Banks : NIM-short term tailwinds and cyclical headwinds : Deciphering the cause of recent compression of NIM - Kotak

NIM-short term tailwinds and cyclical headwinds. 1QFY18 has accentuated the pressure of NIM as several banks reported a decline. RBI appears to have valid concerns on the base rate transmission being less sensitive to changes in policy/deposit rates, though the central bank's data shows the MCLR regime to be effective. The recent compression appears to be driven by shift from a high spread base rate to MCLR as well as by slippages. Improving pricing is a challenge as liquidity is high, as is the availability of funds from alternate channels; the shift in loan mix towards retail is also a factor.

MCLR movement appears to be effective in meeting the regulatory requirement

The recent observations from RBI to conduct an internal study to understand the transmission of policy rates is leading to fresh concerns for an industry that is seeing sharp NIM compression in recent quarters. Steep cuts in a relatively short term raise concerns despite our negative outlook on NIM being discussed quite frequently. Reported data from RBI suggests that the transmission of policy rates on MCLR can improve-it has been as good as possible in the circumstances but the base rate appears to be far from satisfactory. If anything, the historical link between base rate and deposit rates appears to have broken with the introduction of MCLR.

Negative outlook on NIM anticipated but pace of compression is unsettling

Hindsight and data analysis suggests that the escalation of NIM pressures could have been anticipated: (1) The cuts in MCLR in January 2017, which is still hard to explain, resulted in a sharp divergence between MCLR and base rate - this made it easier for borrowers to shift. Pressure from alternate channels was quite high, this resulted in the spread between fresh loans and weighted average loans expanding to counter this challenge. The impact was a bit more severe for public banks as they have been giving fresh loans at even higher spreads to the base rate or average lending rate as compared to private banks (2) Deposit rate cuts have not been commensurate and CASA ratio growth does not explain the rate cut in MCLR rates. (3) High slippages and elevated NPLs are leading to income de-recognition and lower interest earning assets.

Deposit rates have room to move downwards; MCLR rates steady in recent months

With 35-60% of loans moving to MCLR, we see some relief from a NIM compression standpoint. Recent cuts in deposit rates, by SBI for example, in May and June, 2017 and recent change in savings rate have not been accompanied by a rate change in MCLR. Weighted average term deposit rates have declined by ~35 bps since January 2017 while lending rates have been stable in this period. Incremental transition to MCLR should not be as painful and we expect the pace to slow down as the corporate portfolio has a fair share of loans that are currently impaired and may not move immediately into MCLR. Finally, we are seeing spreads between the weighted average lending rates and fresh lending rate gradually narrowing. Slippages are showing signs of softening, leading to lower income de-recognition.

NIM drivers still negative

Even as NIM moves back to a slightly better position from current levels, the underling drivers for NIM still remain negative. We see comfortable liquidity conditions, falling interest rates, high NPLs still leading to lower income de-recognition, a loan mix that is shifting towards lower yielding retail loans and low visibility of loan growth leading to higher competition for better-rated corporates.

Source : Equity Bulls

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