Stressed loans plateauing, provisions to remain high

Starting from the RBI’s AQR (asset quality review) in 3QFY16, Indian banks have seen accelerated transition in stressed loans from standard stressed or restructured loans to NPAs. Thus, even as the total stressed ratio has remained broadly stable in the last 6-7 quarters, gross NPA ratio has increased to 10.5 per cent versus 7.9 per cent at the end-FY16.

With continued NPA addition and provisions or write-offs of old NPAs, credit cost has remained significantly elevated in the past two years. Trends in upgrades/recoveries from NPAs show that the environment remains too muted to drive any significant upgrade/recoveries yet. NPA recovery/upgrades has thus remained muted. Given a large part of banking system – PSU banking – is also under-capitalised and weak on operating profitability, banking system has struggled to drive NPA reduction through write-offs as well.

Corporate data shows plateauing fresh stress

Segmental NPA trends show mid-corporate and large corporate loans have seen the worst deterioration in asset quality in the last two years in the corporate/commercial segment. To understand how worse these numbers can get, we looked at a sample of 2,283 non-financial companies (having revenues of Rs 100 crore or more in each of the last three years – FY15, FY16 and FY17). The companies in the sample had total debt of Rs 39.7 lakh crore as at FY17, which is 74 per cent of total corporate credit.

We analysed these companies on interest coverage ratio, defined as EBITDA to cash outflow for debt servicing. A ratio of more than one or negative suggests financial stress, where the company would struggle to service its debt. Trends suggest that the share of debt of such companies in total sample debt has been high but has moderated in the last two years. In FY17, debt of these “stressed companies” formed 32 per cent of total sample debt (as compared to 38 per cent in FY15). Some of this reduction has also been due to debt restructuring in large stress cases such as Bhushan Steel.

There are 190 companies with stressed interest coverage ratio (negative or less than 1) in all the three years under question; i.e. F15, FY16 and FY17. The total debt of these companies is 12 per cent of the overall sample debt. Some names in this list include the likes of Essar Steel, Jaiprakash Associates, Lanco Infratech etc. which are already referred by the regulator to the NCLT under the Insolvency and Bankruptcy Code.

Streamlined framework

The RBI recently released a new streamlined framework replacing all the existing guidelines for stressed asset resolution.

Objective is to accelerate clean-up: The new stressed asset resolution framework attempts the following objectives: (1) ensuring a quick resolution of stressed corporate debt in a time-bound manner; (2) ensuring better co-ordination across corporate lenders so that default with even one lender triggers a coordinated response; and (3) limiting flexibility/incentives to both lenders and promoters to delay matters and nudging them to take tough decisions (e.g. insolvency filing or restructuring) under an institutionalised framework.

Near-term slippages to stay high

Given the RBI’s new framework to accelerate recognition and resolution of stressed loans, we expect transition from banks standard stressed loans to NPA to accelerate in the next 2-4 quarters. However, given that banks’ overall pool of stressed assets has been broadly stable and debt servicing indicators of corporates also suggest plateauing stress, we expect normalization in banks’ corporate slippages following the clean-up in the near term. For key stressed corporate banks, 60-80 per cent of their stressed corporate loans (depending on each bank’s definition of stressed loans) are in the category of NPA now and 3-5 per cent of their loan book now sits in various stressed categories such as watchlists, SMA-II and restructured.

Haircuts likely to increase

Reports on the bidding process for cases under the first list for IBC indicate that a fair amount of competitive bidding has taken place in some cases. Reported bids so far indicate likely haircuts in a wide range of 20-90 per cent. More alarmingly, except for a few large cases such as Bhushan Steel, Essar and Jaypee, haircuts in smaller cases are much steeper. As the IBC process rolls on to smaller cases of the second list and other cases that would be referred to IBC under the new stressed asset resolution framework, there is high likelihood that haircuts will increase.

Retail asset quality –  best is behind

Credit bureau data shows largely benign level of delinquency in banks’ retail/agri portfolio so far. In particular, private sector banks have seen stable to low delinquencies in their retail/agri portfolios. PSU banks have seen deterioration in retail delinquencies, seemingly caused by their agri portfolios.

While NPAs and delinquency rates have been extremely low in retail so far, trends are deteriorating at the margins now. Led by demonetisation, farm loan waivers, and implementation of GST/RERA, retail loans exposed to self-employed/rural sector have been inching up in NPA. This is reflecting in the NPA ratios of HDFC Bank, RBL Bank and DCB Bank. Further, strong retail asset quality in recent years was playing out in the context of easing interest rates and minimal job losses in the organized sector of economy.

With interest rates set for an increasing trend and subdued job creation data, it’s safe to assume that retail asset quality is unlikely to improve hereon. Further, the share of riskier unsecured loans in retail lending has increased in recent years, which expose the retail loan book to higher risk in case of any deterioration in the macro environment.