Have asset quality woes really bottomed out for our banks?

Domestic banks have generally reported good numbers for December quarter due to moderating slippages and a drop in provisioning. Whether this portends better times going ahead needs to be deliberated upon.This is crucial, as expectations that Nifty earnings will jump in FY20 (21-27% based on different forecasts) are pegged on an increase in bank earnings (55-60%). This jump is expected to be due to a steep drop in loan loss provisions driven by peaking of NPAs and slippages in Q4FY18, high provision coverage ratio at end of December 2018, and a possible recovery on loans already written off on successful resolution of a few large cases in the NCLT.Actual earnings of Nifty companies have lagged analyst estimates year after year and if banks do not perform in line with these heightened expectations, then we may be in for some disappointments in FY20 too.In the past, Indian insolvencies took longer to resolve than in any other major economy. Overall, India was No. 103 in the World Bank’s 2017 ranking of how nations handle insolvencies, just behind Nicaragua. India’s recovery rate out of insolvency proceedings has been low at 22 per cent vs developed economies’ average of 60 per cent and Russia’s 40 per cent. Only in Brazilian creditors typically recover less.As of March 2018, India’s scheduled commercial banks carried Rs 10.3 lakh crore of gross NPA out of total advances of Rs 92.6 lakh crore (11.2 per cent). PSU banks had higher gross NPAs of 14.6 per cent.Excess capacity creation (without addressing raw material availability or tying up with customers) a few years back due to liberal lending practices and easy availability of equity fund due to encouraging FII flows was one of the key reasons why a lot of loans turned bad.The main reason for the recent turnaround in bank earnings has been the implementation of the IBC code over the past two years, although strict recognition and provisioning norms laid by RBI also helped. The IBC law has been a real achievement in terms of unlocking asset values of sick companies.The implementation of IBC code means if you now default and cannot persuade your creditors that you are going to restructure your debt within 180 days, you are going to be liquidated. Of course this law and its implementation is still not perfect as it is a new law and is still evolving. In the US, the first decade of implantation of such a law was pretty unsteady and at one point they even thought of repealing it. In the UK, a similar law took more than half a decade to settle down. Looking at it from this angle, India is doing quite well so far. The main issues faced in the implementation of the law include higher time taken in the resolution of cases. As per ICRA, almost 68% of the cases exceeded the 270-day timeline allowed under the IBC.There is a trade-off between timely resolution and maximisation of value. Delays are caused by objections, counterbids, a general bias against liquidation, late bids by resolution applicants, differences in interpretation of law, including varied interpretation of Section 26A on eligibility of applicants, challenges made by original promoters, challenges by the operational creditors, lack of adequate infrastructure to handle rising applications filed to NCLT.As per ICRA, the timely conclusion of the pending cases could have brought in additional Rs 65,000-6,7000 crore to the financial creditors, which is equivalent to about 6.5 per cent of the gross NPAs in the banking sector.Despite these hiccups, there has been growing preference lately for resolution outside of NCLT. On the positive side, there is noticeable change in credit behaviour of company promoters.As per the latest release of the Insolvency and Bankruptcy Board of India, some 1,484 cases have been registered under the insolvency process as of December 2018, out of which 264 new cases were admitted in December quarter. In all, 52 per cent of all cases (586) closed till date were done via liquidation of the corporate debtor and only 34 (13%) cases were resolved with an average haircut of 52 per cent. Out of the 134 cases which were closed in December quarter, only 13 cases were resolved while 78 faced liquidation. The average duration of resolution was ~313 days (for all resolved cases till December 2018 quarter; 350 for those resolved in that quarter).Although the first few cases have got aggressive bids (mainly in steel - due to bullish cycle), the haircuts in some other cases could be high. In future, large funds to bid for sick companies will have to be arranged separately, as there may be a limit to how much will existing Indian promoters can buy.The recent credit rating downgrades for IL&FS, Jet, Tata Motors, DHFL show ominous signs. If ratings of highly rated companies get slashed overnight, how much reliance can lenders put on ratings and how many more such downgrades can happen are questions that will continue to bother Dalal Street.Declining operating income and profitability, adverse capital structure, deterioration in debt servicing parameters (delays/default in debt servicing) and worsening liquidity positions could be some of the factors that may lead to more rating downgrades.After large cases from the steel, power, textiles and infrastructure segments are referred to IBC and/or resolved, some other segments or sectors like aviation, telecom, MSME (16% of bank lending and 23% of all lending) – including MUDRA loans, real estate, retail loans (LAP), NBFC, HFC could drive NPAs going forward. How much pain these can cause and how they will be tackled need to be watched keenly.Disruption due to changes in regulation, technology, absence of entry barriers and difference in access to liquidity got accelerated due to demonetisation, GST (goods and services tax) implementation and the Real Estate (Regulation and Development) Act (RERA). This has impacted the companies, especially in the smallcap and midcap segments. They are slipping in terms of their market shares, revenue growth and margins. This is likely to continue for some more time till the weak ones among them get eliminated and there is some consolidation.Promoters’ credibility and corporate governance is another issue. Corporate governance norms practised by most companies in these sectors have been poor so far. There is also a question on the competence of some promoters in these trying times.Availability of growth capital over the next two years, especially for PSU lenders, capital conservation buffer, adherence to Basel III norms and migration to Ind-AS will be key challenges, especially if there is a delay or shortfall in recovery from sick accounts.PSU banks can do well only when they see consolidation, better corporate governance, better compensation structure, disciplined/involved workforce and a faster legal system in India.Growth in bank deposits has lagged growth in advances over the last few months. The credit-deposit ratio has touched a five-year high of 79. A key risk for the banking sector remains on the deposit side and if deposit growth doesn’t pick up, there could be challenges on the lending side too. The funding advantage has significantly reduced for the NBFC sector at large. In this environment, banks have significant funding advantage, while NBFCs will remain tentative, fearing the next liquidity squeeze and, therefore, maintain more defensive ALM/balance sheet liquidity.At a time when global growth is slowing down synchronously, debt servicing could become a problem. Over the past four-five years, retail and SMEs have been key growing segments of credit. They together account for 47% of the total financial system’s (Banks + NBFCs) credit book and hence need close monitoring.NBFCs have slowed lending, banks have not increased exposure to this space, thus suggesting liquidity crunch for retail and SMEs. While retail loan growth has increased sharply, wage bill growth has slowed. In this scenario, rising rates could make debt servicing more challenging at the margin.Indian banks have a chance to come out of these grave times due to a favourable combination of IBC implementation, supportive regulator and government and adverse developments in the NBFC space. They need continuation of these conducive developments along with continued economic growth to come out clean.

from Economic Times https://ift.tt/2Ud6wnV