Public sector bank NPAs may rise 180 bps in FY16

Regulatory forbearance yields gains but balance sheets and earnings quality worsen: Analysts

Bank stocks are a proxy for the country's economic growth and the promise of achche din (good days) have driven the prices of these stocks quite sharply over the past 12 months. Bank Nifty is up 82.5 per cent over the last one year, which is more than double the returns the Nifty has given in the same period. This outperformance, however, is not based on actual economic improvement, which is what has led the market to turn bearish on these stocks. The Bank Nifty is down 9.3 per cent after hitting a life-time high on January 27.

There are several reasons behind the market's scepticism. While slow credit growth and rapid accumulation of stressed assets are obvious enough reasons, regulatory forbearance and the downside risks emanating from it are also concerns. Through the slowdown, the Reserve Bank of India (RBI) has given banks many concessions by making changes to prudential norms, which enabled banks to provide less for all standard assets (0.4 per cent) and postpone recognition of losses for certain sector-specific loans. Despite these concessions, banks have continued to ratchet up impaired assets. Short-term gains might have followed these events for banks, says Emkay Global, but eventually stocks tend to underperform. "While a delay in recognising bad loans removes the pressure on banks to promptly deal with the problem, history suggests that delayed recognition only worsens the issue," the brokerage adds.

Despite concessions, large cap banks have seen non-performing assets (NPAs) rise fourfold from 2.7 per cent of loans in FY09 to 4 per cent of loans in FY14. Fresh additions of NPAs have risen from 2 per cent of loans in FY09 to 2.7 per cent in FY14. The deterioration in balance-sheet has led to a drop in earnings quality. Return on assets has dropped from 1.2 per cent to 0.9 per cent for large-cap banks.

Given that there is no sign of any revival in the economy, analysts are now coming to terms with the reality that earnings and returns profile will remain a challenge, as FY16 will continue to see a sharp build up in impaired assets. What will make matters worse is that the restructured portfolio of banks is now turning into non-performing assets. Analysts believe that impaired assets of public sector banks are understated due to sale of NPAs to asset reconstruction companies. With asset sales slowing down in FY16, the accretion of stressed assets will accelerate believe analysts.