Plateauing stressed assets …but credit costs to hit profitability
Private sector banks and large public sector banks (PSBs) have been given stable rating, while negative sector outlook for small and mid-sized PSBs retained for FY18
India Ratings and Research (Ind-Ra) has maintained a stable rating and sector outlook on private sector banks and large public sector banks (PSBs) while it has retained the negative sector outlook for small & mid-sized PSBs for FY18. Large PSBs with better access to capital and private sector banks with their robust capitalisation are expected to navigate another year of low growth and high credit costs with a stable outlook.
The agency retains its negative outlook on mid-sized and smaller PSBs with weak capitalisation and large stock of aging non-performing loans (NPLs). These banks will find it increasingly difficult to grow given increasing capital requirements and large funding gaps impeding their ability to compete on spreads.
Ind-Ra expects banks to require Rs 91,000 crore in tier-1 capital (including Rs 50,000 croreof Additional Tier-1 (AT1) bonds) till March 2019 to grow at a bare minimum pace of 8 per cent to 9 per cent compounded annual growth rate (CAGR). This includes Rs 20,000 crore of residual tranches from the government of India’s Indradhanush programme.
There is an increasing divide between the large and smaller PSBs, with the former having some access to growth capital, better market valuation, and also some non-core assets to divest while the latter would only receive bailout capital if required. Additional Tier-1 (AT1) bonds have seen some tailwinds in FY17 due to favourable treatment from mutual fund and insurance sector regulators while a kick-start of an infant secondary market has started improving the pricing.
Even as the recent Reserve Bank of India guideline improves the coupon serviceability of even the weakest PSBs, a broad-based deepening of the market would likely only come from demonstration of PSB’s ability to exercise issuer call options in the medium-term.
Impaired assets are expected to peak at 12.5 per cent to 13 per cent by FY18/FY19 while credit costs will show an extended recovery period (FY18F:185bp; FY16:230bp) as a large proportion of the recently acquired higher–bucket non-performing loans keep aging. This would keep blended return on assets (RoAs) for PSBs and private sector banks 20bp-30bp below their respective long-term medians. Our study pegs stressed corporate/SME debt at 22 per cent of bank credit of which 12 per cent has found recognition as impaired so far while about 7 per cent remains as non-PSU debt without any current dispensations such as 5/25 or S4A.
The sector-wise stress analysis, sectors such as iron & steel and textiles have seen a fair bit of recognition but provisioning might still not be adequate to protect against eventual loss given defaults (LGDs). On the other hand, significant proportion of unrecognised stress pertains to sectors such as infrastructure, realty and capital goods which potentially have long-term viable assets but would increasingly need cash flow restructuring to avoid slippages.
On the funding side, the analysis reveals that about ten odd mid-sized PSBs were running high asset liability mismatches which could potentially impact their ability to transmit any easing or compete aggressively on marginal cost lending rate. It is expected that the liability momentum to be another large differentiating factor between large and mid-sized PSBs. Sector net interest margins (NIMs) are expected to remain stable at 2.9 per cent for FY18F, 15bp-20bp lower than the long-term average.
Ind-Ra’s Long-Term Issuer Rating (which is used to benchmark senior bonds and Basel-III Tier-2 instruments) on PSBs will change only if there is any change in the government’s support stance or a relative shift in their systemic importance.
Ratings for private sector banks and ratings on tier-1 bonds (such as AT1) for all banks are linked to the respective banks’ standalone profile. Positive triggers such as improvements in funding gaps and single-name concentrations together with increased capitalisation levels and lower loan loss provisions may result in a positive outlook for banks whose ratings are driven by performance.
Negative triggers such as pressure on capital ratios due to weak profitability, a spike in credit costs and delays in equity injections may lead to a negative sector outlook.

The writer is director and co- -head, financial institutions, India Ratings and Research