Asset quality risks for banks and NBFCs remain elevated despite the recent decline in assets under moratorium: ICRA

  • Collections performance to define asset quality of lenders amidst uncertainty on further regulatory forbearances
  • Loan book under moratorium have declined sharply across most lenders; however, the last ten percentile of this book will remain the key to the extent of asset quality pain
  • Extension of moratorium or one-time restructuring or combination of both could be credit negative for many lenders if such loans account for more than 5% for a lender, once the economic conditions improve
  • Even in a low credit growth scenario of 6-7% during FY2021, the additional capital requirements are high at ~ Rs. 450-825 billion for PSBs during FY2021 and Rs 250-483 billion for PVBs during FY2021-22; NBFCs may raise about Rs. 250-350 billion in the current fiscal

INDIA: Rating agency ICRA has said that further deterioration in asset quality and the risks thereof for banks and non-banks (NBFCs[1]) continue to remain high despite most of them (banks as well as NBFCs) reporting a decline in the loans under moratorium under phase 2 (June-August 2020), compared to phase 1 (March-May 2020). This is due to the fact that the last ten-fifteen percentile of the borrowers who continue to opt for the moratorium will be more vulnerable to slippages. Although the gradual relaxations in restrictions imposed during the lockdown have helped in improving the collection efficiencies and thereby reduction in residual assets under moratorium, the pace of recovery seems lower than expected because of localised re-imposition of lockdowns by various states over the last two months.  In view of the above, already the GDP forecast for the current fiscal has been revised to a contraction of 9.5% vis a vis an earlier estimate of a 5% contraction.

Giving further insights, Mr. Anil Gupta, Vice President, and Sector Head Financial Sector Ratings, ICRA Limited says, “A higher share loans under a moratorium for a prolonged period or loans restructured by a lender would reflect incipient stress in the asset quality and will be credit negative for the lenders unless such losses are sufficiently offset by timely capital raise. As we await clarity from the RBI on the future course of action, both one-time restructuring and extension of the moratorium could pose challenges to lenders not only in implementing the same but also on their financial stability if the quantum is large. In our view, as the lenders may continue to have discretion on extending the moratorium, a one-time sector-specific restructuring may also create implementation challenges, given the inter-linkages with various sections of the economy.”

As per ICRA estimates, the median loans under moratorium would be around 25-30% compared to broadband of 10%-50% of total loan books with many of the borrowers being common under Phase 1 and 2. In general, the moratorium levels across banks are lower than those of NBFCs with private banks having even relatively lower levels.  Early trends for July 2020 indicate a nominal improvement in collections over June 2020 levels but remain considerably lower than the pre-COVID levels of around 90-95% for most asset classes. Given the commonality of borrowers under both phases, the asset quality risks are likely to continue to remain high for the lenders. However, unlike the previous asset quality cycle, where the stressed assets build-up was driven largely by the corporate segment, this time, the stress is relatively higher for borrowers in micro small and medium enterprises (MSMEs), Agriculture and Retail (especially self-employed) segments. Therefore, the debate is now on the need for a further extension in moratorium or a one-time restructuring for the borrowers who continue to face challenges and remain under moratorium by end of August 2020. While loan restructuring could postpone the recognition of stress in the lender book in the near-term, high share of such assets would be a credit negative. Also, the efficacy of this restructuring would be crucial as lenders would be faced with many requests coming from the smaller ticket size borrowers (in the retail and MSME space) vis a vis the large borrower restructuring done by them in the past. ICRA believes that if a one-time restructuring window is made available, more borrowers may opt for it to ease out the near-term uncertainties, conserve liquidity and, to smoothen their cash flow as economy takes the turn for revival. If the RBI were to consider one-time restructuring, it is expected to be extended to certain sectors which would take longer to recover.

Earlier ICRA estimated around 10-15% of borrowers under moratorium out of 30-40% of the overall loan book under moratorium to default, with the expected slippages at 3-6% of advances in the current fiscal. However, with the reduction in loan books under moratoriums, a higher percentage of this moratorium book now becomes vulnerable. With core equity capital at 10-15% for most of the banks and 12-15 % for non-banks, even a 5% incremental asset quality stress due to COVID would pose risk to the capital of some of the lenders in the current fiscal.

ICRA’s had earlier highlighted that the Gross NPAs for banks are likely to rise to 11.3-11.6% by March 2021 from an estimated level of 8.5% for March 2020. Amid rising NPAs, it also highlighted the stress on profitability for public sector banks (PSBs) and private banks (PVBs) return on equity to remain weak at ~(4.5)-(8.0)% and ~3.4-5.1% respectively during FY2021. Hence, even in a low credit growth scenario of 6-7% during FY2021, the additional capital requirements are high at ~ Rs. 450-825 billion for PSBs during FY2021 and Rs 250-483 billion for PVBs during FY2021-22.

Concludes Mr. A M Karthik, Vice President, and Sector Head Financial Sector Ratings, ICRA Limited. “Banks and NBFCs are highly leveraged entities with leverage of 4-10 times and generally operate at thin operating profitability of 2-4% of assets. Ability to absorb even a 4-5% loan loss without eroding capital will be a challenging task for many lenders and hence strong capital position or fresh capital raising to absorb expected losses will remain a key driver for the credit profile of the lenders.  In particular, the NBFCs, though they are fairly comfortable on current capital position, based on the extent of estimated slippages, they may need to raise equity capital of up to Rs.250-350 billion in the current fiscal to shore up their solvency and also provide comfort to their lenders on their ability to absorb shocks. ICRA also notes that the pre-provision profits of non-bank are about 4%, which would also support their capital position as AUM growth is expected to be negligible, in the best-case scenario, with a bias towards a contraction, as the impact of a pandemic may linger around longer in the current fiscal. Further, for NBFCs, the funding constraints would remain a key concern for the sector in the near to medium term.”

[1] Private NBFCs including Housing finance companies