ₹ 661 crore (assuming EBLR linked loans at 40%, 25 bps of repo cut) depicting MTM gains offsetting pressure on NII.

Among the pack of lenders, NBFCs are relatively better placed owing to repricing of liabilities aligning to decline in yields enabling to maintain margins. In addition, lower trend in interest rates is expected to aid momentum in credit growth. With asset mix and relatively faster repricing of liabilities, preferred NBFCs are Bajaj Finance, SBI Cards and L&T Finance