FY19 Bank Outlook: Recovery in Sight; Credit Costs to Follow a Longer Tail

India Ratings and Research (Ind-Ra) has maintained a stable rating and sector outlook on private sector banks and large public sector banks (PSBs), while retaining the negative sector outlook for small and mid-sized PSBs for FY19. Private sector banks and large PSBs would benefit from early signs of macro revival, enabling them to start the credit growth trajectory. The credit costs for these banks would remain high but begin trending downwards through FY19.

The agency retains its negative outlook on mid-sized and smaller PSBs with weak capitalisation and disproportionately large stock of unrecognised stressed assets. These banks will find it increasingly difficult to grow and continue to lose their market share despite government infusion under recapitalisation, given the provisioning required for migrating to Indian Accounting Standards (Ind-AS) 109, along with asset quality overhang and Basel III transition, which would surge capital consumption. However, Long-Term Issuer Ratings of all PSBs are largely support driven and will mostly remain resilient on the expectations of continued government support.

Ind-Ra estimates the quantum of the government's proposed capital injection in PSBs (around 28% of PSBs equity base ending March 2017), together with the banks' proposed mobilisation of capital to largely cover the provisioning shortfall for their stressed assets. The agency estimates PSBs' capital requirement of INR2.06 trillion at a modest credit expansion of 8%-9%. Ind-Ra expects impaired assets to peak at 12.7% by FY19-FY20, while credit costs to witness an extended recovery period (FY19F:178bp; FY17: 253bp), due to aging of a large stock of non-performing assets added over the last four quarters (FY17: INR4.2 trillion). However, a meaningful proportion of mid-size stressed corporates (1.6% of bank credit as of September 2017) continues to be standard on bank books with absolutely no form of recognition and could slip to the non-performing category in the next 12-18 months.

Ind-Ra believes retail growth strategy merits cautious monitoring, given slowdown in the employment and average wage growth in the service sector. Ind-Ra conducted a study of the top employers in the service sector, which also form a part of the 500 largest corporates in India. As per Ind-Ra's analysis, employment and average wages grew at a CAGR of 4.4% and 4.1%, respectively, over FY15-FY17 (FY11-FY14: 7.7%, 8.7%). During the same period, retail portfolio grew at a CAGR of 18% (FY11-FY14: 13%). Moreover, the unsecured retail portfolio grew at a CAGR of 19% over FY15-FY17 (FY11-FY14: 11%), largely on account of the non-priority sector, with unsecured retail segment witnessing a substantial growth over the last 24-30 months. In addition, about half of the retail asset portfolio is constituted by mortgage (52% as of November 2017); real estate segment has been under stress with a large pile-up of under construction projects with significant delays. While Ind-Ra notes a part of the growth in the retail segment is from new to debt customers, the leverage of existing retail customers has seen an uptrend. In Ind-Ra's view, increasing focus on unsecured loans, with greater mix of non-traditional methods of sourcing and underwriting, needs to be monitored closely.

On the funding side, Ind-Ra's analysis reveals that about nine odd mid-sized PSBs were running high asset liability mismatches which could potentially impact their margins in the current increasing interest rate scenario. Additionally, the trend of shrinking wholesale deposits could reverse in FY19 owing to normalising credit growth. With increasing yields on capital market instruments, a portion of capital market borrowings may shift towards banks, thus creating a need for an upward revision of wholesale deposit rates.

OUTLOOK SENSITIVITIES

Ind-Ra's Long-Term Issuer Rating (which is used to benchmark senior bonds and Basel-III Tier-2 instruments) on PSBs will change only if there is any change in the government's support stance or a relative shift in their systemic importance.

Ratings for private sector banks and ratings on tier-1 bonds (such as AT1) for all banks are linked to the respective banks' standalone profile. Positive triggers such as improvements in funding gaps and single-name concentrations together with increased capitalisation levels and lower loan loss provisions may result in a positive outlook for banks whose ratings are driven by performance.

Negative triggers such as pressure on capital ratios due to weak profitability, spike in credit costs and delays in equity injections may lead to a negative sector outlook.

Powered by Capital Market - Live News