Most state banks have serious non-performing loan problems, a shortage of capital, and tend to lag far behind in their technology and product capabilities, he says.
‘Although credit growth in the Indian economy is very weak today at only 5-6%, the stronger private sector players are taking advantage of the chronic weakness of their state sector competitors, who represent about 60% of system assets, to rapidly grow market share.'
'HDFC Bank and Indusind Bank are good examples of private sector banks that are growing consistently at 20%+ rates and earning attractive returns on equity of almost 20%. Indian bank HDFC Bank has low levels of non-performing loans and healthy capital ratios,’ Hudson explains.
Another draw for private sector banks is their leadership in the rapidly evolving digital payments network, he says.
‘The recent demonetisation exercise in India, which cancelled older, large-denomination bank notes, along with the introduction of a nationwide sales tax this year, has provided a significant boost to the formalisation of the economy, as cash transactions and “under the mattress” savings get squeezed out of the system.'
While the favoured stocks have performed well so far, the very low credit penetration in India and continued share gains means they still have a long ‘runway for rapid growth’ in the next decade, Hudson says.
‘We do not expect their competitive advantages to be eroded given the structural issues faced by the state-owned players. As such we think earnings and book values for these banks can continue to compound at high rates, which should continue to drive share price upside over the longer term.’