Indian Banks at record highs
Last Friday, the Indian equity market, and Nifty bank index reached record highs, in local terms, on the back of improved economic growth, better than expected 1Q FY earnings and an expectation that the worst of the country’s bad loan problem is behind them.
Over the past few weeks, there have been some new developments on the banking front that have given investors renewed hope that there is light at the end of the tunnel for the resolution of India’s bad loan problem. To date, despite continued efforts by the government in terms of introducing a bankruptcy code and cash injections, NPLs have remained stubbornly high. According to RBI data, at the end of March, the gross non-performing assets (NPA) of the country’s financial institutions had reached 12.5% of all loans, a record high. Additionally, Fitch Ratings has reported that the cumulative losses at the state banks were almost equal to the entire $113 billion government infusion last fiscal year.
However, with the economy improving and continued efforts by the banks and the government to uncover and recognize impaired loans, analysts and investors are making the bet that these efforts will pay off. That sentiment seemed to be echoed by S&P in a report they published last week titled, “The Worst Is Almost Over For India's Banks”. In their commentary, they said that going forward, the ratings on these financial institutions are "more likely to be raised than lowered" in the next 2 years and that because of more RBI recognition standards, “Indian banks' recognized NPLs now cover a substantial part of weak loans in the system.” However, they caution that the recovery is still fragile and will unfold at a slow pace; most likely not generating an earnings recovery in the sector until fiscal year 2020.
This snapshot of the sector was reflected in last week’s ICICI’s earnings announcement. On Friday, the country’s third-largest lender posted a worse than expected first-quarter net loss on higher provisions for bad loans and treasury losses. The bank lost Rs. 120 crore ($17.47 million) compared with a profit of Rs. 2,049 crore a year earlier. According to Thomson Reuters I/B/E/S, the analyst community was expecting a net profit of Rs. 1,462 crore.
The bank, which has the largest amount of bad loans in the private sector added Rs. 4,036 crore in additional non-performing loans during the quarter. While impaired asset additions in the June quarter were the slowest in 11 quarters, total provisioning more than doubled on the year with an increase in recognized NPLs. In total, gross bad loans as a percentage of total loans was 8.81% in the 1Q FY, compared with 8.84% end of the previous quarter and 7.99% during the same period last year. While the pace of improvement is slow for ICICI, the deteriorating NPL metric shows an attempt to uncover and recognize non-performing debt which are a necessary part of the clean-up process.
There are expectations that this resolution will pick-up at a faster pace. Last month, more than 20 of India’s largest financial firms signed an agreement that will give a bigger say to the lead lender in a consortium and allows a workout plan to be approved if 66% of the banks involved agree to it. Dissenting parties would have the ability to sell their stressed loans to the remaining participants at a discount. State Bank of India was one of the main firms to sign the accord.
Although the headlines concerning India’s banks still appear to be negative, under the surface, the government’s efforts to force recognition, is making progress in bad debt workout. This, coupled with more capital injections this year, should mark a peak in the NPL numbers and allow earnings recovery in the next few years. The market already seems to be making that bet.