SOE banks' balance sheets have improved, and bad loans formation should moderate going forward. Prefer SBI; Morgan Stanley sees continued structural challenges at others, limiting re-rating. Valuations, however, are cheap, and hence Morgan Stanley upgrades Bank of Baroda, Punjab National Bank to Equal weight and Stay Under weight on Bank of India, Canara Bank given low profitability. SBI Share price today is Rs 389.5, down Rs 6 or 1.5%.

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For SOE banks under Morgan Stanley’s coverage, the balance sheets have improved materially over past few years, capping downside risk. CET 1 for SOE banks (excluding SBI) under our coverage is now at 9.6% vs. 9.1% in F20 (6.8% in F18). Over the past few years, SOE banks have seen significant capital infusion by the government, lower RWA density, higher provisioning and some large recoveries.

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GNPL coverage ratio for SOE banks (excluding SBI) under our coverage has improved to 67% and is 55% on overall impaired loans. As slippages moderate, expect gradual moderation in credit costs over the next few years.

Valuations are cheap at 0.4-0.5x F22e BV – is now a good time to buy? There could be near term upside but we prefer large private banks and SBI to play the corporate recovery cycle. For SOE banks (excluding SBI), we see structural challenges which will keep return ratios muted – limiting any significant re-rating potential beyond the short cyclical upswing.

Morgan Stanley prefers to play the cyclical rally via SBI. In order to turn constructive on SOE banks (excl. SBI), Morgan Stanley requires a sharp macro recovery.

Morgan Stanley raises BVPS estimates for SOE banks (excluding SBI) to factor in:

a)      lower impairments
b)      lower dilution
c)       higher PPOP