Moody's: Indian public and private sector banks' asset quality, profitability and loss absorbing buffers differ

Moody's Investors Service says that while the public sector bank, the State Bank of India's (SBI), profitability metrics could face lingering pressure as it spends the next 6-8 quarters rebuilding its balance-sheet buffers, its private sector counterpart, ICICI Bank Limited has seen significant improvement in its core operating profitability, allowing ICICI to absorb a higher level of credit costs.

"SBI is also showing a stabilization of its underlying asset quality, and we believe that recent developments provide further confirmation that it has moved past the worst of its latest asset cycle," says Alka Anbarasu, a Moody's Vice President and Senior Analyst.

 

Anbarasu explains that SBI's new impaired loan formation has slowed, and Moody's sees this development as a sign that, barring new adverse shocks, the bank's delinquencies in this cycle have peaked.

"By contrast, ICICI's asset quality has deteriorated over the last few quarters, and the bank's corporate loans will remain under pressure, because some of its corporate customers show weak debt servicing metrics," says Srikanth Vadlamani, a Moody's Vice President and Senior Credit Officer.

Vadlamani explains that ICICI exhibits a meaningful exposure to large corporates, and that the exposure represents a key source of risk for the bank's asset quality.

On the issue of loss-absorbing buffers, Moody's says that such buffers for SBI are weak, and that SBI's profitability will remain under pressure, as the bank seeks to rebuild its buffers.

In fact, a key weakness of SBI's credit profile is its thin loss-absorbing buffers, making its profit metrics highly sensitive to the credit-loss cycle. SBI reported a jump in credit costs to 2.2% of growth loans in the third quarter ended 31 December 2015 for the current fiscal year ending 31 March 2016 (FYE 2016) compared to 1.5% in FYE 2015.

This situation consumed 81% of SBI's pre-provisioning income and reduced its annualized return on assets to 0.21% from 0.68% over the same periods.

Nevertheless, Moody's expects that SBI's strong core earnings capacity as measured by operating/pre-provisioning profits as a percentage of total assets will limit downside risks for profitability, even if credit costs were to increase.

By contrast, ICICI demonstrates significant buffers to withstand a meaningful deterioration in its asset quality.

Moody's points out that ICICI has seen significant improvement in its core operating profitability over the last few years, with its pre-provision income (PPI)/average assets increasing to 3.18% for the fiscal year ended 31 March 2015 (FY2015) from 1.91% at FY2009. The increase in its core profitability was driven by structural improvement in its funding profile, as well as higher net interest margins and better cost-to-income ratios.

As a result, even if ICICI's non-performing loans increase sharply, the bank can rebuild its loan loss reserve levels over a reasonable period of time by providing for higher credit costs. Credit costs/PPI for the bank for the nine months to 31 December 2015 registered 28%, indicating that the bank has the capacity to support a much higher level of credit costs if required.

On the issue of capital levels, Moody's says SBI's capital will broadly remain stable, and access to internal and external capital sources is a key strength. Moody's expects SBI to maintain its capitalization levels, such that its common equity tier 1 (CET1) ratio will register around 9.0%-9.5% for FYE 2017.

ICICI exhibits strong capital levels, with a CET 1 ratio of 12.7% at end-2015. As demonstrated in the sale of its stake in its life insurance subsidiary completed in 2015 ICICI can further support its capital levels by selling down some stakes in its subsidiaries if needed.

As the largest bank in India by assets and deposits, SBI accounted for around 17% of system loans and 16% of system deposits as of end-June 2015. As of the same date, ICICI accounted for 6% of system loans and 4% of system deposits.

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