Cloud over banks, NBFC stocks as moratorium ends and NPA concerns weigh

Impact of rising bad loans may become discernible only in the second half of FY21. This may hurt asset quality and earnings growth, particularly of small and medium-sized banks

A cloud of uncertainty hangs over the outlook on banking and non-banking financial stocks (NBFC) amid the indecision over extending the moratorium period. On Tuesday, the Bank Nifty index climbed nearly 2 per cent but failed to sustain the gains to end just 0.24 per cent higher. In an earlier session, the index had tanked 3.14 per cent. 

Banking and NBFC stocks have been laggards this year which makes them attractive bets. However, most investors have wary making large bets given the uncertainty over loan restructuring following the end of six months of moratorium period.

In recent months, excess liquidity has made its way into beaten-down banks and financial services firms. However, the rally seen from March lows hinges on hopes that the asset quality deterioration would not be to the extent as expected earlier.

The impact of rising non-performing assets (NPAs), however, may become discernible only in the second half of 2020-21 (FY21). This may hurt asset quality and earnings growth, particularly of small- and medium-sized banks. The Reserve Bank of India’s (RBI’s) assessment in its Financial Stability Report projects banks’ gross NPA formation to rise from 8.5 per cent in 2019-20 to 12.7 per cent by the end of FY21.

Banks have accelerated collection efforts and may soon launch board-approved restructuring for retail loans. “Banks expect nearly 5-7 per cent of the systemic loans to be restructured, while some private banks may adopt an aggressive NPA recognition policy instead of restructuring, which will keep provisions elevated,” said Anand Dama, research analyst at Emkay Global Financial Services.

Foreign brokerage UBS believes that asset quality risks in the near term have been pushed into the future as the governmental guarantee funding and restructuring rules would allow time for borrowers’ cash flow to normalise after lockdown and reduce overall default rates.

 

 

“We believe non-performing loan (NPL) risks are lower than our earlier estimates and the new rules would give banks more time to build provisions. The recent capital infusion at some banks and NBFCs are additional cushion. We cut our FY21/2021-22 estimates for gross NPL formation from 7 per cent/5 per cent to 4 per cent/5 per cent of loans,” observed UBS. ICICI Bank, Kotak Mahindra Bank, Axis Bank, and YES Bank have raised a combined Rs 47,000 crore in the past four months, while HDFC Bank has raised Rs 14,000 crore. Another four NBFCs have raised Rs 5,470 crore, shows the data from PRIME Database. Goldman Sachs recently upgraded State Bank of India — the country’s largest lender — to ‘buy’.

Market players say the RBI had taken similar measures in the 2008 crisis, but the loan book size of banks has grown manifold since then and the stress on asset quality became palpable even before the pandemic hit home. HDFC Securities Chief Executive Dhiraj Relli said the extension of the interest holiday may be necessary in a few cases, as businesses will have to be given time to recover from the pandemic.

“Although this could mean sweeping the problem under the carpet and deferring the pain for some cases, we really don’t have a choice. Hopefully, the provisioning requirements for moratorium and/or restructuring may prevent banks from evergreening. If banks continue evergreening by offering moratorium, the pain will compound and create a larger balance-sheet hole. If a blanket moratorium extension does come through, it may result in a sharp derating of the financial sector,” said Relli.

NBFCs may find themselves in a more difficult position than banks. “The overall liquidity scenario has improved for NBFCs, but underlying weak economic activity and general risk averseness keep growth in check. Moratorium rates have moderated, but remain high. Awaiting the asset quality fallout, most NBFCs have shored up provisioning buffers, weighing on profitability,” said Emkay’s Dama.

“We think NBFCs’ funding troubles could result in stronger pricing and higher loan growth for banks in the near term. We believe certain banks are well placed in the emerging landscape, given their strong offering of most financial products and solid retail deposit franchises,” added UBS.