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n Pension liability pegged at ~INR 330 bn; equivalent to 14% of networth
There is lot of uncertainty regarding the quantum of obligation that banks will add to its outstanding retirement liability along with the extent of provisioning for the same due to Second Pension Option (SPO) and increased gratuity limits. Our in depth analysis and interactions with banks’ management and various industry experts lead us to conclude that pension liability (pretax) for PSBs (SPO + wage revision catch up for existing employees under pension) will catapult by INR 330 bn. This translates into a hit of 14% on networth and if allowed to be amortised over five years, will imply a hit of 17% on earnings for banks. However, our downward revision in earnings estimate is pegged at 3-7% as Street has factored in some provision based on pension liability indicated by banks .
n Employee costs to move up structurally
We believe PSBs’ cost structure will undergo a structural change with almost the entire workforce falling under the pension scheme now. The servicing costs of pension is ~24% of basic pay (compared to 10% under CPF), implying a 3-4% rise in employee costs. We expect cost/income ratio for banks to move up by 100-150 bps and RoEs to be adversely impacted by 40-60 bps as cost escalation is structural in nature. Moreover, banks will be exposed to shortfall/surplus on account of actuarial valuation for the entire workforce.
n Wage revision catch up not talked about; DA unspoken pressure point
We arrive at the bank’s SPO liability (pretax) at ~INR 270 bn (refer table 3) implying that extrapolating Union Bank’s liability only to arrive at SPO obligation for other banks will lead to an over-estimation. However, what is not much discussed, is the jump in banks’ liability due to increase in pension obligation for employees already under the scheme due to the wage revision – we estimate catch up liability at INR 59 bn (~INR -0.2 per employee). Dearness allowance (DA) is another unspoken pressure point in bank’s employee cost, given the high inflation scenario banks are operating in. DA adversely impacts employee costs due to higher wage bill, pension payout and rise in provisioning for future retirement benefits. Sensitivity of retirement liability to DA is maximum compared to other variables like discounting factor, life expectancy etc..
n Resolving INR 63 bn to ~INR 270 bn liability conundrum
The moot question at this stage is what caused the quantum jump in SPO liability to such high levels from INR 63 bn estimated at the time of settlement. While INR 63 bn was based on 2007 salary levels i.e., before the wage hike, our numbers fully incorporate the current service costs for each year of service in between, wage hike impact and most importantly the DA increase. The outstanding pension liability/employee jumped from INR 0.8 mn to INR 1.5 mn, of which INR 0.3 mn (INR 97 bn for industry) is due to the exorbitant level of inflation, and INR 0.2 mn each (INR 60 bn) for wage revision and current servicing cost
n Gratuity bill to inch up post revision in benefit limits and wage hike
Effective 24 May 2010, the Gratuity Act, 1972, was amended, increasing the ceiling on gratuity payable from INR 0.35 mn to INR 1 mn. While the impact of increased limits on gratuity provisioning is difficult to calculate given different bank specific policies, we have estimated incremental gratuity liability due to wage hike and pegged the increase at 16% of outstanding gratuity obligation. We estimate incremental provisioning on this count at INR 15 bn for the industry
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