Banks : Marginal improvement - Annual report analysis on NPLs, restructured loans and others - Kotak

Marginal improvement. In FY2017, fresh slippages declined 17% yoy largely led by public banks. Gross NPLs increased 24% yoy largely due to weak recovery environment and elevated slippages. Provision coverage ratio improved ~270bps to 45% yoy nudged by18% yoy growth in operating profits. Restructured loans declined 140bps yoy to 2.8% of loans. We do see some early signs of improvement but resolution of problems in key sectors remains the key for instilling greater confidence in the recovery cycle.

Slippages decline 17% yoy to 4% of loans; still above average levels

FY2017 marks the first year in a decade where slippages declined 17% yoy. It still remains uncomfortably high at 4.6% of loans but we see this as a positive development as it is moving in the right direction. Slippages declined 28% yoy for public banks to 4.7% of loans while it increased by 85% yoy for private banks to 4.3%. Recent data from RBI suggests a sharp pullback in SMA-2 loans, which in our view is positive. NPLs in the corporate book are at 19%.

Divergence restricted to a few private and public banks; 0.6% increase in NPLs for FY2016

The divergence reported by banks: In the reported data, only nine banks showed over 15% variance. The chart shows that of the nine banks, five were from the private sector of which Yes Bank and Axis Bank had the steepest divergence. Among public banks, J&K Bank and IDBI had large divergences. We see an increase of ~0.6% in gross NPL ratio if we adjust this number to FY2016 NPL data taking gross NPLs to 8.4% of loans.

Strong growth in operating profits helps improve provision coverage for public banks

Operating profits grew by 18% yoy with public banks reporting an increase of 19% yoy and private banks 16% yoy. A large share of this increase came from growth in treasury income of ~140% yoy as interest rates declined in FY2017. We saw public banks reporting an increase in provision coverage of ~380bps to 44% while private banks, mainly ICICI Bank, reported a decline of ~380bps to 48%. We expect banks to further improve this coverage as we see stable operating profit in FY2018.

Restructured loans decline to 2.8% of loans from 4% in FY2017

Overall restructured loans declined to 2.8% of loans from 4% in FY2017. Note that a large decline was expected as their SEB exposure was moving out of their portfolios this year as well under the Uday scheme. Fresh restructuring for the year was negligible at 0.7% of loans and it mostly pertains to the infrastructure sector. Downgrades declined ~50% yoy with a near similar decline from CDR as well as bilateral portfolio. ~17% of the slippages was explained by restructured loans as compared to 24% in FY2016 indicating an increase in slippages from the normal book or the watchlist of individual banks.

Data on other formats still not very clear as there could be some overlap

The annual report did give a fair amount of disclosure on 5:25, SDR and S4A. Overall data in all these formats are not too high when we exclude NPL data from them. However, there could be a possible overlap with the restructured loan portfolio. Also, we note that banks have reported flow data as compared to outstanding making it challenging to understand overall stressed loans. We do believe that SDR and S4A have a higher possibility of taking a larger share of slippages from these portfolios as compared to 5:25 where most companies have taken the opportunity to reduce the mismatch in their project cash flows appropriately.

Visible decline in fresh additions to NPLs; first in the past decade for public banks

Overall slippages in FY2017 declined to 4.6% of loans as compared to 5.9% of loans in FY2017, which is a decline of 17% yoy. This is the first time that we have seen a decline in the pace of additions of fresh slippages in the past decade. Note that most public banks started reporting higher NPLs, mainly in the steel sector, following RBI's directive of reporting higher stress post the annual inspection of accounts. Hence, FY2016 could possibly be recorded as the peak of fresh slippages for the banking system for the current cycle. It remains to be seen if whether a repeat of such high NPLs will happen but it looks unlikely considering that a large share of metals and SME/mid-corporate exposure has already been declared as NPLs by the banking system. The improvement in SMA-2 performance in FY2017 does suggest a much more favorable outlook on slippages. This does not mean that we are likely to move back to normalized levels immediately considering that a fair share of infrastructure loans is yet to be declared as impaired. However, it does appear that this is the only sector where the stress is yet to be recognized. In other sectors like iron and steel, cement, textiles the outstanding share of NPLs is already high at 30-45%, as per the latest report from RBI.

Public banks have reported ~30% decline in fresh slippages which resulted in the slippage ratio declining to 4.7% of loans as compared to 6.3% of loans in FY2016. This is the first time in the past decade that showed a decline in slippages for public banks. On the other hand, private banks saw a sharp rise in slippages of ~85% yoy to 4.3% of loans as compared to 2.8% of loans in FY2016.

Overall gross NPLs for the system is quite high at ~9.7% as compared to 4.8% in FY2016, but the increase in NPLs have started to show signs of slowing down. As compared to NPLs which doubled in FY2016, the increase in NPLs in FY2017 was slower at 24% yoy. The increase in NPLs for public banks was 20% yoy while that for private banks was higher at 75% yoy mainly led by ICICI Bank and Axis Bank.

Divergence mainly restricted to nine banks; five of them in the private sector

In FY2017 banks reported their divergence to RBI their gross and net NPLs. The overall impact on FY2016 NPLs was negligible at 0.6% of loans, which implies gross NPLs would be at 8.4% as compared to 7.8% reported in FY2016. A total of nine banks accounted for the bulk of divergence which was greater than 15% as compared to RBI's assessment. However, nearly five banks from the private sector account for the bulk of this divergence. Yes Bank and Axis Bank had the highest divergences among private banks while J&K, IDBI and Bank of Maharashtra account for a large share of the divergence in the public sector.

NPLs in corporate and services takes the bulk of pain; retail NPLs stable yoy

The sharpest rise in NPLs were in the corporate sector followed by services. As per the data available from annual reports, NPLs in the corporate sector is at 19% and this would be higher if we include the balance of restructured loans which is yet to be reported as NPLs.

Improvement in provision coverage ratio of ~270bps to 44% in FY2017

After nearly a decade of continuous decline, provision coverage ratio began to move in the positive direction for the first time in FY2017 for public banks. A broadly similar trend is visible when we remove SBI from this list. Note that the dispersion across banks on provision coverage ratio is still quite high. Provision coverage ratio improved to 44% in FY2017 as compared to 41% in FY2016. Note that the provision coverage ratio does not include the technically written off asset portfolio.

Operating profit is ~30% of stressed loans or 45% of net NPLs in FY2017

Of the 33 banks that we covered in this study, we note that operating profit growth was fairly strong in FY2017 at 19% yoy. The growth is stronger for public banks at 19% while that for private banks was marginally slower at 16% yoy. We note that a large share of the growth was led by strong contribution from treasury income. Treasury income as a share of operating profits was at 27% for public banks as compared to 18% for private banks. Given that we are still looking at another year of muted interest rates, we expect the contribution from treasury income to remain relatively high for FY2018.

Overall operating profits were ~30% of overall stressed loans for the banking system. As a share of net NPLs this ratio improves further to 44% which implies that the operating profits for FY2018 should be broadly comfortable to further improve the underlying coverage for public banks. The underlying performance shows a marginal deterioration if we remove SBI from this coverage universe.

Restructuring of loans negligible

The outstanding share of restructured loans declined in FY2017 to 2.8% of loans. Actual restructured loans are likely to be marginally higher as we do not have FY2017 data for SBI's associate banks. On an absolute basis, this is a decline of ~30% yoy, the second year of sharp decline following ~40% yoy decline in FY2016. The decline is broadly similar across major segments like CDR and bilateral.

For the year, the decline has been led by slippages to NPL from standard restructured loans (80 bps), followed by write-offs (60 bps) and upgrades (50 bps) in the restructured portfolio. Fresh restructuring was similar to last year's at ~70 bps.

We note that all public banks in the table below have reported declines in outstanding share of restructured loans. Select banks such as Canara Bank, Vijaya Bank, OBC and PNB witnessed sharper decline in restructured loans possibly explained by the decline in exposure to SEBs. The sharp fall in fresh restructuring and high slippages/repayments led to a steep decline in FY2017.

Absolute amount of fresh restructuring declines 3% yoy

The fresh restructuring showed continued decline in FY2017. Sharp decline from FY2016 onwards reflected removal of regulatory dispensation which allowed restructuring of loans while continuing to keep them as standard loans.

In terms of mix of fresh restructuring through various modes, the share of CDR loans continue to decline to 6% of fresh restructuring while bilateral restructuring comprised 77%. With the introduction of JLF, banks have been able to identify these loans faster and look to address concerns at the earliest rather than waiting as we saw in earlier years.

Data from CDR forum suggests negligible fresh restructuring, compared to Rs23 bn suggested by bottom-up analysis of PSU banks. This difference could be the result of incremental additions to existing accounts.

Failure rate of restructuring explains nearly 18% share of slippages

As highlighted in our previous reports, we notice that the failure rate in restructuring has been on an upward trend in recent years. ~20% of FY2017 opening restructured loans slipped in to NPLs as compared to 22% in FY2016 and around 10-15% earlier. On an absolute basis, the outstanding share of slippages declined ~50% yoy in FY2017. CDR portfolio continued to show maximum weakness with ~30% of outstanding seeing downgrades in FY2017.

The other way to look at this would be to assess the contribution of slippages from the restructured portfolio to the slippages reported under NPLs. Here we note that the slippages explained by restructured loans have declined to 18% from ~25% in the previous two years. Many banks like Andhra Bank, BoB, Indian Bank, OBC, PNB and SBI saw more than 20% of the slippages explained by downgrades in the restructured book.

Reductions led by satisfactory performance broadly showing unchanged trends

FY2017 saw a reduction in the restructured loans due to satisfactory performance at 12% of opening restructured loans which is similar to that of FY2016. The reduction in the non CDR book was similar to the CDR portfolio. We do believe that this would include a fair share of loans from the SEB exposure which was taken off the books of the bank under the Uday scheme. The disparity across banks with respect to upgradation is likely to continue in FY2017 as well as many loans are closer to completion of their two years of satisfactory performance. This ratio should see further improvement considering that a large portfolio of loans have now completed or are closer to completion of their satisfactory performance period.

Fresh disclosures on new forms of restructuring (SDR, 525, S4A, etc.)

- Strategic debt restructuring (SDR). PSU banks in aggregate have about Rs522 bn i.e. ~1% exposure to SDR. However, nearly 30% of these loans are already classified as NPL by banks. There is likely to be an overlap between the remaining standard loans and standard restructured loans, but we are limited by lack disclosures here. There may be some inconsistency among banks with regards to including accounts where SDR has already failed. Relatively weaker banks such as United Bank, UCO Bank, IOB, Central Bank and Dena Bank have higher exposure to SDR loans.

- Flexible restructuring (5/25 scheme). PSU banks have nearly Rs730 bn of exposure to loans which have been restructured under the 5/25 scheme i.e. loans where repayments have been staggered over a longer time-frame compared to initial repayment schedule. NPL ratio is close to ~40% for these exposures.

Source : Equity Bulls

Keywords