Indian banking stocks have virtually across the board been de-rated significantly in the past several quarters on concerns of mounting NPAs and restructured loans.
Worries that the slowing economy and high interest rates would contribute to higher bad debts have more or less panned out, but the concern amongst investors is also that the large amount of restructuring of loans done by banks is masking the real deterioration in asset quality.
First of all, let’s look at the data. Gross NPAs of PSU banks have increased to 2.25% of loans a year ago to as much as 3.02% by the end of March 2012. Similarly, Net NPAs have gone up from 1.1% to 1.5% during the same period, indicating that the banks have not been able to provide fully for the fresh NPAs from their operating profits. In fact, 18 out of 27 major banks under our coverage reported higher slippages (new NPAs) sequentially. As a result, even after a significant 37.7% yoy increase in provisioning costs for PSU banks (excl. SBI), most banks saw their provision coverage ratios deteriorate and by the end of the fourth quarter, 14 out of 22 PSU banks have less than even 70% provisioning coverage (a bare minimum benchmark set by the RBI a couple of years ago).
But it would be wrong to paint the entire sector with the same brush. Private banks have sharply been improving their asset quality over the past 2 years and even in this quarter, those under our coverage saw their provisioning costs decline by 20.9% yoy and also witnessed a decline of 2.6% qoq and 13.5% qoq in their gross and net NPA levels, respectively. This is a pretty phenomenal performance considering the external environment and is not just by chance or luck. Right since the Lehman crisis, private banks have stopped aggressively chasing loans, significantly tightened up their asset appraisal systems and exited or de-focused from risky segments such as unsecured personal loans. Due to this conservatism, they are now experiencing relatively benign asset quality as compared to PSU banks.
Going forward we expect the asset quality to also improve on back of lower interest servicing costs for borrowers. RBI has cut the repo by 50bp and we expect further 25-50bp reduction in repo rates over FY2013. More importantly, inflation levels have come off considerably over the last 6 months and are expected to average at least 150 bps lower in FY2013 compared to FY2012. This is bound to give a downward trajectory to interest rates going ahead, so we expect lower defaults which coupled with higher recoveries (from higher delinquencies during the last 2 years) should lead to improvement in asset quality of the banking sector towards the second half of FY2013. So, while in the near-term we remain circumspect on some of the PSU banks because of incremental asset quality pressures, but broadly on the larger (and structurally stronger) banks, especially the private sector banks, we have a positive view from a one year perspective.