NPLs slowly stabilising, says Bk of Baroda's Mundra

Latha: Let me start with the road projects, there the government’s move is very clear. Premiums can be deferred by those who are building projects two lane to four lane, there the premiums can be played later even for four-six lane projects, some of them have been allowed to defer payments. Have you done any back of the envelope calculations, will it save some people from becoming non-performing loans (NPLs)?

Pai: We have done some back of the envelope calculations broadly. So, overall at more of a policy level, this is something which is a positive because people can defer their premium payments and that is definitely something that is going to be a positive over a period. Furthermore, what is important to state is that notwithstanding these positives, the reality is that the issues that the road sector is facing are slightly larger than this and issues like non-availability of land for completing their work.

Latha: Positive step is not taking us anywhere. Is it going to mean that those who would become NPLs are now saved from that simply because they don’t have to pay the government? There is a little more cash, they can pay the banks. Is there any tangible result like that?

Pai: I think we will be awaiting some of the finer policy details in that which we still don’t have at this point but all in all, definitely it could ease the liquidity situation for some of the developers.

Latha: On road projects it seems very tangible, in power tariffs there is still some time before the tariffs are raised and the distribution companies (DISCOMs) become solvent, what is the sense you are getting in roads, are you seeing that exposure a little safer now?

Varadarajan: My view is slightly different. A lot of policy initiatives happen on the power front and the effort has been to kick-start that sector, create more enablers in terms of getting the sector back on track. So, in power sector, I think we have seen a lot more policy initiatives.

As far as roads are concerned I think the problems are two-fold. One is the macro itself has had a bearing on roads a lot more than on power side because the overall traffic has been much lower.

To that extent, I don’t think it is a problem associated with the project or a developer as such but the overall traffic has been much lower because the macro has been very different from what has been projected two-three years back. If we believe we have hit the bottom and then things are going to look up, the traffic scenario and the toll collections also should looking up.

Latha: You don’t see any improvement because of exports because that is one part where we suddenly saw logistics companies shares rising.

Varadarajan: I think it will happen but it has not yet happened. But we can see that the macro impact on roads has been a lot more than any other sector and to that extent, whether it is operational or in terms of projects under development, we are seeing a lot more than that happening.

The redeeming feature on the road front is that tale associated with these projects meaning the loans are of 15 years but the concession is for 25 years. So, one has a 10-year leeway in terms of the concession, having the project and the cash flow associated with the project, even the loan is only for 15 years, so the cash flows for the next 10 years can be used to repay the loans.

So, it is not a question of whether the loan is going to go back or not because of traffic projections not being on track vis-à-vis what was projected three years back, there may be some cash flow tinkering which needs to happen. From a point of view, viability of the project or the loan itself, I think it is less of an issue.

Latha: Sooner or later that money will come is what you are saying, it may come a little late. But I am just asking you that for the system as a whole or anecdotally for your bank in particular, are you seeing that the number of road developers who might have gone bad is decreasing or that trend is not yet something you can speak about.

Varadarajan: I don’t think in roads we have seen some more restructuring but I don’t think roads going bad. That is the story across the banks. I would think if one you look at the interest of PE investors or equity investors in projects, the interest on roads is much more than any other sector. Anecdotally, if you see the projects which have been sold and the interest which you are seeing because primarily it is annuity based.

Latha: In roads, the trigger that clearly was visible in the stock markets, shares of Nagarjuna Construction Company went up 12 percent, IRB Infrastructure developers went up 8 percent and all the banking space, your bank in particular is up 20 percent in a week. The underlying assumption of investors is that probably things that would have gone bad, will now not go bad because the National Highways Authority of India (NHAI) Chairman has allowed them to pay the money back later. Your comment on road exposures, is the worst over?Mundra: Of course! Your question is encompassing both the road sector and the larger overall direction. But nothing wrong in starting with the road; if you have to commence a journey you have to come on the road only. I will extend what Varadarajan was mentioning. As a matter of fact, if we see the infrastructure story of past few years, there were two major sectors - power and road. _PAGEBREAK_ If I reflected my portfolio, at least the story thus far, the power was more affected sector, road was not so much affected. Of course fact remains that a number of projects were still under commencement and the whole issue was that if you look at the scenario today and run a stress test then probably there was a possibility that some of these projects may face the cash flow crunch for both the reasons, delay in the projects but also because of the slowing economy, the load coming down and the cash flow getting affected. That was the position.But at this point of time if I look at portfolio, I don't think that the position of the road portfolio in non-performing loan (NPL) formation was in a situation as the power portfolio had been. So, going forward now, of course the premium is one thing. If the macro picture improves, if the growth rate is to revive then traffic projections may also improve. However, one thing which I fully agree with Varadarajan that in whole road project or for that matter any infrastructure project, obviously the life of project and the cash flow 20-25 years, which for the purpose of financing, gets compressed in the 10-12 years. If sensitivity has to change on few parameters then it becomes a problem and then the NPL formation and other issues come up. While take out is one route but it is entirely different kind of a structure. I personally feel that I have argued at a few forums. There is a strong case when project life is 20-25 years; there is a merit that a tail can be allowed to left. Let's say 10 years from now and with a strong belief that at that point of time this tail can be refinanced. If the project has run and repaid for 10 years, there is no reason to believe why it cannot be refinanced at that point of time and the second phase of repayment can commence. That will take care of a lot of problems which we are facing today.Latha: Let me come back now to the power sector since the problem is larger and the government's efforts started earlier. What is your sense now, purely in terms of the situation at hand? Have the number of NPL started declining or do you think that you will see some more NPLs in that sector before things plateau out? Mundra: There were problems more in the power sector but in power sector, it will be very difficult to equate the entire power sector under one bracket because there were many kinds of division within that, one clear segment which can be signalled out is the gas based power project. Now, that is one segment where resolution is still some time ahead. It is not going to happen tomorrow. Within thermal there were a number of varieties, the domestic allocation, the mix of domestic and imported, the ones who are having the captive mines. So, there were a variety of factors but, fact remains that two-three things which have happened. First is the recent revision of tariff; the kind of policy direction which has come.The second thing is restructuring of state electricity boards (SEBs) and some of them have started moving in the framework which was decided, some of the mining getting clear. All these factors, if put together, the fear which we were having about that the magnitude of problem would be lower than what it was being felt a quarter back or two quarter back, saying that it doesn't mean that there won't be a problem. There would be still project specific problems but the magnitude on overall portfolio basis would certainly be diluted.Latha: Are you saying that fresh NPLs will be created but slowly or are you saying that the total stock of NPLs you have will start receding?Mundra: It will be both things. This talk of NPA as the project starts come on the stream, some of those may get out of the NPL position. But to say that there won't be at all a new NPL formation, probably it will be little too early to believe that. There could still be occasional cases and as I said the sector specific or the raw material specific which may still have some problems on hand.Latha: In the specific area of power and roads, in CRISIL's own rating, what is the rating situation, more upgrades, more downgrades?Pai: In both of these sectors, as of now, we definitely see more downgrades then upgrades and there are several policy level issues which need to be sorted out in both the sectors and we are much ahead on the power side compared to on the road side. So, as of now we see far many more downgrades.Latha: Far many more downgrades in both sectors?Pai: In both the sectors, we are seeing far many more downgrades. The issues could definitely be different in the two sectors but today we see many more downgrades and our estimate is that it will be a while before we start seeing upgrades in this sector.Latha: In power sector you are now seeing a decrease in downgrades also? Pai: Not really, not yet. It is too early.

Latha: If you can intervene the way Ramraj Pai ended the conversation. He said that on the ground, there are still more downgrades than upgrades or still rising downgrades in the power and road space, how is it with respect to the loans?Varadarajan: That is exactly how rating agencies and markets look. Rating agencies are going to go by what is happening on the ground, what are the last year’s financial results? I don’t think they will take a call in terms of how the sector is going to sort of change based on policy initiatives. Of course they do take a call but again in terms of factoring them, they will be a lot more conservative in terms of what could happen.

_PAGEBREAK_As far as the market is concerned, it also goes the other way in terms of trying to build a lot more bullishness than what possibly is happening on the ground. As they said, right upfront, power sector has seen a lot more changes than any of the other sectors primarily because media and everyone has kept it on a front pages for last almost one year. Banks have reasonable exposures to it and have been focused to trying to resolve some of this but whether with government or with developers.All I can say is that fuel supply agreements (FSAs) for 78,000 megawatt has been signed and even the linkages were not there, the projects are broadly nearing completion by March 2015, tapering linkages are being given so from a fuel side, I think things are happening. DISCOMs have raised prices over the last year to eighteen months and these price rises have been fairly substantial and overall across the country it is almost like close to 30 percent increase in tariffs have happened as far as the consumer is concerned.SME restructurings are in progress. You have seen some of the big state governments restructured, payments coming through for most of the developers from these state government DISCOMs.Lastly in terms of power purchasing agreements (PPAs), you have seen Tamil Nadu, you have seen Rajasthan, you have seen Uttar Pradesh, the PPAs have been bid out and the levels have been Rs 5 or higher and those are levels which projects clearly seem viable. Broadly things are moving and have moved substantially over the last six-nine months to say that the sector is in a much better position right now than before.Just to answer your NPLs, I think the projects were not the ones which were become NPAs. The RBI window of these two years in terms of extension of commercial production has turned out to be very right move where projects have got the time to breathe and get back on track. That is exactly what is happening on power. So it was not like any deferment of COD would have made it an NPA. That window which they gave has clearly helped in sort of putting the sector back on track.

Latha: Let me expand the argument a little bit more. On one hand we have seen a lot of project exports coming in for capital goods. So even if they don’t get local business, they are getting business from outside. Generally exports have increased but on the other hand, huge slashing of government plan expenses and last time around, that created NPLs. Growth is still at 4.8-4.7 percent that creates its own NPLs in the MSME-SME sector. Your comment on your own NPL position in Q4 and Q1 of next year and for the system as a whole; is the pain at its peak and going to recede or is there one more quarter to peak or two more quarters to peak?Mundra: Before that, just a couple of points on the power sector what Varadarajan had earlier mentioned. The couple of points like the number of stalled projects which were taken up further resolution and quite a few have been able to get the clearances, some of them have started picking up the tools again and we are also seeing some disbursement. So that is one factor I want to add.I also agree that as far as the rating is concerned, it takes some time. We are talking about the last year’s financials, we are talking about the leveraging level but even if you look from that perspective in the last couple of months, there have been few cases where people have been able to dispose off the surplus assets as they have been able to find the investors. These are all positive pointers. Now as far as the NPL formation is concerned, slowdown in the payment cycle is a worry. I have argued many times that we have many projects or the businesses, which are otherwise doing well, selling on profit, they have a demand but because the realisation is not coming and the NPL recognition in our system is rule based so despite all other things being positive, account can still face the prospects of being an NPA. But to my mind, we are about to enter into the next fiscal year and by then the formation of the next administration quite a few events would have taken place. Therefore, I believe the payment cycle in the economy would certainly improve and once that improves, it will help the accounts.Latha: Would you say that Q1 of next year will be the worst and you must see a receding of NPL pressure in the September quarter?Mundra: Why worst? If I talk about the Bank of Baroda (BoB), I have been mentioning from last four quarters - so I would see position stability and improving barring something very extraordinary happening in the macro environment.Latha: So for this quarter you think it is better?Mundra: Yes, I would see stability continuing. Even for the system, I would expect that now there should be a stability and improvement coming.Latha: This upgrade/downgrade overall picture, how is the ratio moving and in Q4 what is your forecast?Pai: From a ratio of about 0.6, which is about 60 upgrades to 100 downgrades in March 13, we are up to about 0.7-0.75 kind of number for the nine months ended. Our estimate is that therefore we are seeing a slight marginal kind of an uptick from the lows that we hit about nine months earlier. Our sense is that we will remain in that kind of a zone with a definitely positive bias upwards is what we would believe we would be able to see over the next few months.Latha: Now you are at 0.7 upgrades to 10 downgrades?Pai: Yes 70 upgrades to 100 downgrades and I think we should be marginally trending upwards.