 "Anil Agarwal")
Anil Agarwal, managing director & head of Asian financial research at multinational financial services entity Morgan Stanley, believes public sector banks will continue to lose market share. He has had a negative view on PSBs for five years and continues to prefer private banks, despite the higher valuations. A chat with Sheetal Agarwal & Hamsini Karthik at the sidelines of the 18th Morgan Stanley India Annual Summit. Edited excerpts:
The March quarter results of most banks indicate that asset quality stress extends beyond the Reserve Bank’s quality review. How big is this demon? And, when do you see the worries easing on this?
For most banks, about two per cent of the loan book was a part of the Asset Quality Review exercise. But, some have reported four to five per cent of their loan books turning bad. It is obviously much higher than the AQR. Gross non-performing loans will keep going up but our view is that the big increase in new bad loan formation or slippages is behind us. They were 4.5-5 per cent of loans in FY16 and we think 2.5-3 per cent of the loan book will still turn bad this financial year. Bad loan formation this year will be meaningfully less than last year but loans from both banks' watch-lists, as well as outside these lists, will turn bad.
Most PSBs have given high targets of recoveries in FY17. Are these attainable?
I do not think they will be able to achieve those targets. In this cycle, every bank is saying they will recover 60-70 per cent of every Rs 100 loan. How? We have been talking about the same set of bad loans for four to six years. This means a large chunk of the loan book today which sits in these banks is only interest. So, if it was a Rs 60 loan five years back, it is now around a Rs 100 loan. The collateral against this 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 fraction of the Rs 40. So, the loss is going to be much higher, simply because a large chunk of corporate lending is just interest compounding.
How do you solve this?
You either write-off or need to make a provision. Right now, the provision coverage ratios in these state-owned banks is 40-45 per cent. So, if I sell it down and an ARC (asset reconstruction company) buys it at 30 cents to the dollar, the bank needs to take a big hit, which their P&L (profit and loss statement) does not allow. So, there is a logjam in recoveries.
The pre-provision profit is only NII (net interest income), 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 about 100 bps. So. their profit margin is 400 bps. Now, even if their credit costs go up to 150-180 bps, they have a huge margin where they can take the hit and still make a return on equity of 10 per cent for one bank, 15 per cent for another. But, these banks will still have good return on equity (RoE).
For the state-owned banks, their pre-provision profits are now 150-180 bps and credit costs 170-180 bps, which is why most of these 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 reason why they are not providing (provisioning). But, if you don't provide, you are saddled with the bad debt for a longer period of time; you raise capital and just write it off.
Two things will help state-owned banks. One is additional capital which can be used to write-off loans. The second thing which could happen is if the economy starts picking up meaningfully. Then, you will start seeing some recoveries, provision write-backs on some bad loans; the credit costs will start coming down. Given what's happening globally, its tough to see that kind of recovery pick-up.
Last year, total bad loans for banks stood at Rs 3 lakh crore. They now stand at Rs 5 lakh crore. For FY17, where do you see the combined figure?
We are saying new bad loans will be 2.5 per cent of loans, roughly. That would mean $25-30 billion of new bad loan formation. Within that, you will 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 (rating) on private banks. Globally, most financial companies are not generating much growth. Those banks are struggling to get RoEs of six-seven per cent. In India, you have banks which are growing revenues at 20-25 per cent (annually) 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. 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 (rating) on state-owned banks for five years now.
