The Indian banking sector has had an eventful past two weeks. On November 2, rating agency Moody's upped its outlook on Indian banks from negative to stable on the back of what it called 'improving operating environment' and hence, slower pace of additions to problem loans.
The agency said these stressed or problem loans have risen from 4.5 percent of total loans in March, 2011 to 10.2 percent by June, 2015, but added that the stressed loan portion should stabilise at these levels over the next 12-18 months. Any rise will occur at a slower pace and will largely be from power and steel sectors where known problems will become recognised.
On the very next day Fitch Ratings corroborated this view. It said stressed assets, that is, Gross non-performing loans, plus restructured loans which stood at 11.1 percent of total loans in March 2015 will soften to 10.9 percent by March 2016.
Both agencies say the stabilising of bad loan problem will be because of a mix of a 7.5 percent gross domestic product (GDP) growth, government spending, speedier approvals from government for projects and resolution of legacy problems such as coal linkages and debt-laden power distribution companies.
There are still some who disagree with this optimistic scenario. Brokerage Credit Suisse, in its report called, 'House of Debt', points out that the top-10 most leveraged groups have shown a further rise in stress in FY15. Their debt is now seven times their earnings before interest, taxes, depreciation and amortisation (EBITDA) in FY15 from 6.8 times in FY14. The loans of these 10 groups are still standard with banks. Counting this debt, the stressed loans will rise to 17 percent.
Care Ratings, meanwhile, says that while the number of upgrades has been more than the number of downgrades since FY13, the total value of loans at risk of default is rising.
Separately, a bunch of big banks announced their Q2 results in the last 10 days and the three biggest banks, State Bank of India (SBI), Punjab National Bank (PNB) and ICICI Bank have shown a lower creation of fresh bad loans in the second quarter versus the first quarter.
So is the worst over for bank asset quality? That is the question asked to Srikant Vadlamani, the banking analyst at Moodys; Saswata Guha, the analyst at Fitch Ratings; Arun Kumar, the head of corporate ratings at Care Ratings agency and Pradeep Kumar, the just retired MD of SBI.
Below is the transcript of Srikanth Vadlamani, Saswata Guha, TN Arun Kumar & P Pradeep Kumar’s interview with Latha Venkatesh on CNBC-TV18.
Q: On what basis are you confident that the quality of assets will not decline further? To what extent are you expecting numerically the quality of assets to improve by March 31, 2016?
Vadlamani: I think the way we framed this problem is that we think it is a problem of recognising already existing problems. There is no real new problem coming in. It is just a question of when you want to recognise already existing problems. So, in that context, when you look at what has happened so far, the reported or the recognised impaired loan ratio in the loans to industry for the system as a whole is around 20 percent. Clearly, not an insignificant amount.
So, we believe that there has been a fair amount of recognition already done. At the same time, we do identify that there are certain pockets, specifically the power and the steel sector where there is going to be more recognition to be done. But, even after factoring that in, we believe that the pace of new additions should come down.
Q: So, what is you calculation of the total stressed assets now?
Vadlamani: The way we put it is that if you look at the pace of new impaired loan formation rates, it was running at around 3-4 percent for the last three-four years. We expect that number to be closer to 2 percent this year, the year ending March, 2016 and maybe, slightly lower, maybe around 1.5 percent the year after next. So, essentially, maybe another 3-4 percent of net new additions is yet to be seen.
However, when we say impaired assets, we are adding gross non performing loans (NPLs) plus standard restructured loans. And that for the 11 rated public sector undertaking (PSU) banks that we rate, is around 12 percent. For the system as a whole, I think it is around 13.5 percent.
Q: What is the number you are working with in terms of impaired assets and what is your definition?
Guha: In terms of the definition, it is largely the same where we look at both the gross NPL ratio and to that we add the performing restructured loans ratio. But that being said, I think some of the results that have been coming out in the last few days seem to corroborate our expectation and belief that while yes, the new cases of NPLs are certainly slowing down, but clearly, what we are seeing is a higher slippage occurring out of the existing restructured loan book. And, we believe that pressure will continue to be maintained. Of course, it is a different story altogether in terms of the existing stock that is already there and that remains a significant challenge for the state banks.
Q: Can you give me some numbers that you are working with? What is the total gross NPL and restructured assets that you are working with now and where do you see it by March 31, 2016?
Guha: Like I said, we expect the gross NPL ratio to touch almost 5 percent, so our number is around 4.9 of the 10.9 total. The rest is essentially restructured loans ratio. If you see, the total stressed asset book as on March, 2013, for the system was 10 percent. So, what we are essentially saying is that while improvement will happen, it will be very gradual. To give you a flavour our expectation in fact for March, 2017 for the system as a whole, stressed asset ratio is actually 10.5 percent which means that we are still expecting that by March, 2017, the number will be higher than what we have seen as of March, 2013. So, we are expecting a recovery but a very gradual one._PAGEBREAK_
Q: There is just one more issue with the impaired loans. There are a lot of loans which are standard but, which are getting recast but, they are not called restructured, they are called refinanced through a technical term called 5/25. The loans are recast for about 20 years and the initial period of the loan is five years. In this list, we have loans like Essar Steel which is a 20 year old steel plant. We have Ratnagiri Power, which again is a 20 year old steel plant strictly speaking. Would you count that as an impaired asset and would you worry that that number may take the entire impaired assets higher?
Vadlamani: When we gave our estimates of 2 percent net addition to impaired loans, we are not really factoring in any benefit from 5/25. So, if the 5/25 is used in immaterial fashion, the actual reported numbers could be lower than that, but we would not really see that as a sign of asset quality coming in better than what we are expecting.
Q: My question is would it not reverse your thesis that asset quality is improving because a lot of what is declining is not being recognised as declining. It is being papered over? Would that change your thesis?
Vadlamani: I think there are two points here. One, 5/25 would be seen as genuine loan or a recast or should we look at that as a restructured loan? We agree with you. We think it should be looked at as a restructured loan, but the issue with the 5/25 is that whatever evidence we get is anecdotal, there will not be any standardised disclosure because it is not a regulatory requirement.
So, the way I would put it is that, when we look at our estimates of what is the sort of impaired loans that we expect to come this year and the next, we are not really assuming any benefit coming in from 5/25. So, we are saying, let us say no 5/25 exists, what is the sort of impaired loans that come in? But 5/25 is a reality, so the actual numbers maybe, I just pointed out some of the big accounts get benefit from the 5/25, the actual numbers we will see after 6-12 months could seen better than what we are projecting, but we would take that with a pinch of salt.
Q: I am actually wondering whether that questions the thesis altogether, because a fresh set of loans are not being recognised and therefore, the total number of impaired assets which is gross NPL plus restructured assets plus refinanced assets would actually be a higher number in March. Is that possible?
Guha: To your question on whether we are factoring to an extent the whole rescheduling under 5/25. In our scheme of things, I would say yes to an extent. Again, I would agree with Srikanth when he says that it is very difficult to assign a finite number to that. But in our set of assumptions, what we have actually said is that a restructured loan in absolute terms is likely to increase as a result of some of the strategic debt restructuring or 5/25. But, the extent may not be as much to influence the total number to rise further up from current levels.
Q: Lately Care has come with maximum number of default ratings. We saw default of Lanco, GMR, JP, a whole bunch of assts. What is the thesis from the corporate angle. Are the numbers of upgrades more than the number of downgrades?
Arun Kumar: For the last two years we have seen the data - the upgrade-downgrade ratio. We call it the modified credit ratio. It is upgrades plus reaffirmations divided by downgrades plus reaffirmations - that means above one, meaning that the upgrades have been exceeding downgrades and just to correct the sentence - it includes even banks, so it includes everything - all ratings are included here.
Q: When you say that the numbers of upgrade are higher than the number of downgrades from second half of FY14? What is the value of assets that are upgraded and value of assets that are downgraded? If you go by the value, will you still say the amount of stress is declining?
Arun Kumar: We have a thing called Care Debt Quality Index (CDQI) which we publish every month. We have not taken the entire sample because it is not possible to track the entire sample of Care rated companies. So we have taken a static pool of some ratings as of March '12. So with respect to March '12, which is 100, index rate 100, we track month on month what is the value; value weighted one, for example for default rating it will be zero, for AAA rating it will be the highest value. So we ascribe this value, weighted average of this value has been declining.
Latha: So the stress is in the system?
Arun Kumar: With respect to '12 definitely today is worse-off and that is what we say in terms of overall credit quality in the system and we do expect this to fall in a couple of months more, it is expected to fall and thereafter we expect the economy to stabilise and recover.
Latha: You are basically contradicting what the other financial rating agencies are saying. You are expecting further defaults at least in terms of amount of money at stake?
Arun Kumar: Not default per se, downgrades._PAGEBREAK_
Q: What is your sense? Do you think that the stress is going to be incrementally less or do you think you just have to wait for a couple of more quarters before you can make that comment?
Pradeep Kumar: I think stress is going to be incrementally less. If you see the numbers of State Bank of India, both for Q1 and Q2 which has been published, for the last three years the quarter-on-quarter decline has come down which is an indication that the stress is coming down albeit not at the pace that which a banker would like but yes, it is coming down. It is perhaps an indication that the stress is coming down very slowly as one of them said incremental NPA formation is going to be slower yes, gross NPAs in terms of numbers about to increase but the incremental pace is going to be much lower.
Q: But these slippages do not include as I have been harping ad nauseam those loans which are not recognised. 5/25 - let us assume only for the sake of hypothesis that it is a troubled asset. It's an impaired asset, it is stressed asst. It is not yet a default. In that case if you include that category, would you still say that as a ratio of total we will come down or we have to wait to make that statement?
Pradeep Kumar: I have been telling you continuously that I do not agree with you on that. We have on our books quite a few good accounts, standard accounts where we have refinanced the loan because there is an option given to us. And you must understand world over this is the way projects are financed. It is only in that in that country we didn't have to option because any refinancing, RBI was calling as restructuring and you must understand refinancing is done only of standard assets. It is not done of stressed assets. If you do a refinance of NPA it will continue to be NPA.
Q: I take your point that a lot of healthy companies have re- extended their credit lines because they are faced with some temporary downturn. I am not denying that but the analyst community continues to maintain that loans like Ratnagiri or like Essar Steel, which are 20 years old and which have got a refinancing or will get refinancing, can be passed off as non NPLs or non stressed loans. This is not my definition. This is accepted industry norm. So I am going by what the investor community wants. There they see stress and if you were to include that would you say that we have to wait for a quarter before things..
Pradeep Kumar: Couple of things I would not like to comment on individual accounts but I would like to say whenever we do refinancing under 5/25, we do for 80 percent of the remaining life of the asset. You must understand many of the steel plant, power plant have very long life. They are not 10-12 duration. Revenues do come in even after 25-30 years. So there is nothing wrong for us to extend the tenure. I am not talking about any specific asset.
Q: We have had a bunch of announcements. The power distribution companies are likely to see their loans getting transferred to state governments as well disentangling of environmental clearances, fuel linkages. Are you getting a sense that the policy environment is going to make for better loans and less bad loans?
Vadlamani: I think from operation environment perspective things have been on the positive track. There may be a debate on the pace of it but directionally we think it is on the right track and having said that we need to set the expectations right. The crux of the problem that we are seeing both in the corporate sector as well as in the banking sector is a balance sheet problem. There is too much debt on corporate balance sheets; banks have lot of NPLs and too little capital. Balance sheet problems, if you have to resolve them quickly, the only way of doing it is by infusing a lot of capital. Absent that, by definition the recovery will be slow because for leverage to come down you need to get the benefit of time. So we need to keep that in context whenever we are evaluating the extent of policy effectiveness.
Latha: What is your take? You think that credit offtake is likely to crawl higher. We cannot expect too much of green field but are you seeing the first signs of urban discretionary demand returning, retail demand returning so much so that the stock of good loan rises to smother the percentage of bad loans?
Pradeep Kumar: If you see the banks growth in loans in the last four-five years, the corporate book has primarily grown due to project growth. Of course the retail growth has been fairly good. This year also I find even the public sector banks retail growth at more than 15 percent; of course some of the private sector banks have done very well beyond 20 percent. Retail growth continues to be -- very good opportunities that are available. As regards demand from corporate, I would say it is still muted. Yes, maybe it is better than what it was -- if you had asked me this question six months back but it is not something like there is a huge demand. I think the demand for credit will grow up slowly.
Q: What is the kind of credit growth you are expecting this year for the industry?
Pradeep Kumar: May 12-13 percent at best.
Q: Which is still better than what you did last year?
Pradeep Kumar: Yes.
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