 "PSU banks unlikely to achieve FY17 loan recovery targets: Morgan Stanley")
Anil Agarwal, Managing Director & Head of Asian Financial Research, Morgan Stanley, believes public sector banks will continue to lose market share going forward. He has had a negative view on public sector banks for the past five years and continues to prefer private banks despite the higher valuations. In a free-wheeling chat with Sheetal Agarwal and Hamsini Karthik from the sidelines of the Morgan Stanley India Summit, he explains why recoveries will be slower for public sector banks going forward. Edited excerpts:
March quarter results of most banks indicate that asset quality stress extends beyond Reserve Bank's asset quality review. How big is the asset quality demon? And when do you see the worries on this front easing?
For most of the banks, about 2% of the loan book was part of the AQR exercise. But some of the banks have actually reported 4-5% of their loan books turning bad. It is obviously much higher than AQR. Gross NPLs will keep going up but our view is that the big increase in new bad loan formation or slippages is behind us. They were roughly 4.5-5% of loans in FY16 and we think 2.5-3% of loan book will still turn bad this fiscal. Bad loan formation this year will be meaningfully less than last year. Loans from both banks' watch-lists as well as outside these lists will turn bad.
Most PSU banks have given high targets of recoveries in FY17. Do you think these are attainable? Why?
I do not think they will be able to achieve those targets. In this cycle, every bank is saying that they will recover 60-70% of every Rs 100 loan. The question is how? We have been talking about the same set of bad loans for the last 4-6 years. This means a large chunk of the loan book today which sits in these banks is just interest. So if it was a Rs 60 loan five years back, today it is around Rs 100 loan. The collateral against this loan might be Rs 40. So today, if you are selling me down that loan of say Rs 100 you are not going to get 60-70, you are going to get a certain fraction of the Rs 40. So my view is that the loss given default is going to be much higher simply because a large chunk of corporate lenders is just interest compounding.
How do you solve this problem?
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You either write off or you need to make a provision. Right now provision coverage ratios in these state-owned banks is 40-45%. So if I sell it down and an ARC buys it at 30 cents to the dollar, the bank needs to take a big hit which their P&L does not allow. So there is a logjam right now in recoveries.
The pre-provision profit includes just NII, fees and costs and is the buffer banks have in the P&L to take credit costs. For private banks, having higher corporate loans and a watch list of bad loans, their pre-provision profits on loans is say 500 basis points and their credit costs is about 100 basis points. So their profit margin is 400 basis points. Now even if their credit costs go up to 150-180 basis points, they have a huge margin where they can take the hit and still make return-on-equity of 10% for one bank, 15% for another bank. But these banks will still have good RoEs. For the state-owned banks, their pre-provision profits are now 150-180 bps and the credit costs are 170-180 bps, which is why most of these banks are making losses. In FY17, the margin before provision will keep trending down because net interest margins are under a lot of pressure.
That’s the key reasons why they are not providing. But if you dont provide then you are saddled with the bad debt for a longer period of time, you raise capital and just write it off.
There are two things which will help state-owned banks. One is additional capital which can be used to write-off loans. Second thing which could happen is if the economy starts picking up meaningfully then you will start seeing some recoveries, provision writebacks on some bad loans and the credit costs will start coming down. Given what's happening globally, it's tough to see that kind of recovery pick up.
There are two things which will help state-owned banks. One is additional capital which can be used to write-off loans. Second thing which could happen is if the economy starts picking up meaningfully then you will start seeing some recoveries, provision writebacks on some bad loans and the credit costs will start coming down. Given what's happening globally, it's tough to see that kind of recovery pick up.
Last year, total bad loans for banks stood at Rs 3 lakh crore and they now stand at Rs 5 lakh crore. For FY17, where do you see the combined figure?
We are saying that new bad loans will be about 2.5% of loans roughly. That would mean about $25-30 billion of new bad loan formation. Within that you will see some recoveries, upgrades and some write offs. So net-net that number depends on how banks provide for it.
We are saying that new bad loans will be about 2.5% of loans roughly. That would mean about $25-30 billion of new bad loan formation. Within that you will see some recoveries, upgrades and some write offs. So net-net that number depends on how banks provide for it.
Do private banks continue to look attractive at these valuations?
I have a buy on private banks. Globally, most financial companies are not generating much growth. Those banks are struggling to get ROEs of 6-7%. In India, you have banks which are growing revenues at 20-25% and will keep growing at these levels in the next five years. The compounding effect here is huge. So I would be worried about valuation multiples only if their compounding effect reduces. But right now, the compounding effect is there and as the economy is stable, the competition for private banks is just not there. We’ve had a sell on state-owned banks for five years now.
What according to you is a comfortable figure on PSU banks recapitalisation?
Historically, we have estimated this number at $40-50 billion. RBI move on allowing revaluation reserves as capital will give them a buffer of high single digit to $10 billion. So now they need anywhere between $30-40 billion. Its all a question of growth. My view is that state-owned banks complex as a whole with the new capital that comes in will be building in 8-10% loan growth and that they will continue to lose market share. The system will grow at 10-12%.
Increasingly, NBFCs are emerging as alternatives to private banks in terms of investment options. Do you see this trend continuing?
If 75-80% of the system is not growing, it is a field day for anybody who wants to growth. These guys (NBFCs) have adequate capital and they have learnt their lessons from the previous cycle. So if they want to grow on a particular segment, they can opt to do so. The optical loan growth number at 9.8%, which is very low and 80% of the system is growing at 5%. This means that the rest of the system can grow at 20-25%.