Pension liabilities force JP Morgan to cut price targets of PSU banks by 10%

MUMBAI: JP Morgan cut price targets for state-run banks by as much as 10% as their pension liabilities may be many times what the market has currently factored in. It downgraded Bank of India to underweight from neutral.

"Optimistic wage inflation and mortality assumptions raise the risk of future provisions, and enhanced funding of plans threaten NIMs," analysts including Seshadri Sen at JPMorgan wrote in a report. "Pensions are putting pressure on PSU banks' poor cost-efficiencies and hampering competitiveness. Cheap valuations discount this only partially - prospects of negative surprises.''

Many analysts and investors are turning negative on banks mainly due to rising interest rates that could lead to higher bad loans. For state-run banks, the pension liabilities could be bigger. State Bank of India shocked the market with a 99% drop in earnings in the fourth quarter of last fiscal, partly due to such provisions. The BSE Bankex has fallen nearly 7% since January while the benchmark Sensex fell 10% during the same period.

"We think the current assumptions ignore the impact of the bi-decadal wage increases from collective bargaining, probably because it's not a certainty" said Sen. The agreement with the unions expires in Sep 2012, and another lumpy provision is likely in FY14. PSU banks and unions renegotiate wages every five years - wages expanded by 18% during the previous settlement for 2007-12. The report also says, with non-pension benefits (post-retiral medical, for one) adding to the pressures, the recent pension changes have blunted the cost efficiencies. "We estimate pension liabilities to expand at 20% against the discount unwind of 8%, with the risk of periodic capital shocks."

The provisions will be uneven, and we estimate that obligations will have to rise by 20% per annum for the next five years to adjust to realistic assumptions. Also, the provisions for state-owned lenders have risen consistently for the past seven quarters as they are migrating to a more stringent computer-based system of identifying bad loans and have set aside more money for restructured loans. PSU banks are more at risk because of their comparatively high exposure to small agriculture loans below 50 lakh which can register as NPAs if not repaid for more than 90 days.