Sharp rise in slippages, large corporate restructuring leading to higher stress

31 May 2012

Update

Financials

SBIN relatively better than peers; other large PSBs' net stress loans (ex Air India and SEBs) up 75-140bp



Overall net stress loans (NSL, defined as NNPA + outstanding standard restructured loans) for our universe of PSBs (public

sector banks) have increased to 7.3% (5.9% ex Air India and SEBs) v/s 5.1% in FY11. Excluding State Bank of India (SBIN), NSL

for PSBs are up 323bp to 8.13%. AI (Air India) and SEB have contributed bulk of increase in restructured loans, both

combined accounting for 195bp out of 323bp increase.

SBIN has the lowest proportion of NSL on the balance sheet at 5.5% (NNPA of 1.82% and OSRL of 3.65%). Also, it is the only

large PSB where NSL have remained flat YoY.

Ex AI and SEB, large PSBs have reported 75-140bp increase in NSLs, whereas midcap PSBs have reported 100-250bp rise.

PNB and OBC has one of the highest total NSLs; however, ex SEB and AI, their NSL are just 50-100bp higher than peers.

Stress loans increase led by restructuring of state

government entities

Over last one year, NNPA for PSBs are up ~35bp to 1.45%

and OSRL by ~190bp to 5.9% (up ~50bp to 4.5% ex AI and

SEB). Thus, overall NSL for PSBs have increased to 7.3%

(5.9% ex AI and SEB) v/s 5.1% in FY11. FY10 through

1HFY12, OSRL for PSBs remained relatively constant at

~4%. However, sharp increase in restructuring in 2HFY12

led to significant increase of OSRL as a proportion of

outstanding loan. Over past two quarters, OSRL has

increased from 4% to 5.9% in FY12.

Stress Loan rise significantly for large PSBs

Ex SBIN, stress loans among large PSBs increased 170-

450bp (75-140bp excluding AI and SEB). Among large

banks, PNB has the highest proportion of NSL on its

balance sheet at 9.4% (1.9x of FY11), of which ~300bp is

contributed by SEB and AI. Higher contribution of SEB

and AI (400bp of loans) is also leading to significantly

higher NSL for OBC (10.7% of loans). BOB's NSL is

relatively better than peers at ~5% (ex SEB and AI); but

this should also be viewed in the context of strong loan

CAGR of 28% over FY10-12.

Restructuring to increase further; asset quality to drive

valuation:

Challenging macroeconomic environment is

moderating growth and raising NSL in the system. While

GNPAs have peaked, further stress on account of SEB

restructuring (INR122b, 50bp of the outstanding loans)

and higher CDR cases will keep asset quality and

valuations under pressure. We like banks with strong

liability franchise, superior capitalization, and stability

at the top management level (specifically for PSBs). Top

picks:

SBIN, PNB, ICICIBC, YES

and

UNBK.

Smaller banks' NSL in the range of 6-11%

SBIN's NSL performance better than peers

Although SBIN faced higher challenges in terms of

significant increase in net slippages over past two years

(average of INR126b over FY11/12 v/s average of ~INR43b

over FY07-10), 16pp improvement in PCR (+9%

improvement in last one year) and the bank's

conservative restructuring policy led to 50bp decline in

NSL to 5.5% during the same period. Even excluding

restructuring of AI and SEB, SBIN's NSL remains the

lowest among PSBs at 5.3%.

NSL: PNB highest among large PSBs; SBIN much better

NSL:

Net Stressed Loans |OSRL: Outstanding Standard Restructured Loans

Alpesh Mehta

(Alpesh.Mehta@MotilalOswal.com) + 91 22 3982 5415

Sohail Halai

(Sohail.Halai@MotilalOswal.com) /

Umang Shah

(Umang.Shah@MotilalOswal.com)

Financials | Update

NSL at 7.3% of loans; further SEB restructuring of 65bp at least

SBIN has lowest NSL, INBK highest; AI and SEBs account for 140bp of NSL



NSL is defined as NNPA + outstanding standard restructured loans (OSRL).

Over the last one year, NNPA for PSBs is up ~35bp to 1.45% and OSRL up ~190bp to 5.85%

(4.55% excluding AI and SEB, up ~50bp).

SBIN has the lowest proportion of NSL at 5.5% (NNPA of 1.82% and OSRL of 3.65%). SBIN

is the only large PSB where NSL remained flat YoY.

Excluding SBI, large PSBs have reported 75-140bp increase in NSL (ex- AI and SEB) and

midcap PSBs 100-250bp.

Challenging macroeconomic environment, policy logjam, lag impact of agri debt waiver

scheme, and government mandate of complete recognition of NPA via system led to

significantly high stress on the FY12 balance sheets of PSBs (public sector banks). In

this note, we try to analyze asset quality of PSBs over the last couple of years based

on the metric of net stress loans (NSL), defined as NNPA + outstanding standard

restructured loans (OSRL).

NSL up significantly to 7.3% of loans v/s 5.1% in FY11

Over last one year, NNPA for PSBs is up ~35bp to 1.45% and OSRL up ~190bp to 5.85%

(4.55% excluding AI and SEB, up ~50bp). Thus, overall NSL for PSBs has increased to

7.3% (5.9% ex AI and SEB) v/s 5.1% in FY11. FY10 through 1HFY12, OSRL for PSBs

remained relatively constant at ~4%. However, sharp increase in restructuring in

2HFY12 led to significant increase of OSRL as a proportion of outstanding loan. Over

past two quarters, OSRL has increased from 4% to 5.9% in FY12.

NSL for PSB increase (%)

While stressed loan for PSBs has

increased 220bp YoY; it was flat for SBIN

NSL ex-SBIN higher (%)

Of the 320bp increase in NSL 190b was

on account of SEB & AI

SEBs expected restructuring in 1HFY13

While GNPA has peaked expect further

restructuring in 1HFY13 led by SEB

restructuring and CDR

Expected SEBs restructuring as a %

to o/s loans

Source: Company/MOSL

31 May 2012

Financials | Update

Analyzing asset quality trend: The NSL methodology and assumptions

Due to difference in reporting of slippages, upgradation and recoveries across PSBs,

we believe movement of net slippages is one of key matrix to analyze apart from

movement in PCR. Net slippages if seen in isolation may give a misleading picture

due to aggressive restructuring or conservative policy of upfront recognition of stress

as NPA. Thus, to judge the asset quality movement we have analyzed movement in

net stress loans on a quarterly basis.

Key assumptions used to make net stress loans comparable:

As the reporting format

of restructured loans varies from bank to bank we have made some key assumptions

to make it comparable.



PNB:

Data for OSRL (net of repayment) is available since 1QFY12, therefore

historic (FY11) numbers are adjusted accordingly to make it comparable



CBK:

In 4QFY12, bank changed its accounting policy from gross basis and also

excluded undisbursed loan for which we have adjusted 4QFY12 nos (based on

discussion with the managment.



UNBK, ANDB, DBNK:

Report facility-wise; so we have incresed outstanding

restructured loan by 25% to make it borrower-wise



IOB:

As slippage from restructured loan book is not available, we have assumed

5% (based on reported numbers of OSRL of peers) of it has already slipped and

arrive at net OSRL.

SBIN relatively better than peers; significant increase for other large PSBs

SBIN faced some tough challenges in terms of significant increase in net slippages

over past two years (average of INR126b over FY11/12 vs.average of ~INR43b over

FY07-10), however 16pp improvement in PCR (+9pp including technical write-off)

and the bank's conservative restructuring policy led to 50bp decline in NSL to 5.5%

during the same period (NSL remained flat as comapred to FY11). Ex AI and SEBs NSL

stood at 5.3%, one of the lowest among PSBs. For all other large PSBs, NSL (ex AI,

SEBs) is up 75-140bp, and for midcap PSBs 100-250bp.

Improvement in PCR and increase in Gross NPA

Even as pressure on asset quality persisted for SBIN, it

increased its PCR significantly

Stressed assets one of the lowest amongst peers (%)

While NNPA has increased standard restructured loan as a %

to overall loan book has declined leading to overall decline

in stressed assets

PCR (cal %)

Source: Company/MOSL

31 May 2012

Financials | Update

NSL highest for PNB among large banks; high loan growth saves the day for

some PSBs

Among the large PSBs, PNB has the highest NSL in FY12 (1.9x of FY11) at 9.4%, broken

down into NNPA of 1.52% (+70bp) and OSRL of 7.85% (+366bp). AI and SEB loans which

got restructured formed 300bp of the NSL. Thus, even excluding the same, NSL is still

high at 6.4% of loans. Strong loan CAGR of 25%+ over FY10-12 partially helped lower

NSL percentage.

BoB's

reported NSL rose 230bp to 6.5%; however, excluding AI and SEB, increase in

NSL is much lower at ~50bp of which ~20bp is contributed by NNPA. However, lower

percentage increase should also be seen in the context of strong loan CAGR of ~28%.

CBK's

NSL at 6.3% is the lowest after SBIN. However, it has not yet restructured any

SEB loans. Management has guided for SEB restructuring of INR55b, adjusting for

which NSL would increase to 8.5%+ in line with peers.

Mid-cap PSB NSL up 100-250bp; INBK and OBC lead the pack

Among mid-cap PSBs, INBK had highest NSL at 11.2% (9% ex AI and SEBs) followed by

OBC at 10.7% (6.7% ex AI and SEB).



INBK,

at the end of FY10, already had significantly high NSL at 5.8% which further

increased to 7.4% in FY11 and 11.2% as of FY12. ~25% of the restructured loans for

INBK are from Textiles.



OBC

has the highest proportion of troubled government entity accounts on

balance sheet. Bank has guided for additional SEB restructuring of INR18b (1.6%

of loan book) in 1HFY13. Higher NSL as % of loans should also be seen in the

context of lowest loan CAGR of ~16% over FY10-12. Prior to FY09, restructured

loans are excluded in disclosure of OSRL.

Stressed loan proportion increase (%)

SBIN only bank to report stable stressed loan; SEB & AI forms

10 - 300bp of stressed loan for large PSBs

Strong loan growth for PNB and BoB leading to lower NSL %

SBIN NSL also be viewed in context of moderate loan growth

Source: Company/MOSL

31 May 2012

Financials | Update

Sharp increase in stressed loan among midcap PSBs (%)

While OBC has highest proportion of NSL percentage AI and

SEB constitutes bulk of it

Loan growth for mid-cap PSB (%)

Magnitude of increase in percentage of net stressed loan

seems higher in case of OBC due to higher restructuring of

state government entities and moderate loan growth

DBNK

Sequential Change in stressed loan (in bps)

Most PSBs see sharp increase in stressed loan in 2HFY12 led by restructuring of state government entities

FY12

-13

-110

FY12

-2

102

FY12

-4

234

152

189

Chg since

FY11

-1

433

228

308

174

243

FY12

-52

-39

-8

-56

FY12

-24

122

4Q Chg since

FY12

FY11

400

375

160

325

544

242

421

245

371

106

290

510

190

130

277

Source: Company/MOSL

SBIN

PNB

BOB

BOI

CBK

UNBK

INBK

OBC

CRPBK

DBNK

ANDB

IOB

31 May 2012

Financials | Update

Restructured loans, slippages rise sharply for most PSBs

Air India, SEBs account for 140bp of 185bp rise in restructuring in FY12



For FY12, restructured loans as a percentage of outstanding loan book stands at 5.85%,

up 185bp over FY11. Of this, 140bp was contributed by restructuring of state government

entities (Air India and SEBs).

For most PSBs, OSRL (outstanding standard restructured loan) is in the range of 5-8%.

Among large banks, PNB's OSRL is the highest at 7.9% (4.9% ex AI & SEBs) v/s 4.2% in FY11.

For PSBs, net slippages have also increased significantly in FY12 to INR417b (1.7% of

opening loans) v/s INR247b in FY11 (1.3% of opening loans).

PCR declined for most of the large PSBs. SBIN was a clearly an exception wherein the PCR

over past two years has improved 16pp to 60% in FY12. Including technical write-offs,

SBIN's PCR improved 9% to 68%, second best among PSBs after BoB's 80%.

Standard restructured loans rise significantly; SBIN a major contrarian

For most PSBs, OSRL is in the range of 5-8%. Among large banks, PNB's OSRL is the

highest at 7.9% (4.9% ex AI & SEBs) v/s 4.2% in FY11. Most other large PSBs also saw

OSRL rise 150-450bp in last one year. Amidst this, SBIN's performance was commendable

with OSRL down 20bp YoY. If we consider a two year horizon, SBIN is the lone bank to

have seen a decline of 60bp in OSRL . This, to an extent, also exhibits SBIN's conservative

approach of upfront taking off stress in form of NPA rather than going for aggressive

restructuring. In case of BoI, ORSL is up 50bp over last two years to 5.8%. However, it

is yet to recognize AI as restructured loan, adjusting for which OSRL would be 6.7%. Of

this, SEB which got restructured accounts for 1.1%.

Net slippages increase to 1.7% of opening loans v/s 1.3% in FY11

For PSBs under coverage, net slippages have increased significantly in FY12 to INR417b

(1.7% of opening loans) as compared to INR247b in FY11 (1.3% of opening loans). We

prefer to look at net slippages rather than gross slippages due to difference in reporting

format which makes it non-comparable. BoB's net slippages increased 2x (although

on a lower base of FY11) to INR25b (1.1% of opening loans), while for SBI and PNB they

rose ~1.6x (already on a higher base) to INR154b (2% of opening loans v/s 1.6% in

FY11) and INR44.7b (1.8% of opening loans v/s 1.5% in FY11).

Among smaller banks, OBC and INBK witnessed significant increase in FY12 net

slippages to INR26b and INR16.2b v/s INR11.5b and INR8.2b in FY11. Higher slippages

in case of OBC were led by sharp increase due to system-based NPA recognition. In

case of INBK, higher slippages were from a few large corporate accounts (mainly in

4QFY12).

PCR declines for most PSBs

Further, due to higher asset quality pressure, PCR (cal.) declined for most large PSBs.

Significant increase in net slippages led to sharp 20pp drop in PCR (cal.) for both BoI

and OBC. PCR for other banks (ex SBIN and DBNK) eroded by 4-15pp. SBIN was a

clearly an exception wherein the PCR over past two years improving 16pp to touch

60% in FY12. Including technical write-offs, SBIN's PCR improved 9% to 68%, second

best among PSBs after BoB's 80%.

31 May 2012

Financials | Update

Stressed loan proportion increase (% of opening loans)

Higher net slippages and increase in addition to restructured loan accounting for higher stress. SBIN net stress addition were

lowest at 2.3%; most of the mid-cap PSB and amongst the large PSB, PNB witnessed significant stress

*AI is included to make nos. comparable

Sharp increase in NNPA among midcap PSBs (in bps)

Significant increase in net slippages couple with drop in PCR

leading to increase in NNPA

AI and SEB form 45-95% of additional restructuring in FY12

Other than AI and SEB other SRL contributed 20-200bp in FY12

(in bps)

PCR declines across banks except SBIN

Increase in pressure on asset quality led to banks depleting their PCR; SBIN on the contrary saw significant improvement over

past two years

PCR (calculated)

Source: Company/MOSL

31 May 2012

Financials | Update

Valuation and view

Interest rates to gradually decline in FY13

In April 2012, RBI cut policy rates by 50bp (repo at 8%) to revive economic growth.

Banks have partially passed on benefits of recent rate actions (50bp repo cut, 125bp

CRR cut and 100bp hike in MSF limit) with 25bp cut in lending rates. For lending rates

to fall further, decline in cost of funds is imperative. However, liquidity conditions

remain tight and deposit growth still low. Higher Reserve money growth (via OMO or

fall in CRR) will be key for deposits growth in FY13. Our economist expects a further

rate cut of 25bp in June monetary policy and 25bp CRR cut in July monetary policy

review.

Macroeconomic environment challenging; expect loan growth of 15-16%

Our interaction with bankers suggests moderation in new sanctions continued even

in busy season of FY12. As in FY12, in FY13 too, working capital is likely to be a key

driver for corporate loan growth. Lag impact of 2-3 years of continued moderation in

capex cycle will have impact on other loan segments.

NIMs to remain healthy; factoring in 10-15bp drop across banks

Tight liquidity conditions, elevated CD ratio, higher asset quality stress and pricing

discipline among all the large players in the industry kept NIMs healthy in FY12 despite

sharp increase in cost of deposits. Moderating growth, fall in interest rates, and the

government's moral suasion to reduce lending rates will put pressure on NIMs.

However, margins will be cushioned by fall in CRR and benefit of capital-raising for

some PSBs. Nevertheless, for our coverage universe, we model in NIM moderation

of 10-15bp.

Asset quality - a key to valuations

While GNPAs have peaked, further stress on account of SEB restructuring (INR122b,

50bp of the outstanding loans) and higher CDR cases will keep asset quality and

valuations under pressure. We like banks with strong liability franchise, superior

capitalization, and stability at the top management level (specifically for PSBs). Top

picks:

SBIN, PNB, ICICIBC, YES

and

UNBK.

31 May 2012

Financials | Update

Neutral

31 May 2012

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