Will banks continue to remain under pressure in FY14?

In an interview to CNBC-TV18, Ananda Bhoumik of India Ratings and Vaibhav Agrawal of Angel Broking spoke about their outlook on the banking sector and the road ahead.

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Below is the verbatim transcript of the interview on CNBC-TV18

Q: Do you think the number of difference between downgrades and upgrades is declining?

Bhoumik: The ratio is a marginal number. If you look at a more statistically relevant number like corporate profitability or corporate debt protection measures, there, the erosion levels have started to stop. While they have not started improving as yet, till December, one can argue that perhaps things have bottomed out or are very close to bottom. On that premise, in January we said that asset quality could start easing off maybe towards the end of the year. So yes, there is possibly a sign of bottoming out.

Q: Is there something like default rate that you all measure and do you see that default rate falling?

Bhoumik: It is a slightly long-term trend and I don't think it changes quarter on quarter. Ratings are supposed to indicate the cycle measure of credit risks. Therefore, I don’t think rating volatility necessarily indicates turn of the cycle. They may indicate structural change like either company’s over leveraging or leverage coming down or funding profile changing or business model changing. Rating changes are more structure driven rather than cycle driven.

Q: With regards to asset quality, you are seeing signs of it having bottomed out. What is FY14 going to look like? Will it not get worse and therefore it has bottomed out or it doesn’t get better as well? It’s a protracted recovery, or do you see signs of some significant improvement in FY14?

Bhoumik: Significant, no if you presume we are talking of bank’s non performing liabilities (NPL) indicators. Unfortunately, these lag, therefore, the next couple of quarters, certainly March and then June and even December quarter would continue to worsen and then stabilise. Improvements, maybe in March 2014 quarter, but very mild. Corporates have leveraged over the last four-five years.

We do not see improvement in cash flows of the corporate levels significant enough to put corporates back at a debt-EBITDA level, back to where they were in 2008. That will take two-three years. As far as NPLs are concerned, our base case is peak around September, plateau in December and then gradually ease off in March 2014.

Q: The Canara Bank chairman expects his gross NPLs to come down by Rs 500 crore in the quarter that just ended, which means from Rs 6,090 crore, he expects it to tick at about Rs 5,500 with percentage coming down from 2.73 percent to 2.30 percent. Is this an industry trend? Do you think the worst of increase in gross NPLs is over and for the system as a whole, gross NPLs as a percentage of total assets could plateau, even fall?

Agrawal: There will be two-three banks in this quarter that would see a decline. Canara Bank has guided for that, even Allahabad Bank to an extent, has guided for that. So there maybe two-three banks that may report very good asset quality numbers. But the broader trend that we expect would be similar to third quarter which is a more or less plateauing.

First half of FY13 over FY12 was a 60 basis points increase in slippage rate, but in the third quarter it was only a 40 basis point increase. So ‘things are getting worse at a slower rate’ is all that can be said right now. Possibly, that would continue into fourth quarter as well. Most of the other banks indicate that there is a plateauing, but it is early to say that they would start being a substantial decline across the board for PSU banks.

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Q: This quarter Suzlon Energy may show up in the asset quality or restructuring. On what other accounts are you expecting some restructuring and which banks would it impact then?

Agrawal: We are not looking much at account specific details. There has not been much news flow in this quarter on that regard. Several PSU banks have guided for a large restructuring amount. For example, State Bank of India (SBI) itself had indicated Rs 8,000 crore restructuring likely and a number of other PSU banks also indicated similar trends. That is reflected in the corporate debt restructuring (CDR) pipeline as well.

The amount of restructuring for sure incrementally would be high in this quarter, but now the Reserve Bank of India (RBI) has also allowed banks to upgrade earlier restructured accounts. So, the outstanding restructured book for most of the banks is likely to be stable in this quarter.

Q: You expect things to peak by September, what is the figure you have in mind? At the moment we have 3.5 percent as non-performing loans (NPL) in the system. How much can it increase to?

Bhoumik: We are saying 4.25 percent between December and September, so another 50 bps to go.

Q: Is there any improvement in the interest coverage ratio? Rival rating agency pointed out another case due to which you will still have more deteriorating cases, but for the bulk, the sales coverage of interest is increasing?

Bhoumik: That is how the numbers looked like in September. They started improving and then they fell back in December, so September was bit of a stutter. Therefore, it is still early to predict a definitive strengthening there. In March, we will see some mild recovery and then take it from there.

Q: Which stocks are you recommending and with what kind of an upside?

Agrawal: Keeping aside the fundamentals that are only improving at a slower rate, the PSU banks are now once again back to their earlier lows, so there is a strong risk-off right now in the PSU banks and that is an opportunity to do some bottom-fishing in the banking space. In terms of our top picks, Axis Bank and ICICI Bank remain strong picks for us with a 25 percent upside.

In the PSU space, we now like SBI, Punjab National Bank (PNB) as well as Bank of Baroda (BOB) with 20 percent upside. Even in the midcaps, we would recommend looking at Allahabad Bank, United Bank, Indian Bank as well as Corporation Bank with upsides ranging between 15-20 percent for each of them.

Q: In the power sector, discoms are being able to buy more power. Maybe in a quarter or two, we will see some resolution to the fuel supply issues as well, to the PPA issues. Likewise in telecom, idle optic fiber and towers could get used. Are all these put into some kind of a model? Do you think all this will improve things more than your expectation?

Bhoumik: Some of these, especially, on the state electricity board (SEB) side are executions of something that has been decided and seems to be taking longer. The path is right. People are taking the right direction and that is good. Assets are viable and therefore, banks can expect very controlled losses on these assets, because ultimately there is a willingness to resolve these matters. The pace at which these things get done is a concern, but the direction is right.

Q: Basel III norms kick in, which will mean higher capital to be set aside by banks in FY14. Do you expect that to be a constraint to their loan lending?

Bhoumik: Not at all this year, because this year the requirements virtually are insignificant. It pops up for a few banks but then the government provided adequate in the Budget so not a new issue at all. Capital is not going to be a constraint this year.