Bank GNPAs may rise to 16-17% of loans in 1-2 yrs: Credit Suisse

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The banking system could be staring at gross non-performing assets (GNPAs) of somewhere in between 9.5 to 16.5 percent by the end of FY18 or some time in FY19, estimates Credit Suisse’ MD and India Head of Research, Ashish Gupta. “There are already banks where the gross NPA number is close to 20 percent,” he notes in a chat with CNBC-TV18’s Latha Venkatesh.

While total gross NPAs or bank loans in default currently stand at 9.5 percent of the total loans given by banks. Credit Suisse says a further 4-8 percent of the loans are stressed, that is they are restructured in some form and could become default category or NPA in the next 18 months.

Gupta also believes if banks need to do a fair level of provisioning on these stressed loans to get to an NPA coverage of about 65-70 percent, they need additional capital of USD 20 billion.

Since RBI provisioning requirements are based on the age of NPAs, roughly Rs 86,000 crore of additional provisions will need to be made by banks just on existing NPAs over the next 12 months. This is because a lot of the NPAs were recognised after RBI’s asset quality review (AQR) a year ago and a step up in provisioning is needed as the process moves into the second year.

Gupta has been analysing the debt of 3,700 listed companies amounting to about Rs 30 lakh crore for over two years now and his reasearch reveals that at the third quarter of a whopping 41 percent of corporate debt is with companies whose earnings are less than their interest outgo.

In June 2014, when Credit Suisse first put out this report 36 percent of the companies were in this state where their earnings were less than their interest outgo.

Below is the transcript of Ashish Gupta’s interview to Latha Venkatesh on CNBC-TV18.

Q: First up your report says that of the Rs 30 lakh crore of corporate advances that you track, 41 percent are with companies who are not making enough money to pay the debt. But, can we at least be sure that this number is the peak, that things are improving with steel prices rising, etc?

A: Actually, our observation from this health tracker is a bit of a disappointment because what we were hoping for in the last 6-9 months is that we should see some relieving of stress levels in the banking systems and in the corporate sector given the rally in the commodities and in particular, the steel sector, because as you know, steel has been a large component of non-performing assets (NPA) that banks have had to recognise in the last 12-18 months.

But frankly, that has not been the case and the reasons for that has been two fold. One that the recovery in the steel sector has been limited to only a select few companies. Some of the overleveraged companies continue to have their earnings before interest, taxes, depreciation and amortisation (EBITDA) level much below their interest cost. And still, what we find is 52 percent of steel debt is sitting with companies with interest cover less than one. Of course, this is better than around 65 percent six months ago.

The second reason why we have not seen the stress actually improve but actually deteriorate slightly over the last six months is that in other sectors, the problem has continued to deteriorate. Two sectors that we have particularly noted, one is the power sector where the stress over the last 6-9 months for most of the generating companies has deteriorated and if you even sequentially look at their EBITDA generation, that has continued to drop. And more lately, even the telecom sector has seen their interest cover fall below one.

If I see power sector, now 67 percent of power sector debt is with interest cover less than one and about 45 percent of telecom debt now has interest cover less than one in our sample. That has been really the broad finding of this health tracker that while overall corporate profitability has not deteriorated, but companies that are under stress, companies that have interest cover less than one, every quarter they are still seeing their EBITDA contract.

Q: Let me take your list of 100 top stressed companies. This has, in your list, Tata Motors
, Adani Power
, Steel Authority of India
(SAIL), JSW Steel
, Tata Teleservices , Kesoram Industries
, Reliance Defence . All these may not default at all because of their sturdy parent groups that they belong to. Should you actually be putting them in your list of your 41 percent stressed loans?

A: We do not imply that the table you are looking at are companies that have interest cover less than one. We are not really looking at all companies that have interest cover less than one turning NPA for the banking system. We are only looking at a sub-set of these companies and these are primarily companies or assets that have been under chronic stress for 2-3 years. So, some of the names that you have mentioned have had an issue on the slip-up just for a quarter or two. So that is really not an area of concern for us. So, in our health tracker, the total magnitude of debt that has interest cover less than one comes out to nearly 40 percent. But we are not saying that 40 percent of bank loans are NPAs. So, our estimates for bank debt that is stressed is about 16-17 percent of their total debt.

Q: Currently, gross NPAs are 9.5 percent of total bank loans. What is the worst it can go to?

A: Now, on top of that 9.5 percent, you already have a piece which is restructured which is another 2.5 percent or so. On top of that, already there are special strategic debt restructuring (SDR) kind of structures. So, there are various tools that RBI has provided and banks have used for the asset. If you add all those pieces together, already that number, for the banking system is close to about 14 percent. We believe that the total amount of stress could be around 16-17 percent.

Q: So, in Q4 of FY18, that is next year, will we be staring at some 16-17 percent gross NPAs?

A: All of it may not turn NPA and many of these forbearances provide a standstill in terms of recognition for 18 months or so. But clearly, we will be midway between 9.5 percent that we have to today and the 16-17 percent that we are talking about. Also, just to point out, the numbers that we are talking about are aggregate for the banking sector and within this, if you individually look at banks, there are already banks where the gross NPA number is close to 20 percent, aggregate state owned bank number is already in double digits. So, there are pockets in the banking system where we are already seeing numbers of this magnitude.

Q: The mid-point of 9.5 percent to 16.5 percent gross NPA, so let us take 13 percent? When do the gross NPAs get to 13 percent? Will that be in FY19 or FY18?

A: For really working out what is the percentage in terms of picking out, you also need to keep in mind the denominator and that is how far the overall loans go. So, if overall loan growth does start to pick up let us say some time during next year, then hopefully in terms of percentage terms, we peak-out some time next year.

Q: The economic survey says that from the second half of 2016, even small and medium companies which were running a tight ship have started defaulting. Your 13 percent gross NPA number includes this category as well?

A: The 13 percent number includes the micro, small and medium enterprises (MSME) pain to the degree it has already been recognised by the banking system. But, we do not have data to do any forward looking analysis of those loans and therefore, in our forecast, we are not really building in incremental addition from there.

Q: Will the normal evolutionary process of growth not cure all this stress? Companies get more orders, product prices rise, volumes grow and so the stress as a percentage of total revenue decreases.

A: I do hope it helps some of the corporates and some of the groups deduce their stress, but I do not believe that can be a solution for the entire problem and the reason being A] the scale of the problem is very large and B] that this problem has been festering now for at least 4-5 years. Therefore, already the aggregate leverage of these stressed companies is much higher than their peers. So, if you see today, there are steel companies which are very profitable while still you have steel companies or half of the steel companies that are unable to cover their interest costs. The primary reason for that is the half that does not cover their interest costs, the debt levels are too high.

So, the waiting game does not help here because you need to right size the debt. So, even in power, there are many such cases where the capital costs per megawatt or debt per megawatt is much higher today for some of the projects that have been delayed for 4-5 years and it is even higher than what it would cost to set up a greenfield project today.

Q: The economic survey says of the top 100 stressed borrowers, 10 of them will need more than 50 percent of the debt to be cancelled and 57 will need 75 percent of their debt to be cancelled which means two thirds of the companies need more than 50 percent of the debt to be cancelled. Any idea what is the quantum of debt that is so unsustainable that we are talking about?

A: I do not have those numbers at the top of my head, but what we estimate is that if banks need to do a fair level of provisioning on these stressed loans that is get to an NPA coverage of about 65-70 percent, then they need additional USD 20 billion of capital. Another number I can provide you is just in the next 12 months because RBI provisioning requirements are based on the age of NPAs, Indian banks will need Rs 86,000 crore of additional provisions just on existing NPAs because as you may recall, a lot of these NPAs who are recognised after RBI’s asset quality review (AQR) one year ago. As we move into the second year, there is a step up in provisioning that is needed.

Q: What about the banks? Would you say you are less worried about the top five banks like ICICI Bank
, State Bank of India
(SBI), Bank of Baroda
(BoB) who have NPAs in single digits? Do you think that on the other extreme, those with 20 percent gross NPAs just need some political surgery or they will not survive?

A: The other way to look at it would be that you have to find a solution asset wise or borrower wise. So if you are going to try to identify 25-50 borrowers and find a solution for that magnitude of debt, that will virtually touch every bank. As I said, most of these borrowers are dealing with 30-40 banks. So, it is difficult to find a solution for a single bank because the borrower that is stressed has relationship across the banking system.

Q: Now let me come to the bad bank idea. Both you and the economic survey say that bankers have lost the will to sign on decisions like foregoing debt. But even in a bad bank the problem will remain the same. Do you see an bureaucrat, any babu having the guts to cut down a large part of the debt of a known large defaulter? Will he have the spine?

A: That really can be resolved based on the structuring of the bad bank. So, if the bad bank is structured where the government ownership is not in excess of 51 percent, where there is additional contribution to the equity from the banks themselves or from state owned enterprises, etc. thereby giving government an effective control or an effective majority then some of these challenges may not exist. So a lot will depend on how the bad bank is structured and empowered if it is decided to be set up.

But clearly, this will be one of the basic questions that needs to be thought through when on the decision of setting up a bad bank is taken. So, just setting up a bad bank in the public sector domain does not help unless it is equipped to be able to undertake faster decision making.

Q: Do you think answer lies in something like the previous government’s project monitoring group (PMG) led by Anil Swaroop? That group coordinates with all the ministries and the banks and forces them to take a solution?

A: There can be various structures that are looked at. What you are essentially referring to is rather than bad banks have a balance sheet, it just becomes an off balance sheet structure where the assets continue to sit with the banks and someone else tries to resolve them. But the challenge therefore comes out that in that case again, the decision will have to be taken by individual bank and bank boards, even if a PMG decides on a particular structure, then it would need to go to individual banks to be ratified.

Q: What is the bill that the nation faces for writing off or providing for all this corporate stress?

A: That number will vary between USD 15 billion to USD 30 billion depending on how soon this kind of structure is set up and how quickly they come to resolution of these cases and sell down these cases because, as you know, the value of these assets decays very fast. So, the longer you wait, the higher the bill goes.