Bank of Baroda (BoB), Axis Bank, ICICI Bank, and State Bank of India (SBI) could be staring at another wave of non-performing assets (NPAs), especially in the telecom and construction sector, as there appears to be a divergence between the credit rating assigned and the financial health of the corresponding corporate entity, says the latest sector report by Jefferies.
In a note on Indian banks and financial institutions co-authored by Nilanjan Karfa and Harshit Toshniwal, Jefferies suggests there is a potential “meaningful divergence” between the ratings and the debt repayment ability. YES Bank, Bank of Baroda, SBI, IndusInd Bank, and RBL Bank are amongst the banks, Jefferies says, that are most prone to “high risk” emanating from Anil Dhirubhai Ambani Group (ADAG), Cox & Kings, CG Power, DHFL and Essar Shipping.
Given the elevated debt serviceability ratio (the higher the ratio the poorer the ability to sustain debt levels), the 'A' rated corporate are the most prone to further credit rating downgrades. The report, however, points out that debt or interest repayment abilities of 'BBB' and below rated companies have seen an improvement.
“While the interest the coverage ratio for the ‘A’ rated group declined to about 5.6x in Q1FY20, the lowest in the last 14 quarters, a deeper analysis reveals that the 'AAA' rated companies have declined the most followed by the 'AA' rated ones. The coverage ratio, however, remains well elevated (for AAA and AA rated companies) so it has caused little issue,” the report said.
An analysis of companies -- who have not yet defaulted on payment, but are prone to further downgrades – includes those with ‘AAA’ rating (38 per cent), ‘AA’ rating (36 per cent), ‘A’ rating (11 per cent), and ‘BBB’ or below rating (14 per cent). They cumulatively have debt worth Rs 33 trillion.
On their part, markets seem to have taken cognizance of the report, with most stocks from the financial sector witnessing a steep fall on Tuesday. Nifty Bank, Nifty PSU Bank and Nifty Private Bank indices were among the top losers, falling 3.5 per cent, 7.7 per cent and 3.7 per cent, respectively. In contrast, the Nifty50 index had lost around 1.44 per cent.
NBFCs AT RISK?
Due to risk-aversion by Asset Management Companies (AMCs) and Mutual Funds (MFs), the onus of lending to the “bottom of the pyramid” has come on banks, Jefferies argues. That said, they believe, non-bank finance companies (NBFCs) are better positioned to brace any further asset quality downgrade given strong Tier-I capital, relative to gross NPA levels.
“Even if we draw out a scenario of doubling Capital to GNPA, we believe the Tier-1 ratio should be adequate to withstand a second-order impact on the banking system,” Jefferies said, cautioning that the risks are higher for NBFCs entirely dependent on the vagaries of banks and debt markets towards refinancing and repayments coming back from the asset side.
In this backdrop, Karfa and Toshniwal believe the potential gains from the corporation tax rate cut for the sector can be capped and that the earnings revival may be pushed to the second half of the financial year 2020-21.
Analysts bet on better-capitalised banks and NBFCs to reap the maximum benefit. Those at Credit Suisse, for instance, prefer well-capitalised banks, but remain cautious on public sector banks (PSBs) and NBFCs. “HFCs and insurance companies will see a limited benefit, as they were already operating at lower tax rates,” they said in a recent note.
CLSA’s top picks include HDFC Bank, Axis Bank, ICICI Bank, and SBI given their potential to plough back part of the tax cut gains to either build contingent provisions/invest. “Shriram Transport Finance Corporation, HDFC, and LIC Housing Finance are well placed among the NBFCs,” it said.
Jefferies, on the other hand, has ‘buy’ rating on Axis Bank, HDFC Bank, Bank of Baroda, SBI, and ICICI Bank due to their strong common equity tier (CET)-1, low on unidentified NPL and reasonable valuation
Jefferies on Banks