See stress on banks' credit profiles; PSUs risky: Experts

Rating agency Standard & Poor's (S&P) on Wednesday revised its credit rating of State Bank of India (SBI) downward by a notch to 'BBB-' on expected deterioration in the asset quality. Geeta Chugh of S&P Ratings told CNBC-TV18, SBI has the highest non-performing loans (NPL) in the Indian banking sector. She also feels that its asset quality problems may persist for the next two years. Moreover, its NPLs in the mid-corporate and rural segments is worrying and the bank’s worries include priority sector obligations, noted Chugh.

Chugh further clarified that they are keeping an eye on the credit profiles of other banks as well as they continue to see stress in many Indian banks. She believes the public sector banks are more prone to risk as compared to its private sector peers as their risk selection is superior to that of government owned banks.

Ananda Bhoumik of India Ratings & Research however, does not feel that there is a likelihood of a ratings downgrade of banks at this stage. He acknowledges the fact that asset quality problems mainly persist with mid-sized public sector banks and believes Canara Bank is going through a turbulent phase at the moment. He is cautious on private banks and says the banks must not grow at the cost of asset quality.

Here is the edited transcript of the interview on CNBC-TV18.

Q: You have some specific rating changes, especially on the credit profile of two banks, State Bank of India (SBI) and Union Bank, let me begin with the micro, why are you particularly worried about those two banks, what is it in their credit exposure that does not bother you about other banks?

Chugh: Yesterday we brought down our standalone credit profiles of SBI and Union Bank of India.

With respect to SBI, they categorically have the highest NPLs in the Indian banking sector. They are seeing problems in the agriculture and the mid-corporate segment with NPLs in both these segments crossing 9 percent. We remain worried about the fact that the asset quality problems in SBI will persist for at least two years.

We expect their credit cost to remain high, which is more than our base case expectations for SBI, which is why we brought down their risk position by a notch and their standalone credit profile by a notch to triple B minus (-BBB) from triple B (BBB) earlier. The final rating has been affirmed at –BBB with a negative outlook. And the negative outlook categorically is a reflection of a negative outlook on the sovereign rating of India.

With respect to Union Bank of India, they also have high NPLs at about 3.7 percent. Union Bank of India in our view is facing the highest risk on agriculture as well as on the infrastructure portfolio. The bank has a relatively higher exposure to infrastructure where we are currently seeing more stress.

These are the two banks where we have already reflected the stress by way of change of a standalone credit profiles. We are continuing to see stress in many other Indian banks as well. It is just that they have not yet tipped the scale. We continue to monitor them closely and if there is a further deterioration beyond our base case expectations then the standalone credit profiles of many other banks could also come under pressure.

When I say that I should mention here that the government owned banks are at a higher risk than the private sector banks that we rate. We rate three private sector banks in India and generally their asset quality, their loan allocation, their portfolio allocation and the risk selection is somewhat superior than the government owned banks.

Q: For SBI in particular the previous quarters saw their asset quality ratios exceed above analysts' expectations. Give us a sense in terms of a certain amount of ratios which you will be possibly factoring in and by when do you expect them to bottom out in terms of worst asset quality trends?

Chugh: Our economic growth outlook is that India will have an economic growth of 5.5 percent in this year which would start getting better from the next year. With a lag we expect the banks should also start seeing bottoming of the asset quality problems within two years from now. But we need to continuously monitor.

The challenge for SBI is that it is a very large organization which brings in a complexity of its own. The other complexity factor for SBI is the fact that their priority sector obligations are seeing much more stress in the agriculture portfolio which is clearly a priority sector obligation for them. Having a pan India agriculture exposure they are not able to cherry-pick economically prosperous sections and so they continue to face higher stress.

We expect this stress to persist for the next 2 years, FY13 and FY14, after which we expect it to bottom out. Going by our outlook on the economy, from next year the economy should start getting somewhat better.

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Q: One of the important points you make in your stress test on Indian banks is that a key finding is that most banks can absorb the stress credit costs through profits and general provisioning that they have done so far except 5 banks. Which are the five banks that you are so worried about in terms of not having the capital or the provisioning?

Bhoumik: Those five names are in the report, mostly government banks. I want to make one point that the stress test obviously is a forward looking exercise in trying to estimate what could be the impact, assuming that the slowdown continues to linger and some of the pressures we are seeing on the infrastructure side were actually not to bear out the way the regulators or the reformers were to predict.

By that extension it is not necessary for us to start downgrading the banks because we would hate to do that when the cycle is bottoming out. Arguably if the economy were to revive next year then we would not like to have a situation where we are downgrading banks at this stage.
 
We have already taken rating actions on a couple of government banks which was UCO and Vijaya Bank earlier this year because we had seen some of their problems on account of structural issues such as concentration and funding. And we are taking rating action there. At this point we think a bulk of our ratings are aligned.

The problems are clearly in the mid-sized government banks which a) have somewhat lesser profitability, b) have somewhat higher concentrations in the power sector which is actually the one infrastructure sector which is facing problems and c) also had fairly accelerated loan growth rates in the last few years, meaning their funding are not as stable as you would expect in a government bank. But, by and large we think our ratings are broadly aligned.

Q: Which would be the other three banks you are worried about where profit and provisioning is not enough to cover losses?

Bhoumik: I think worry is also with respect to rating levels. We have talked about Canara Bank in our report because it is right at the upper end as far as standalone credit profile is concerned and it is indeed going through a turbulent phase. Canara seems a bit of an outlier at this point if you just apply the stress test but, we understand from management that there are plans to turn that around.

Couple of things are bearing out well, one is a basel III plan which is an extensive six-year plan to inject capital. It is good and secondly, the government's initiative to reduce the dependence on wholesale would mean that some of the business plans of these banks could indeed change. So, Canara Bank is an obvious outlier.

On Union Bank we always had that rating a notch lower than the better performing bank. That rating, the stress test output is in line what our rating levels are anyway.

Q: I actually wanted to come to you with regards to exposure to agriculture, one of the other banks which has a strong exposure to agri from the PSU space is PNB? They show their extremely dismal set of numbers in the previous quarter, how exactly would you be placed in terms of their asset quality trends going forward?

Chugh: We don't have a rating on PNB but, at least in our rated portfolio of government owned banks, State Bank of India and Union bank of India are outliers in terms of how their performance on agriculture sector is. While we have generally seen that the priority sector NPLs are on the higher side, SBI and Union bank both have NPLs in this segment in the upwards of 9 percent which is rather very high.

These two banks categorically stand out as outliers. As I explained part of it could be attributed to the fact that these banks have pan India exposure and they are not necessarily targeting the economically prosperous agriculture segment. Both banks are beginning to focus more on gold pact loans which should over a longer period of time bring down their NPLs in this segment because it will be collateral lending. That should help.

But, I think that will help only over a period of time. At least in the near term we expect these problems to persist for both the banks.

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Q: I understand there is a difference of opinion between the two of you on Union Bank. Ananda in your report while there is stress on Union Bank you believe that they have enough by way of capital as well as profits set aside to be able to tide over this stress?

Bhoumik: It is not necessary that we rate the banks exactly in order of which they come out in a stress report. There are other factors including funding. About Union Bank the point I made in the earlier half was that the national ratings on them at this point is not AAA it is AA+. So despite their numbers, there are other issues with them including capitalization which is why we rate them much lower than the best rated banks in India.

Q: You made another point about restructured assets and you say you expect 25 to 50 percent of the restructured book to slip into NPL. This is not what we heard either from the bankers or from RBI, the Mahapatra committee very clearly says it will be only 25 percent.

Chugh: When we talk about slippages happening from the restructured loans we are not talking about a one year period, we are talking about an economic cycle. A typical economic cycle, a down cycle could last a couple of years. If the economic down cycle is not too severe then the slippages will be on the lower side of our expectations which is more like a 25 percent. But, if there is a prolonged down cycle, these slippages could go as much as 50 percent. That is the first point I want to make.

Second point I want to make is the level of slippages that we will see will vary from bank to bank, it depends upon the quality of restructured loans as well. There are banks which have done opportunistic restructuring, there are banks which should have ideally reported accounts as NPL but they are reported as restructured.

Outside India interestingly, if a loan is restructured it is anyways classified as a non-performing loan. In our classification, we look at them together as weak assets. We do expect that slippages from these restructured loans will be high.

Q: We heard from IndusInd yesterday and they have been resilient in terms of the asset quality this time around, no additions to their restructured book, in fact it has fallen on a sequential basis. Give us a sense in terms of the asset quality trends in private banks and how would you be placed on them and which would be your top pick?

Bhoumik: I think there are two categories here; one is the banks with the superior product reach or branch reach which is the large private banks or some of the new private banks including the one you mentioned. The advantage they have is there are multiple products, primarily consumer focused or in the corporate. They are basically going after the better rated corporate.

They do not have any noticeable sector concentration which is unlike the government banks. One of the reasons why they have escaped the radar, the scrutiny this time around in terms of NPLs is exactly because the sectors that they are exposed to so far are doing quite well.

Having said that, we need to be a bit careful with some of the banks which are exposed to the SME sector, which are doing fine so far but, with the economic downturn at some stage that could just catch up. Some of the banks are strong on the consumer side including the unsecured consumer space and as long as they are adequately priced in, I think they should be able to see the cycle through.

But that's key. I mean we do not want banks to be acquiring customers at less than ideal pricing for competitive reasons at this stage. The point I am making is while the bottom-lines are good, we would be careful about private banks that are growing a bit too fast at this time at the expense of other banks who are trying to get market share because one needs to be a bit careful at this pace.

That is one sector which is basically the new private banks. Some of the old private banks of course are a bit more public sector undertaking (PSU) like and therefore, they have problems and that's also reflected in their ratings and in the stress test.

Q: When is the quarter or the half where you see the worst of stressed assets and when you see the banking sector kind of troughing out?

Bhoumik: I think March'13 is certainly going to be bad. I would think from the mid of 2013 we could see some relief.

Chugh: We continue to expect that there will be problems in March '13 as well as by March'14 and after that the banking sector's performance should start improving.