Is the worst over for PSU banks?

Rating agency Moody’s has said that Indian banks' outlook is set to stabilise as asset quality concerns bottom out. The rating agency in a report said  ‘India’s banking system is moving past the worst of its asset quality down cycle, supporting its stable outlook - Baa3- over the next 12-18 months.’ The report however, adds that while the quantum of impaired loans may still increase, the pace is likely to be lower.

SBI chairperson Arundhati Bhattacharya has also made the same point but for a different reason. She points out that that the level of stressed assets in the banking sector will come down once the key industrial sectors start functioning at their optimum capacity. Manufacturing activity in the country is down to 60-65 per cent of the installed capacity as against a desired utilisation of 80-85 per cent.

PSU banks have travelled some distance from their recent lows. The NSE PSU Bank index has moved from a low of 1,894 in mid-February 2016 to the current level of close to 3,200. During this period, financials of PSU banks have deteriorated further. Since the financials are yet to improve, equity analysts are not convinced that the recovery is anytime soon.

Macquarie Research in a report titled ‘Indian Banks – It’s still a tough road to recovery’ say that stressed assets picture remains worrisome. Despite all talks of recovery in the economy, stressed assets were as high as 13.5 per cent of loans in FY16.  Slippage ratio, says the report is at one of the highest, if not the highest level at around 6 per cent for PSU Banks.

The reason analysts are not comfortable to call the bottom in PSU banks is because of the opacity of the data. Multiple forbearances and resolution mechanisms over the years – including restructuring, SDR (Strategic Debt Restructuring) and 5/25 scheme have created opacity in bank balance sheets.

Data submitted by banks do not reflect the optimism of rating agency and SBI chairperson. Disclosures of ‘watchlist’ suggest further deterioration of assets. As per Macquarie, leading corporate lenders – SBI, ICICI Bank and Axis Bank – have disclosed watchlist accounts which could be a large source of stress in FY17/18. In the case of Axis Bank, watchlist forms around 6 per cent of loan book and its management expects 60 per cent of these to slip into non-performing category by FY17/18. For ICICI Bank, watchlist stands at 8 per cent of loan book while for SBI, impaired assets plus watchlist accounts for 8.8 per cent of the loan book.

Though analysts are apprehensive, there seems to be some truth in the hints given by Bhattacharya and Moody’s. If one looks at the stress in the PSU banks it is predominantly on account of steel, construction and infrastructure. Steel sector has been adequately protected by the government through import duties and has shown signs of improvement. As work picks up in the infrastructure and construction space, chances are companies in these sectors will start reviving.

Rise in share price of PSU banks suggests the worst is behind us as we are close to the end of the recognition cycle. Capital requirement needed for PSU banks to meet the Basel III requirement can result in dilution going forward, but the banks that are well capitalised like SBI and Bank of Baroda are on the radar of the investors.