Why UBS Thinks Indian Banks’ Bad Loan Cycle Will Extend Into Next Fiscal

Just when Indian banks expected their bad loan burden to ease, analysts at UBS said the recent corporate rating downgrades would extend the asset quality cycle to the next financial year.

That, according to the brokerage which analysed 3,200 Indian corporate houses, would weigh on Yes Bank Ltd., Punjab National Bank, IndusInd Bank Ltd. and Bank of Baroda as they had higher exposure to the downgraded corporates (default category) in the past 12 months. The four banks’ exposure as a percentage of loan book in the default category is more than 1 percent.

While the improving macro environment could alleviate new stress on Indian banks, the deterioration in the last 12-18 months has yet to be recognised as non-performing assets, UBS said in its report. The brokerage expects the gross NPA formation for Indian banks to remain elevated at 4.2 percent in the financial year ending March 2021 and decline to 3.4 percent in 2021-22.

Indian lenders had begun to witness a decline in stressed assets in the financial year ended March 2019, helped by recoveries from resolution of large corporate houses such as Essar Steel Ltd., Bhushan Steel & Power Ltd. and Ruchi Soya Industries Ltd., among others, under the bankruptcy law, and a fall in slippages. But stress on banks’ balance sheets started to build-up again in the first half of the ongoing fiscal following a slew of debt downgrades at Anil Ambani's Reliance Group, Cox & Kings (India) Ltd. and CG Power & Industrial Solutions Ltd., to name a few.

According to UBS, corporates with debt equivalent to about 4.7 percent of system loans have been downgraded to non-investment grade in the first nine months of the ongoing financial year. That compares with 4.9 percent in the financial year ended March 2019. UBS considers corporates with BB and B-rated, C and D ratings as non-investment grade.

Also Read: Behind India’s Largest IBC Recovery: The Essar Steel Story

Also, the aggregate interest coverage ratio—used to determine how a company can pay interest on its outstanding debt—of 3,000 non-financial listed companies has deteriorated from 4.5-5.5 times in the last five quarters to 3.1 times in September 2019, a multi-quarter low, the brokerage said. That’s mainly because of the stress in the telecom sector. The interest coverage ratio of non-financial companies, excluding telecom, has remained largely in line with the two-year average of 5.7 times, it said.

Also Read: Patanjali Plans To Sell 20-25% Of Ruchi Soya Over Next Two Years

Target Price Cuts

Higher defaults will lead to higher provisioning requirements. Thus, UBS has cut the target price for select lenders.

• Yes Bank: Maintained ‘sell’ rating and cut target price to Rs 20 apiece from Rs 45.
• IndusInd Bank: Has a ‘sell’ rating and cut target price to Rs 1,150 a share from Rs 1,210.
• Axis Bank: Has a ‘buy’ rating but cut target price to Rs 950 per share from Rs 970. UBS, however, expects changes in the lender’s management team are likely to support its asset quality in the next cycle. “We continue to prefer Axis as we think its retail franchise is strong and valuation is inexpensive.”
• Bank of Baroda: Has a ‘neutral’ stance and cut target price to Rs 100 apiece from Rs 105.