In spite of sustained weakness in the macro-climate with rising non-performing assets (NPAs), asset restructuring and weak credit growth outlook, few voices have been raised on the long-term (two-year) outlook for Indian banks.
Macquarie Research, however, has called for a structural de-rating of the sector, citing the impact of these factors and tightening financial inclusion requirements on profitability and return ratios. Basel-III implementation from January 1, 2013 will lower leverage ratios for the sector and increase appetite for capital in five years, which in turn will increase the risk of dilution, significantly in this period.
“Stocks are currently trading at above 10-year averages on the back of a opaque book. The 20 per cent re-rating from recent lows more than adequately factors a 100 bps cut in benchmark rates and aggressive rate cuts are unlikely considering the fiscal and inflation dynamics,” the report states. The brokerage adds that its top pick is HDFC Bank with no other ‘outperform’ in the banking space, having downgraded ICICI Bank, Kotak Mahindra Bank and YES Bank to Neutral from ‘outperform’ on account of valuations. It has all ‘underperforms’ in the PSU banking space. Basel-III will require banks to achieve a common equity ratio of eight per cent and capital adequacy ratio of 11.5 per cent over the next five years. This means Indian banks will need to raise at least $30billion, assuming 18 per cent compounded annual growth rate for loans in this period, mainly to fund the projected growth.
Also, RBI has specified a minimum Tier-I leverage ratio of five per cent which isn’t specified currently. Indian banks maintain a capital adequacy ratio of nine per cent and Tier-I capital ratio of six per cent with no specified common equity limit at present. The average Tier-I capital ratio of Indian banks is 10 per cent with more than 85 per cent of it comprising common equity and about half the banks meet the Basel-II requirements already. The issue according to Macquarie is once growth picks up, it will compound the common equity requirements increasing the appetite for capital.
The brokerage has factored in a 10-15 per cent equity dilution for most banks in FY14 estimates which will be the first full year of the beginning phase of Basel-III implementation. Asset quality pressures are not going to abate with stress on the agriculture portfolio as well corporate and SME loans. Macquarie expects ‘stressed assets as a proportion of networth to rise to over 50 per cent by FY13.
For PSU banks this number will likely be over 90 per cent.’ Credit costs are expected to touch a 10-year high of 90 bps for PSU banks even as they increase by 25 bps for private banks. The report states ‘Non performing loans (NPL) provisioning coverage ratios including stressed assets (as well as a 10 per cent coverage on restructured assets) stand at low levels of 23 per cent for PSUs. Even on a reported basis, NPL coverage ratios are at 45 per cent for PSUs compared to regional peers whose coverage ratio is over 150per cent on an average.
Macquarie expects return ratios to reduce structurally as earnings ‘witness pressure from all components of return on assets namely: net interest income (slower loan growth and pressure on margins), higher operating cost mainly for PSU banks, increase in credit cost due to structural problems in some segments of infrastructure, deteriorating credit behaviour in agriculture and increased slippages from mid-corporate segments given higher interest rates and slowing economy.
Private banks are expected to feel the impact of priority sector lending norms which will tell on margins and profitability as well as asset quality. PSU banks earnings growth is expected to decelerate in FY12 as they post sluggish growth of 11-12 per cent for FY13/14. Private sector banks earnings growth momentum is likely to moderate considerably (an average growth of about 15 per cent over FY12-14E).
Extracts from a Macquarie report: “Indian banks: After the high, comes the hangover”, dated March 20
