Sharp fall in interest rates or provision of transfer of stress loans to new entity or aggressive recoveries from write-off accounts remains the only hope as of now, says a research report
Public sector banks (PSBs) reported one of their worst quarters in the last decade, with no near-term visibility in operational improvement. For the first time, PSBs are likely to report negative core margins for FY2016. Taking cues from near-term weak economic outlook, their valuations have corrected sharply. Aggressive write-offs helped by sharp fall in interest rates and provision of transfer of stress loans to new entity or fund or aggressive recoveries from write-off accounts remains the only hope for PSBs as of now, says a report from Motilal Oswal Securities Ltd.
"Significant pile-up of stress loans on the balance sheet would keep credit cost elevated (for PSBs), with limited support from core pre-provision operating profit (PPoP) or higher non-interest bearing loans on balance sheet now. The Reserve Bank of India (RBI) is also likely to come out with the guideline for increasing provisions on 5:25 and special drawing rights (SDR) accounts, which would further intensify pressure on credit cost," it said.
Motilal Oswal Securities said its calculations suggest that the RBI’s asset quality review (AQR) covered, including all three lists, is about 3.5% of the system stressed loans. Contribution from restructured loans was significantly higher at around 2.2% (0.9% relapse and 1.3% loans requiring enhanced provisioning). New stress addition at the system level from non-stress recognized standard loans was lower at 1.3% of loans. RBI AQR contributed about 50% of the slippages for the quarter. Aggressive stress recognition outside the RBI AQR surprised us. Banks have utilised the opportunity to clean up aggressively and this is likely to continue in fourth quarter of FY16 as well, it added.
With RBI focussing on balance sheet health, the credit cost is likely to remain elevated, the report said. Over 50% of the non-performing asset (NPA) recognition in the RBI AQR happened via relapse from restructured loan (RL), wherein the account status classification into NPA happened from date of restructuring. Hence, most loans in this category moved to over two years NPA classification (D1/D2), leading to higher NPA provisioning.
"Total provisioning requirements on RBI AQR, including issue, rule, application, and conclusion (IRAC) norms for ageing of NPA portfolio, would be Rs40,000-45,000 crore with over 90% expected to be with PSBs, of which half would hit profit and loss (P&L) in FY16 and the rest in FY17. Significant pile-up of stress loans on the balance sheet would keep credit cost elevated. The RBI is also likely to come out with the guideline for increasing provisions on 5:25 and SDR accounts, which would further intensify pressure on credit cost," Motilal Oswal Securities said in the report.
Sharp rise in risk-weighted assets (RWA), significant downgrade of loans, profit before tax (PBT) losses or negligible profits and build-up of deferred tax asset (DTA) as banks used this to report PAT although DTA is deducted while calculating common equity Tier I (CET1) capital, led to sharp drop in capitalization in 3Q FY16. Most PSBs are at 7-8.5% now. With the guidance of half of the stress recognition related to RBI AQR to be taken in 4Q and dividend payout (expected in few cases though), stress on capitalization is expected to continue.
Given the combination of a weak outlook for internal accruals for mid-sized PSBs, the report says need for fresh capital infusion assumes even greater significance. "In this context," it said, "the inability of such mid-sized PSBs to access capital markets, especially at such depressed valuations, implies that all of their Tier-1 capital requirements will need to be fulfilled by the government in the form of CET1."
"Inability of small PSBs and weak large PSBs to raise additional tier 1 (AT1) capital may aggravate the need for equity capital requirement. RBI relaxations for recognition of capital in the form of revaluation of assets and other strategic investments would, however, provide some relief. State Bank of India around 9.4% consolidated, Bank of Baroda, at around 9% and Indian Bank at over 11% are well placed on capitalisation in our coverage universe," the report concluded.