Ageing loans may weigh on banks in FY18

Expectations are rather mild over June quarter earnings of corporate India. With overall loan growth yet to spring up, expectations are equally mild even for the banking industry. Deutsche Bank expects banks under its coverage to post a 10.5% loan growth on an average and in such as lacklustre loan growth scenario they expect net interest income (NII) to grow at 16% and 8% for private banks and public sector banks (PSBs), respectively. Those at Motilal Oswal Financial Services feel that while the private banks could post an aggregate 11% net profit growth, many PSBs may turn from loss to profit in June quarter (but still below their past glorious performance).

The good news is that the rate of bad loan additions or slippages may reduce in June quarter. According to Deutsche Bank slippages ratio or proportion of loans incrementally turning bad may reduce from 4-9% in June'17 quarter for PSBs to 3-5.5% in Q1. For larger private banks such as Axis Bank and ICICI Bank, the ratio is expected to decline from 4.3-7.6% a year ago to 4-5.7% in Q1.

Yet, amidst these positives, banks, particularly the corporate-facing ones may still have to grapple with significant credit costs or loan loss provisioning. An analysis by Antique Stock Broking suggests that ageing related provisioning is likely to account for 56% to 107% of total FY18 bad loan provisioning. This suggests that while slippages may sequentially reduce, bad loan provisioning may remain elevated as banks will have to provide for older loans not meeting the repayment timelines or which are turning bad. Added to this, analysts at Deutsche Bank point out that credit costs could remain high for banks which have exposure to the 12 cases referred under Insolvency and Bankruptcy Code. With Reserve Bank of India asking banks to take higher provisioning towards these accounts, it could add pressure to their Q1 earnings.

"We note that banks like Bank of India, Punjab National Bank and Union Bank are going to be most vulnerable as ageing related provisioning coupled with requirement towards fresh bad loan formation will keep credit cost at an elevated level," analysts at Antique Stock Broking said in their note. They added that the total quantum of sticky provisions (that is ageing loans plus fresh slippages less — recoveries and upgrades) will account for 20% to 98% of pre-provisioning profits for these banks in FY18. Axis Bank, Bank of Baroda, ICICI Bank and State Bank of India could be relatively better placed as their provision coverage ratios are already upwards of 50%, they say.

Therefore with loan growth looking muted and provisioning remaining high, FY18 will be yet another year of dependence on non-interest income for many banks. Thankfully despite a fall in bond yields, analysts at Elara Capital highlight that change in accounting methodology for bonds could leave them with reasonable trading gains in June quarter. The increase in usage of products such as credit cards and ATMs is also expected to boost this income.