Have The NPAs Bottomed Out For Banks?

Banking stocks are reeling under pressure and have under-performed lately. In-spite of underperformance there remains tremendous appetite for the banking stocks as they truly capture the Indian growth story. Nikita Singh explores how Banks have performed lately while the DSIJ research team recommend buying couple of good stocks in the space.

When it comes to taking exposure to Indian equities, Indian banks are something that have always fascinated the foreign portfolio investors (FPIs). For those investors who have shown faith in the Indian banking growth story, the rewards have been humongous in the past decade or so. If one would have invested Rs1,00,000 in 2008 in IndusInd Bank, it would have become Rs17,28,340 as on February 20, 2018. The same amount invested in City Union Bank would have appreciated to around Rs6,75,720 and if it had been invested in Yes Bank, the amount would have grown to Rs6,48,290. Investing the same amount in HDFC Bank would have turned it into Rs6,07,270 and in Kotak Mahindra Bank it would have become Rs4,81,710. These are all the best performing private banks, which have multiplied investors' wealth in the past decade. If one would have simply invested in all the private banks, including some of the underperformers such as Karnataka Bank, J&K Bank and Dhanalaxmi Bank, Rs1,00,000 invested 10 years back would have still grown to Rs3,89,000.

Such extraordinary performance has lured investors into looking at investing opportunities in private banks, till now. But, today, the Indian banking story needs to be revisited, as it may be foolish to live in the glory of the past, when it comes to investing in banking stocks. The reason is quite obvious:- non-per- forming assets of banks. 

What are NPAs and how did these get so big? Can’t these be managed – con- trolled? How to come out of this NPA mess? It is going to get worse? 

These are the very questions that are bothering today's investors who are actively looking at investing opportuni- ties in the banking sector in India.

The average return of the 21 PSU banks in one year has been negative 19.59 per cent. The average return for the same set of PSU banks is negative 24.30 per cent during the previous three months.

Rajat Jain, CIO,
Principal PNB AMC 

In your view, have the NPAs peaked out for the PSU banks? 

We are seeing an economic recovery, the consumptions demand remains robust and, incrementally, industry is going for capital expenditure as brownfield projects and tactical capacity additions. The infrastructure sector is seeing good work in railways, roads and ports sector. In this scenario, things look to be on a path of recovery and hence creation of fresh NPAs seem to have peaked. Also, the banks have been proac- tive in recognising the bad assets. However, while fresh NPA creation could have peaked out, aging-related provision and those resulting from RBI directive would be there. 

What is the key reason behind the NPA s being low for the private banks when compared to the PSBs? 

This could partly be due to the fact that PSU banks have lent to infrastructure projects and large corporates for term loans, etc. which many private sector banks did not do. The private sector banks were more focused on retail lending. This is one of the dominant reasons. But where both have exposure to the same entity, then obviously there would be NPAs in both the PSU and private banks. The difference is that private sector banks are more aggressive in selling down these assets, and so, at least it would not show in their books. 

From investment point of view, are private banks a better bet than the PSU banks? Or will the PSU banks outperform once the NPA mess is settled? 

In our view, the large PSU banks are as well run as any private sector bank. They have the capital and the capacity to grow and their systems are quite robust. They have grown in the con- sumer space as any private sector bank. So it is about a well-run bank and a not so well-run bank. Hence, large PSU banks are also a very good opportunity to invest. Whether the NPA mess settles or not, it is not about PSU versus private. It is more about a bank which is well-run, has strong systems and has good manpower, which I think, the large PSU banks have as well. 

Jinesh Gopani, Head – Equities, Axis MF 

Have the NPAs bottomed out for banks, in your view? Though most of the baggage is out in the open in the form of recognition, provisioning and resolution will take some time. Also, some one-off cases like the recent one can come now and then. What is your call on the banking sector? Rising interest rates are good for the banks who have no ALM mismatches, especially private sector banks. So, we are bullish on them. Some weak NBFCs who have high mismatch on ALM would suffer as NIMs will be under pressure. 

Should investors prefer NBFC stocks over banking stocks at the current juncture? 

No. It’s better to be having more weightage in private banks and only in select good NBFCs who have niche in their spaces, such as housing finance companies, CV finance companies.

According to FSR report 

The overall risks to the banking sector remained elevated due to asset quality concerns. Between March and September 2017, the gross non-performing advances (GNPAs) ratio of scheduled commercial banks (SCBs) increased from 9.6 per cent to 10.2 per cent and the stressed advances ratio marginally increased from 12.1 per cent to 12.2 per cent. Public sector banks (PSBs) registered GNPA ratio at 13.5 per cent and stressed advances ratio at 16.2 per cent in September 2017. The macro stress test for credit risk indicates that under the baseline macro scenario, the GNPA ratio may increase to 10.8 per cent by March 2018 and further to 11.1 per cent by September 2018.

India ranks fifth on the list of countries with highest Non-Performing Assets (NPAs) and is on top spot among the BRICS nations 

Praveen Nigam, MD & CEO of Amplus Consulting (P) Ltd 

“It is high time that banks, especially PSU banks, adopt advance auditing techniques. Most of the private sector banks have withdrawn virtually all powers from their branches and kept it with the central office, including the smallest of the powers. This is one of the techniques adopted by the private sector banks. The banking systems are ever-evolving in India and specifically the public sector banks are most venerable to any fraud, primarily because of not having a very rugged IT systems in place, though most of the banks and their branches are on the core banking, but the systems and the connectivity is a big issue. Advance auditing techniques is a probable solution, but it will work when all the processes are well-defined in the first place. Adopting advance auditing techniques can help banks detect the wrongdoing even before the transaction takes place but, having said that, these techniques will work if they have well-defined systems in the first place so that any intervention from any corner does not permit the system until and unless the same is authenticated in the system itself. Advance auditing techniques with a well-placed system in place may help PSU banks to considerably stop such frauds, if not eradicate the same.”

The banking sector in India can be studied by looking at the performances of the PSU banks and private banks separately. We see that the PSU banks are definitely facing a big problem when it comes to NPAs. The problem exists to a lesser extent in the private banks too. We can see in the table below that the The NPAs of PSU banks have steadily increased over the past three years, but these have increased for the private banks too.

It is interesting to note here that the NPAs as a percentage of net advance have shown an increasing trend in the past three years not only for the PSU banks but also for the private banks. While the PSU banks are widely known for their poor management of assets leading to higher level of NPAs, the performance of the private banks on this front is not something to be proud of. 

In fact, if we consider the figures of net NPAs to net advances for the last three years for the PSU banks and the private banks, the growth rate of the NPAs during this period is faster for the private banks as compared to the PSU banks. The net NPAs to net advances of private banks jumped from 0.89 to 2.21, reflecting a growth of nearly 57 per cent on an annualised basis. 

Readers must know that the net NPA to net advance ratio is used as a measure of the overall quality of the bank’s loan book. A higher ratio reflects the increasing bad quality of loans. 

For the PSU banks, the net NPAs to net advances have grown from 2.92 to 6.89 during the past three years, which reflects a growth of 53 per cent on an annualised basis. While the growth in bad quality of loans at 53 per cent is alarming, it is still less than the growth of 57 per cent in the bad quality of loans of private banks 

This clears the myth that the private banks as a set are superior for investing because of less net NPAs. If we ignore the net NPAs to net advances ratio and simply look at the growth in net NPAs, the net NPAs have grown by 21.5 per cent for all the PSU banks, while the net NPAs of the private banks have grown by 30.5 per cent in one year (Dec 2017 vs Dec 2016 figures). 

Where the PSU banks lose out big time is the size of net NPAs. As on December 2017, the net NPAs of the PSU banks stood at a whopping Rs4,15,704.41 crore, while the net NPAs of the private banks stood at Rs53,573 crore. 

What is the reason behind the alarming growth in NPAs ? 

There could be many reasons for the piling up of NPAs. The reasons are as varied as business failure, wilful defaulters, non-cooperation from banks, diversion of funds and poor legal framework to resolve the bad loans issue, etc. Several studies have been done on why the NPAs have increased and it was found that the NPAs have increased due to improper selection of borrowers' activities, weak credit appraisal system, lack of proper follow-up by the banks, inefficiency in management of borrowers, prolonged recessionary periods in the market and business failure due to product failure. Granting of loans to certain sectors of the economy purely based on government directives instead of commercial considerations is also one of the major reasons for the rising levels of NPAs in the banking sector. If we look at the list of reasons it becomes clear that it might take ages to fill the lacunae in the banking system. The quality of human resources and the method of recruitment in the banking industry – especially for PSU banks – deserves special attention. The challenge is to recruit skilled bankers and define processes that will work in today's world. The auditing process will have to be redefined and, wherever needed, external consultant’s services need to be hired in order to make good for the lack of expertise in the bank. All these corrective steps will take time and it does look like the situation may get from bad to worse for the Indian banking system. 

Conclusion :- 

Investors who have shown faith in the growth story of Indian banks have reaped rewards so far. It does look like the investors, going forward, will have to narrow down on select banks which are well-run, whether PSU or private, for investments. Investing in well run-banks, rather than relying on a blanket bullish call on the banking sector, looks more like a mature strategy at this point of time.

Harshil Mehta, JMD and CEO, DHFL. 

The government has been taking several significant, growth-oriented steps to build wide-reaching, impactful policy frameworks towards greater financial inclusion and, in the process, it is paving the way forward for the speedy development in housing and finance sector. As a result, housing finance companies (HFCs) are growing at 30% quarter-on-quarter. These HFCs are not only helping broadbase the market, but are also driving financial literacy, thereby creating opportunities. 

Our asset quality is well-protected by our strong understanding of the market segment, underwriting skills and well-built systems. DHFL has been maintaining a high level of customer quality checks and have a robust collection machinery, supported by a strong back-end for timely action in maintaining a good asset quality. 

DHFL has been maintaining one of industry’s lowest NPAs quarter-on-quarter and a good asset quality book due to its strong yet flexible underwriting standards and servicing customers who are first time home buyers who utilise this finance to provide a shelter to their family.

Anita Gandhi, Whole Time Director, Arihant Capital Markets 

The seeds of higher NPAs that we are currently seeing were sown in the times when Indian GDP was at 9%. These banks went for aggressive lending in those years and the economy went into de-growth mode thereafter. Lending specially in steel and infrastructure sectors suffered heavily due to heavy dumping from China and slowdown in infrastructure segment. As a result, many projects became unviable or suffered from very heavy cost over-runs, resulting into NPAs. Poor tracking of projects post lending by the PSU banks may also be one of the reasons for the high level of NPAs

Haresh Mehta, Chief Institutional Trader, First Global Solutions 

Logically, the NPA cycle wouldn't bottom out so easily. Going by the simple logic that if we project India to become $5 trillion economy by 2025, then I expect there would be a rise in NPAs too. I also believe that the "Rate Cut" cycle in India has bottomed out. Hence, there is more of a probability of rate hike going ahead given the rising inflation, rising yield and higher commodity prices.

With The Worst Over For PNB, The Stock Makes A Good Bet 

The tragicomedy episode at one of India’s oldest banks, Punjab National Bank (PNB), has hardly missed anyone’s attention. On February 14, PNB had detected a fraud wherein diamond czar Nirav Modi and his associates had allegedly acquired fraudulent letters of undertakings (LoUs) from one of the branches of PNB for overseas credit from other Indian lenders. The scale of the fraud, the biggest to hit an Indian lender, has stunned the country and put the lack of supervisory oversight by the central bank and auditors under the spotlight. The extent of loss to PNB from the fraud is still unclear and is estimated to be around Rs12,700 crore. However, there is still a lot that the bank could do to revive its fortune and come out of the rut. 

PNB has set aside more than the mandated money as provisions on its Rs4,900 crore exposure to Bhushan Steel’s delinquent account and PNB can meet its capital requirements by writing back provisions after the expected sale, since according to India’s bankruptcy laws, Bhushan Steel has to be sold this year itself. However the timing of sale and pricing is still unclear. 

PNB can also sell some of its non-core assets. The bank might sell its headquarters in New Delhi which is expected to have a valuation of Rs1,400 crore. Also, PNB might trim its stakes in brokerage PNB Gilts and PNB Housing Finance. These sell-offs could allow PNB to offset losses that may arise from the scam, thus obviating any need for the government to increase its Rs5,500 crore capital allocation. 

Over the last three years, the Nifty PSU Bank index has fallen at a compound annual rate of 4.92 per cent and the banking space has been seen as a value destroyer. However, we believe that most of the large losses are out and the prices at which the PSU banks are currently quoting make them a good investment bet. The potential risk aversion and a greater focus on operational controls after the fraud might hamper the growth in the near term for the bank. Nevertheless, the long term outlook remains stable. We recommend our readers to HOLD PNB

FEDERAL BANK 

Federal Bank is an old-age Indian commercial bank in the private sector with a history dating back to the pre-independence era. The bank has a dominant presence in South India, especially in Kerala. In the last few years, the bank has increased its presence and visibility at the national level. 

The bank offers a variety of services such as internet banking, mobile banking, online bill payment, online fee collection, depository services, cash management services, merchant banking services, insurance, mutual fund products, etc. The bank has a network of 1,252 branches and 1,679 ATMs across the country. 

Recently, the bank announced that it would acquire a 26 per cent stake in privately-held investment bank Equirus Capital in order to diversify beyond traditional banking and create additional revenue streams. This will help the bank offer wealth management services to its high net worth and NRI clients, financial solutions for capital markets, structured finance, capital market products, advisory, and others. 

On the financial front, Federal Bank posted a 26.43 per cent growth in net profit in the third quarter at Rs260.01 crore, as compared to the corresponding period of the previous fiscal. The operating profit increased by 18 per cent to reach Rs561.40 crore in Q3 FY18. The bank’s NRE deposits grew by 14.14 per cent to Rs39,430.97 crore and CASA deposits increased to Rs33,141.43 crore from Rs31,972.97 crore. 

The bank earned a net interest income (NII) of Rs950 crore for the quarter, with net interest margin (NIM) of 3.33 per cent. The gross NPAs and Net NPAs stood at Rs2161.19 crore and Rs1156.68 crore, respectively. Gross NPAs as apercentage of net advances reduced to 2.52 per cent and net NPAs as a percentage to net advances stood at 1.36 per cent. 

The capital adequacy ratio (CAR) computed as per Basel III guidelines stood at 14.41 per cent as at the end of the quarter. The bank has a price-to-earnings ratio of 17.84x and price-tobook value of 1.83x. It has been maintaining a healthy dividend payout of 20.09 per cent. Going forward, we expect steady loan growth and improvement in operational efficiency to increase profitability. We recommend a BUY on the stock

Shriram Transport Finance 

Shriram Transport Finance (STF) is one of the largest companies in asset financing. It is mainly engaged is funding pre-owned commercial vehicles (CVs). The company has a pan-India network of over 900 branches, 850 rural centres and partnerships with approximately 500 private financiers. STF sold Shriram Automall for Rs160 crore in 3QFY18 and the transaction is expected to be completed by April this year. 

Due to the increase in rural demand and higher rural agri-output, the company witnessed good demand during the last quarter. STF’s revenue improved by 13.7 per cent YoY to Rs3,088.9 crore. The company reported net profit of Rs495.6 crore, as against Rs346 crore reported in the corresponding quarter last year. Its GNPAs for Q3 FY18 declined by 8 bps QoQ and stood at 7.98 per cent,,whereas its NNPAs for the quarter remained flat QoQ at 2.45 per cent. Going ahead, the GNPA ratio is expected to improve along with decline in credit cost. 

Due to the strong growth in new CV financing and healthy growth in used CV segment, its disbursements grew by 64.7 per cent YoY and 8.1 per cent QoQ to Rs13,380 crore. The demand in CV segment in the coming quarters is expected to continue along with improved demand for construction equipments and passenger vehicles. 

STF’s AUM improved 18 per cent YoY and 5.3 per cent QoQ to Rs90,000 crore. This was its highest AUM growth in over 15 quarters which was driven by 17 per cent YoY growth in used CV loans and 26 per cent YoY growth in new CV loans. The company does not expect pressure on cost of funds in Q4 FY18, since most of the funding will come from the securitisation transaction. 

The company has a price-to-earnings ratio of 19.08x and price-to-book value of 2.36x. It has been maintaining a healthy dividend payout of 18.53 per cent. Thestock has a return on equity (RoE) of 11.72 per cent and return on capital employed (RoCE) of 35.49 per cent. 

STF has a strong business model with niche product and significant geographical depth. In the last few years, the company was affected by cyclical growth trends and distressed asset quality. However, in the quarter gone by, the company has shown improvement on the operating front, led by higher disbursement and higher operating profit. The company is positioned much better currently to deliver strong performance operationally. We recommend our reader-investors to BUY the scrip.