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Action: Initiate coverage of Indian banks; headwinds to tailwinds
We initiate coverage of the Indian banking sector with a Bullish view as we
believe current headwinds in the form of tight monetary conditions, higher
government borrowing and credit losses from utility loans are priced into
current valuations. We believe many banks are well positioned to leverage
the impending turn in India's rate cycle. We believe current valuations
factor in the worst, but do not price in the benefits of a rate cycle turn.
Attractive even after factoring in stress case LLPs for utility loans
We calculate the likelihood of the restructuring of 60 power projects that
have achieved financial closure by analyzing their fuel linkages and
demand agreements. Our proprietary analysis indicates that the proportion
of loan book of our covered banks, which are at risk of being restructured,
ranges from 1.3%-3.5%. We expect their LLPs to peak out at 120bps in
this cycle and we have factored these provisions into our forecasts. Our
analysis of the provisioning cycle in India for the last 15 years indicates
these are stress-case provisions comparable to relevant episodes in the
past. If these loan losses come to bear, we estimate an average ROA loss
of 21bps across the sector, which we believe is priced in at current levels.
We back-test this ROA loss by a factor analysis of ROA to fundamental
drivers like net interest income, fee income, cost efficiency and LLP.
Savings rate deregulation: seems more dynamic than headline CASA
The deregulation of interest rates on savings accounts is likely to change
many of the competitive dynamics in the sector, but in our view, it is too
early to distinguish winners from losers on this count. We enumerate a
number of dynamics that are at play here. We will continue to side with
banks that have a wide product suite, excellent service levels and a
demonstrated ability to respond to structural changes in the industry.
Crowding out concerns appear overplayed
We are budgeting in base-case loan growth of 16.5% for the banking
sector for FY12F. To achieve this, credit growth for the rest of the year will
have to be 18% annualised (or flat incremental addition compared to
2H11). The current incremental LDR of 50% leaves significant scope for
loan growth to improve through the rest of the year and we see no risks to
our loan growth estimates.
SBI (Buy; TP: INR2,400) and Axis Bank (Buy; TP: INR1,400) are our top
picks. We also initiate on HDFC Bank (Buy; TP: INR570), ICICI Bank (Buy;
TP: INR1,050), Indusind Bank (Buy; TP: INR325), Bank of Baroda (Buy;
TP: INR950), Punjab National Bank (Neutral; TP: INR1,070), HDFC Ltd
(Buy; TP: INR780), and IDFC (Neutral; TP: INR140).
Executive summary
• We are Bullish on the Indian banking sector, as we believe the rate cycle is currently at
a cusp and we expect a beneficial turn in the cycle. In our view, Indian banks are well
poised to benefit from this as the current loan-to-deposit ratios are fairly muted at 50%
and liquidity in the system remains adequate. We believe the higher-than-expected
government borrowing for FY12F is unlikely to present a risk to our loan growth
estimate of 16.5% for the sector. We expect retail lending to track relatively more
strongly than large ticket corporate loans until interest rates decline meaningfully.
• Indian banks have corrected by more than 22% YTD (6% under-performance with
respect to the broader market index S&P CNX Nifty) on tightening rates, deteriorating
asset-liability mix and higher expected incidence of non-performing loans from loans
given to the power sector. Our analysis of 60 projects that have achieved financial
closure indicates that approximately 1.3-3.5% of the outstanding loan book for our
coverage universe may come up for restructuring (due to issues arising out of fuel
supply shortage or demand falling off). We expect loan loss provisions from this
possible restructuring and in general from credit deterioration from a high interest rate
regime to peak out at 120bps vs the current run rate of 70bps. We estimate an ROA
loss of 21bps from this provisioning cycle. We believe the current valuations already
factor in this risk. Our sensitivity analysis of the ROA to fundamental factors like net
interest income, fee income, cost ratio and loan loss provisions ties in our ROA
projections for the sector.
• The deregulation of the savings deposit rate changes the competitive dynamics in the
sector structurally, in our view. We believe it is too early to distinguish between winners
and losers and doing so on the basis of headline CASA ratio is simplistic and ignores
the banks’ abilities to respond to structural dynamics. We will continue to favour banks
that have a demonstrated ability to manage their deposit franchise through the past
interest rate cycles, have a good product suite and high customer service orientation.
• Given the above context, we continue to like the following broad themes:
1) Robust funding franchises backed by decent product suites and demonstrated
ability to manage funding franchises through rate cycles.
2) Retail lending orientation.
3) Attractive valuations which are pricing in worst-case loan losses.
We are initiating coverage on HDFC Bank, IndusInd Bank, ICICI Bank, Axis Bank, State
Bank of India, Bank of Baroda and HDFC with a BUY rating; on Punjab National Bank
and IDFC with a NEUTRAL rating.
The headwinds
• Given the persistent inflation, what will the Reserve Bank of India’s (RBI) monetary
policy stance be into the next few quarters?
• The federal fiscal deficit is higher than budgeted for at the beginning of FY12. Will this
lead to crowding out of private sector credit? How much loan growth can be realistically
expected in this scenario?
• How severe will be the incidence of bad loans arising out of the power sector? What
can we learn from the past provisioning cycles in the Indian banking sector?
• What will be the impact of slower loan growth and higher provisioning on the sector
ROA? How sensitive is the ROA to underlying business factors?
• The sensitivity of valuation multiples to global risk aversion
We discuss each of these questions in detail in the following sections.
On the macro front, Nomura’s Economics Research team finds that seasonally adjusted
core inflation has steadily moderated over the past few months. Looking ahead, they
expect this trend to continue as both domestic demand and external demand are likely to
weaken further. They expect the headline WPI inflation to remain around 9% until
November, beyond which they expect it to moderate and reach 6.8% in March 2012,
primarily due to base effects. Overall, our economics team expects WPI inflation to
average 8.7% y-o-y in FY12 (year ending March 2012) vs 9.6% in FY11. They expect no
further hikes in policy rates by the RBI despite the recent depreciation of the rupee since
developments over the past few months indicate: (1) core inflation has moderated; (2)
domestic demand has weakened considerably, indicated by production, PMI and tax
collection data; and (3) the near-term outlook for the global economy remains weak.
We are budgeting in base case loan growth of 16.4% for the banking sector for FY12F;
our estimate is derived as detailed below.
We anticipate sector deposit growth of 18% for FY12F (current run-rate as of 30
September 2011 is 19.1%), which leads to incremental deposit accretion of US$209.7bn
over the FY11 ending deposit base of US$1165 bn. The net government borrowing is
likely to be US$125bn for FY12F (assuming 5% fiscal deficit), 48% of which is likely to be
subscribed to by non-bank entities like insurance companies, pension funds, etc. The
banking system is likely to subscribe to US$65bn of government borrowing, which
represents 52% of the net government borrowing for the year. Of the net deposit
accretion for FY12F, approximately US$145bn will be available for private sector credit,
which translates into a loan growth of 16.4% over the FY11 loan base.
Given the loan & deposit growth in the system in F1H12, what does this imply for loan &
deposit growth in F2H12? As of 7 October, 2011, the annualized credit growth in the
sector over FY11 was 10.2%. To achieve the forecast growth of 16.4% for FY12F,
annualized credit growth in the rest of the year will have to be 24%.This implies the same
quantum of net addition in credit for the balance of the year as compared to the
corresponding period of the previous year (essentially flat 2H12 versus 2H11). The
current incremental LDR is 50%, so that leaves a lot of scope for loan growth to improve
through the rest of the year.
Savings rate deregulation
An important new dynamic, but too early to distinguish
winners from losers, in our view
In a significant move, the Reserve Bank of India deregulated interest rates on savings
deposits effective 25 October, 2011. The following text summarizes key regulations.
• Each bank will have to offer a uniform interest rate on savings bank deposits up to
INR100,000, irrespective of the amount in the account within this limit.
• For savings bank deposits of more than INR100,000, a bank may provide differential
rates of interest, if it so chooses. However, there should not be any discrimination
between customers on interest rates for similar amount of deposit.
This is an important new dynamic in the sector as it essentially brings in new competitive
dynamics into deposit mobilization, more specifically the savings deposits. The initial
reaction of stocks to the announcement was negative for the high current accounts &
savings accounts (CASA) banks and positive for the low CASA banks. Near term, the we
believe most apparent would be a negative impact on the net interest margins in the
sector, the impact being relatively higher for the banks with a high proportion of savings
accounts. But longer term, we believe many dynamics would be unleashed, some of
which we have enumerated below.
1) What deposit rate would be offered by banks to small ticket sizes below the
INR100,000 limit? This we believe will be largely determined by the marginal cost of
deposit for the specific bank in question. The marginal cost of deposit is still
evolutionary as the mode of acquisition of new accounts by banks is undergoing
many changes.
2) What proportion of savings deposits in a bank will be fungible to higher rates
elsewhere is debatable right now.
3) The ability to shift savings deposits between banks in the near term may be largely
limited to metro/urban banking centers. The following table summarizes the
proportion of savings deposits sourced in metro / urban areas and the average ticket
size per account across SBI & its associate banks, other PSU banks and private
sector banks.
4) Given their respective customer base, will PSU banks have more sticky savings
deposits than their private sector peers - due to relatively higher proportion of rural /
semi-urban savings deposits?
5) Banks are demanding that the RBI deregulate fee structures as well for the banks,
which is currently tightly regulated. How this issue is resolved will be an important
determinant of how banks protect their profit margins.
6) CASA deposits have so far been considered as long-term liabilities by banks for
their asset-liability matching and allied risk management. This could change in light
of the deregulation. If so, what kind of adjustments needs to be made on the asset
side to balance out the risks?
7) With all these dynamics at play, we believe it is too early to distinguish between
winners and losers due to deregulation of the savings rate.
8) According to the experience in other countries, savings rate deregulation has led to
the introduction of money market rate linked savings products and other product
innovations. This was also accompanied by enhancement of the fee structure
associated with operating a savings account.
9) The RBI does not expect unhealthy and disruptive competition from the deregulation
of the savings deposit rate. To gain a historical perspective, back in 1997 when term
deposit rates were deregulated, the spread between the term deposit rate and the
effective policy rate did not widen in a disruptive manner. What we observe from the
chart below is a cyclical variation in the spread depending on the liquidity conditions
in the market.
For the savings rate as well, the probability of disruptive competition in the sector should
be low. The term deposit share within the total deposit base in India has increased from
an average of 60.9% during 1990-97 to 64.5% during 1998-2009. This represents a
growth of 19.1% during 1998-2009 versus 1990-97. However, this higher growth was
also accompanied by higher volatility in the term deposit base. The experience with
savings deposits could be similar – as the savings deposit rate settles to a higher
equilibrium, savings deposit growth will increase but also accompanied by a greater
volatility.
10) As per RBI estimates, the core component of the savings deposits (calculated on
the basis of average monthly minimum balance) has ranged between 89-98% during
2006-11. Given the convenience value attached to the savings deposits, we believe
the war for savings deposits will be won on the basis of depth of a product offering
and service quality than purely on rate arbitrage.
11) However, to assess the impact of the deregulation, the following table gives the
impact on our FY13F PAT of our coverage universe of a 1% increase in savings
rate. This assumes ceteris paribus on all other key variables and assumes that
banks will not pass on the funding cost increase to their customers.
Attractive valuation, despite factoring in
stress case LLPs for utility loans
Loans given to power generation projects are expected to be under stress due to fuel
shortage issues and poor health of state utilities. We have analysed 60 projects that
have achieved financial closure to assess the likelihood of being restructured. Our
analysis indicates that 1.3% to 3.5% of the loan book of our coverage banks is likely to
be restructured. We cross-check our analysis with notes gleaned from discussions with
lenders and independent power sector experts. We factor in the appropriate loan loss
provisions into our forecasts, based on this probability of restructuring.
The bigger picture
We estimate total borrowing by the Indian power sector to be around INR6.5trn. Of this
private sector IPPs account for 38%, while state electricity boards (SEBs) account for
47% of the loan outstanding. Banks exposure to SEBs is 26% of their power sector loans
compared to 60% towards IPPS (Independent power producers). Infrastructure finance
companies (IFCs) like PFC and REC account for more than 50% of SEB exposure.
Other FIs include LIC and EPFO among others.
The total installed generation capacity currently stands at 182GW for India of which 23%
is through IPPs, while 55% of installed capacity is coal-based. Of the planned addition
until FY14, our utilities analyst expects 65GW of capacity to come from IPPs with 80% of
these projects thermal (coal/gas) based.
Key areas of concern
Investors have two key concerns regarding power sector lending:
• Poor health of SEBs – High aggregate technical & commercial (AT&C or distribution)
losses, sustained period of low tariffs and delay in subsidy payments from respective
state governments have pushed a majority of SEBs into the red with their net worth
wiped out. As per the Power Finance Corporation report, estimated aggregate losses of
state utilities were INR295bn for FY10 and INR635bn without accounting for subsidy.
This situation in turn has endangered a lot of IPPs supplying to these SEBs creating
demand uncertainty for them.
• Lack of coal linkage – As evident above, the bulk of capacity addition is dependent on
linkage of coal and gas for thermal based plants. Despite being the biggest coal
producer, the shortfall of coal requirement is expected to balloon to 20-30% of the
demand by FY14. Coal India hasn’t been able to keep pace with the demand
requirements while lack of logistical linkages and environmental regulation related
delays have further worsened the supply situation. Using imported coal or buying from
spot markets could possibly make many of the projects unviable. Also quite a few IPPs
don’t have the logistics and even the infrastructure (like boiler design) to handle higher
proportion of imported coal.
Takeaways from channel checks with banks and industry
experts
Based on our discussions with bank managements, infrastructure lenders and industry
experts we highlight a few key findings below:
• Projects with captive coal at least risk: Despite the strong demand outlook, unless a
company is able to sell above INR3.5 / unit – power is a loss-making proposition, as per
industry experts. In the current context of lack of adequate domestic coal supply and
higher cost of imported coal – projects with captive coal supply (either domestic /
international) are at least risk.
• Banks/ FIs exposed to stand-alone promoter projects at higher risk: Banks /
NBFCs exposed to projects from large sponsor groups with a diversified project base
(geographically, fuel supply-wise, etc) are at relatively lower risk compared to those that
have taken an exposure to single projects.
• Collaterals generally do not extend to non-project assets like coal mines: Even in
cases where the project sponsor has a captive coal mine, most of the financial
institutions have collateral specific to the power project and have no lien on the mine as
collateral – if structured otherwise, the project specific risk would have been much
lower for the financial institution.
• We estimate 30% of upcoming capacities from IPPs to possibly get restructured
in FY13/FY14: approximately 20 GW of the ongoing capacity addition to be
restructured – should translate into approximately INR700bn of loans to be
restructured. However, one may see the start of the restructuring cycle only towards 3Q
CY12. The following table gives a rough back-of-the envelope ROA impact for the
entire banking sector. Most of the lenders expect the impact of restructuring to come
only after H2FY13 and FY14. The typical moratorium period could be 12-18 months
which would entail 10-12% haircut on present value losses. We summarise the
expected impact on sector RoAs from possible restructuring in the table below.
• Near-term projects more likely to get restructured: Projects most likely to come up
for restructuring are those that are likely to be completed in the near term. So if fuel
linkages, transmission grid and associated problems are not sorted out early enough,
these exposures may come up for restructuring. On this basis – a capacity of 6-8 GW
(INR270-360bn) is likely to come up for restructuring most likely around late CY12.
• 55-65% of plant load factor (PLF) sufficient to service debt: Most of the banks we
spoke with said they expected the borrowers to be able to service debt payments even
if their plants were running at 55-65% PLF.
• SEB loss concerns overdone: A majority of bankers believed that concerns around
SEB losses were overdone. Some stated that tariff reforms were being considered
seriously, with the finance ministry recently conducting a meeting with relevant
stakeholders, asking SEBs to hike tariffs or face curtailment of bank. They pointed out
instances of recent tariff hikes in some of the weaker SEBs although we believe more
needs to be done to address the situation.
• Disbursals on existing sanctions appear largely on track: Although no new
sanctions are happening at the moment, the disbursals for sanctioned projects were
largely on track. Most lenders continue to disburse loans to projects with power
purchase agreements (PPAs) and coal linkage in place even if the coal linkage is
based on letter of assurances LoAs and not fuel supply agreements. The sector could
well see 20% loan book growth just on existing sanctions until FY13F.
Estimation of credit cost impact of IPP lending for banks
Based on the above findings we have analysed approximately 60 upcoming IPP projects
with achieved financial closure to assess the broad quantum of restructuring for banks
under our coverage. A few words on our methodology:
• For each of these projects we have listed four key risk factors – 1) Fuel linkage,
2)certainty of off take through either PPAs or captive demand, 3) progress on
regulatory clearance like environment and land acquisition and 4) exposure to loss
making SEBs. We have given significantly higher weights to the first two parameters.
• We have used publicly available information from credit rating notes, company
postings, government notifications and press releases to arrive at an assessment of
each project for each risk factor on a ‘good’, ‘bad’ or ‘ugly’ scale. Using the weights we
have computed an overall score on the scale for each project.
• Based on publicly available information on the lenders to these projects, we have tried
to assess the proportion of “good”, “bad” or “ugly” projects in the power sector portfolio
for each of our coverage stocks.
• Finally applying a 100% probability of “ugly” projects getting restructured and 50% to
the “bad“ ones, we have tried to arrive at the proportion of loan book that could possibly
get restructured over the next three years.
• This exercise is not exhaustive in any sense and we have used our subjective
assessment for the risk status of every project which can change rapidly. We believe
the underwriting standards differ across banks and this analysis enables us to get an
indicative proportion of a particular bank’s book under stress rather than paint the entire
banking sector with a broad brush.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Action: Initiate coverage of Indian banks; headwinds to tailwinds
We initiate coverage of the Indian banking sector with a Bullish view as we
believe current headwinds in the form of tight monetary conditions, higher
government borrowing and credit losses from utility loans are priced into
current valuations. We believe many banks are well positioned to leverage
the impending turn in India's rate cycle. We believe current valuations
factor in the worst, but do not price in the benefits of a rate cycle turn.
Attractive even after factoring in stress case LLPs for utility loans
We calculate the likelihood of the restructuring of 60 power projects that
have achieved financial closure by analyzing their fuel linkages and
demand agreements. Our proprietary analysis indicates that the proportion
of loan book of our covered banks, which are at risk of being restructured,
ranges from 1.3%-3.5%. We expect their LLPs to peak out at 120bps in
this cycle and we have factored these provisions into our forecasts. Our
analysis of the provisioning cycle in India for the last 15 years indicates
these are stress-case provisions comparable to relevant episodes in the
past. If these loan losses come to bear, we estimate an average ROA loss
of 21bps across the sector, which we believe is priced in at current levels.
We back-test this ROA loss by a factor analysis of ROA to fundamental
drivers like net interest income, fee income, cost efficiency and LLP.
Savings rate deregulation: seems more dynamic than headline CASA
The deregulation of interest rates on savings accounts is likely to change
many of the competitive dynamics in the sector, but in our view, it is too
early to distinguish winners from losers on this count. We enumerate a
number of dynamics that are at play here. We will continue to side with
banks that have a wide product suite, excellent service levels and a
demonstrated ability to respond to structural changes in the industry.
Crowding out concerns appear overplayed
We are budgeting in base-case loan growth of 16.5% for the banking
sector for FY12F. To achieve this, credit growth for the rest of the year will
have to be 18% annualised (or flat incremental addition compared to
2H11). The current incremental LDR of 50% leaves significant scope for
loan growth to improve through the rest of the year and we see no risks to
our loan growth estimates.
SBI (Buy; TP: INR2,400) and Axis Bank (Buy; TP: INR1,400) are our top
picks. We also initiate on HDFC Bank (Buy; TP: INR570), ICICI Bank (Buy;
TP: INR1,050), Indusind Bank (Buy; TP: INR325), Bank of Baroda (Buy;
TP: INR950), Punjab National Bank (Neutral; TP: INR1,070), HDFC Ltd
(Buy; TP: INR780), and IDFC (Neutral; TP: INR140).
Executive summary
• We are Bullish on the Indian banking sector, as we believe the rate cycle is currently at
a cusp and we expect a beneficial turn in the cycle. In our view, Indian banks are well
poised to benefit from this as the current loan-to-deposit ratios are fairly muted at 50%
and liquidity in the system remains adequate. We believe the higher-than-expected
government borrowing for FY12F is unlikely to present a risk to our loan growth
estimate of 16.5% for the sector. We expect retail lending to track relatively more
strongly than large ticket corporate loans until interest rates decline meaningfully.
• Indian banks have corrected by more than 22% YTD (6% under-performance with
respect to the broader market index S&P CNX Nifty) on tightening rates, deteriorating
asset-liability mix and higher expected incidence of non-performing loans from loans
given to the power sector. Our analysis of 60 projects that have achieved financial
closure indicates that approximately 1.3-3.5% of the outstanding loan book for our
coverage universe may come up for restructuring (due to issues arising out of fuel
supply shortage or demand falling off). We expect loan loss provisions from this
possible restructuring and in general from credit deterioration from a high interest rate
regime to peak out at 120bps vs the current run rate of 70bps. We estimate an ROA
loss of 21bps from this provisioning cycle. We believe the current valuations already
factor in this risk. Our sensitivity analysis of the ROA to fundamental factors like net
interest income, fee income, cost ratio and loan loss provisions ties in our ROA
projections for the sector.
• The deregulation of the savings deposit rate changes the competitive dynamics in the
sector structurally, in our view. We believe it is too early to distinguish between winners
and losers and doing so on the basis of headline CASA ratio is simplistic and ignores
the banks’ abilities to respond to structural dynamics. We will continue to favour banks
that have a demonstrated ability to manage their deposit franchise through the past
interest rate cycles, have a good product suite and high customer service orientation.
• Given the above context, we continue to like the following broad themes:
1) Robust funding franchises backed by decent product suites and demonstrated
ability to manage funding franchises through rate cycles.
2) Retail lending orientation.
3) Attractive valuations which are pricing in worst-case loan losses.
We are initiating coverage on HDFC Bank, IndusInd Bank, ICICI Bank, Axis Bank, State
Bank of India, Bank of Baroda and HDFC with a BUY rating; on Punjab National Bank
and IDFC with a NEUTRAL rating.
The headwinds
• Given the persistent inflation, what will the Reserve Bank of India’s (RBI) monetary
policy stance be into the next few quarters?
• The federal fiscal deficit is higher than budgeted for at the beginning of FY12. Will this
lead to crowding out of private sector credit? How much loan growth can be realistically
expected in this scenario?
• How severe will be the incidence of bad loans arising out of the power sector? What
can we learn from the past provisioning cycles in the Indian banking sector?
• What will be the impact of slower loan growth and higher provisioning on the sector
ROA? How sensitive is the ROA to underlying business factors?
• The sensitivity of valuation multiples to global risk aversion
We discuss each of these questions in detail in the following sections.
On the macro front, Nomura’s Economics Research team finds that seasonally adjusted
core inflation has steadily moderated over the past few months. Looking ahead, they
expect this trend to continue as both domestic demand and external demand are likely to
weaken further. They expect the headline WPI inflation to remain around 9% until
November, beyond which they expect it to moderate and reach 6.8% in March 2012,
primarily due to base effects. Overall, our economics team expects WPI inflation to
average 8.7% y-o-y in FY12 (year ending March 2012) vs 9.6% in FY11. They expect no
further hikes in policy rates by the RBI despite the recent depreciation of the rupee since
developments over the past few months indicate: (1) core inflation has moderated; (2)
domestic demand has weakened considerably, indicated by production, PMI and tax
collection data; and (3) the near-term outlook for the global economy remains weak.
We are budgeting in base case loan growth of 16.4% for the banking sector for FY12F;
our estimate is derived as detailed below.
We anticipate sector deposit growth of 18% for FY12F (current run-rate as of 30
September 2011 is 19.1%), which leads to incremental deposit accretion of US$209.7bn
over the FY11 ending deposit base of US$1165 bn. The net government borrowing is
likely to be US$125bn for FY12F (assuming 5% fiscal deficit), 48% of which is likely to be
subscribed to by non-bank entities like insurance companies, pension funds, etc. The
banking system is likely to subscribe to US$65bn of government borrowing, which
represents 52% of the net government borrowing for the year. Of the net deposit
accretion for FY12F, approximately US$145bn will be available for private sector credit,
which translates into a loan growth of 16.4% over the FY11 loan base.
Given the loan & deposit growth in the system in F1H12, what does this imply for loan &
deposit growth in F2H12? As of 7 October, 2011, the annualized credit growth in the
sector over FY11 was 10.2%. To achieve the forecast growth of 16.4% for FY12F,
annualized credit growth in the rest of the year will have to be 24%.This implies the same
quantum of net addition in credit for the balance of the year as compared to the
corresponding period of the previous year (essentially flat 2H12 versus 2H11). The
current incremental LDR is 50%, so that leaves a lot of scope for loan growth to improve
through the rest of the year.
Savings rate deregulation
An important new dynamic, but too early to distinguish
winners from losers, in our view
In a significant move, the Reserve Bank of India deregulated interest rates on savings
deposits effective 25 October, 2011. The following text summarizes key regulations.
• Each bank will have to offer a uniform interest rate on savings bank deposits up to
INR100,000, irrespective of the amount in the account within this limit.
• For savings bank deposits of more than INR100,000, a bank may provide differential
rates of interest, if it so chooses. However, there should not be any discrimination
between customers on interest rates for similar amount of deposit.
This is an important new dynamic in the sector as it essentially brings in new competitive
dynamics into deposit mobilization, more specifically the savings deposits. The initial
reaction of stocks to the announcement was negative for the high current accounts &
savings accounts (CASA) banks and positive for the low CASA banks. Near term, the we
believe most apparent would be a negative impact on the net interest margins in the
sector, the impact being relatively higher for the banks with a high proportion of savings
accounts. But longer term, we believe many dynamics would be unleashed, some of
which we have enumerated below.
1) What deposit rate would be offered by banks to small ticket sizes below the
INR100,000 limit? This we believe will be largely determined by the marginal cost of
deposit for the specific bank in question. The marginal cost of deposit is still
evolutionary as the mode of acquisition of new accounts by banks is undergoing
many changes.
2) What proportion of savings deposits in a bank will be fungible to higher rates
elsewhere is debatable right now.
3) The ability to shift savings deposits between banks in the near term may be largely
limited to metro/urban banking centers. The following table summarizes the
proportion of savings deposits sourced in metro / urban areas and the average ticket
size per account across SBI & its associate banks, other PSU banks and private
sector banks.
4) Given their respective customer base, will PSU banks have more sticky savings
deposits than their private sector peers - due to relatively higher proportion of rural /
semi-urban savings deposits?
5) Banks are demanding that the RBI deregulate fee structures as well for the banks,
which is currently tightly regulated. How this issue is resolved will be an important
determinant of how banks protect their profit margins.
6) CASA deposits have so far been considered as long-term liabilities by banks for
their asset-liability matching and allied risk management. This could change in light
of the deregulation. If so, what kind of adjustments needs to be made on the asset
side to balance out the risks?
7) With all these dynamics at play, we believe it is too early to distinguish between
winners and losers due to deregulation of the savings rate.
8) According to the experience in other countries, savings rate deregulation has led to
the introduction of money market rate linked savings products and other product
innovations. This was also accompanied by enhancement of the fee structure
associated with operating a savings account.
9) The RBI does not expect unhealthy and disruptive competition from the deregulation
of the savings deposit rate. To gain a historical perspective, back in 1997 when term
deposit rates were deregulated, the spread between the term deposit rate and the
effective policy rate did not widen in a disruptive manner. What we observe from the
chart below is a cyclical variation in the spread depending on the liquidity conditions
in the market.
For the savings rate as well, the probability of disruptive competition in the sector should
be low. The term deposit share within the total deposit base in India has increased from
an average of 60.9% during 1990-97 to 64.5% during 1998-2009. This represents a
growth of 19.1% during 1998-2009 versus 1990-97. However, this higher growth was
also accompanied by higher volatility in the term deposit base. The experience with
savings deposits could be similar – as the savings deposit rate settles to a higher
equilibrium, savings deposit growth will increase but also accompanied by a greater
volatility.
10) As per RBI estimates, the core component of the savings deposits (calculated on
the basis of average monthly minimum balance) has ranged between 89-98% during
2006-11. Given the convenience value attached to the savings deposits, we believe
the war for savings deposits will be won on the basis of depth of a product offering
and service quality than purely on rate arbitrage.
11) However, to assess the impact of the deregulation, the following table gives the
impact on our FY13F PAT of our coverage universe of a 1% increase in savings
rate. This assumes ceteris paribus on all other key variables and assumes that
banks will not pass on the funding cost increase to their customers.
Attractive valuation, despite factoring in
stress case LLPs for utility loans
Loans given to power generation projects are expected to be under stress due to fuel
shortage issues and poor health of state utilities. We have analysed 60 projects that
have achieved financial closure to assess the likelihood of being restructured. Our
analysis indicates that 1.3% to 3.5% of the loan book of our coverage banks is likely to
be restructured. We cross-check our analysis with notes gleaned from discussions with
lenders and independent power sector experts. We factor in the appropriate loan loss
provisions into our forecasts, based on this probability of restructuring.
The bigger picture
We estimate total borrowing by the Indian power sector to be around INR6.5trn. Of this
private sector IPPs account for 38%, while state electricity boards (SEBs) account for
47% of the loan outstanding. Banks exposure to SEBs is 26% of their power sector loans
compared to 60% towards IPPS (Independent power producers). Infrastructure finance
companies (IFCs) like PFC and REC account for more than 50% of SEB exposure.
Other FIs include LIC and EPFO among others.
The total installed generation capacity currently stands at 182GW for India of which 23%
is through IPPs, while 55% of installed capacity is coal-based. Of the planned addition
until FY14, our utilities analyst expects 65GW of capacity to come from IPPs with 80% of
these projects thermal (coal/gas) based.
Key areas of concern
Investors have two key concerns regarding power sector lending:
• Poor health of SEBs – High aggregate technical & commercial (AT&C or distribution)
losses, sustained period of low tariffs and delay in subsidy payments from respective
state governments have pushed a majority of SEBs into the red with their net worth
wiped out. As per the Power Finance Corporation report, estimated aggregate losses of
state utilities were INR295bn for FY10 and INR635bn without accounting for subsidy.
This situation in turn has endangered a lot of IPPs supplying to these SEBs creating
demand uncertainty for them.
• Lack of coal linkage – As evident above, the bulk of capacity addition is dependent on
linkage of coal and gas for thermal based plants. Despite being the biggest coal
producer, the shortfall of coal requirement is expected to balloon to 20-30% of the
demand by FY14. Coal India hasn’t been able to keep pace with the demand
requirements while lack of logistical linkages and environmental regulation related
delays have further worsened the supply situation. Using imported coal or buying from
spot markets could possibly make many of the projects unviable. Also quite a few IPPs
don’t have the logistics and even the infrastructure (like boiler design) to handle higher
proportion of imported coal.
Takeaways from channel checks with banks and industry
experts
Based on our discussions with bank managements, infrastructure lenders and industry
experts we highlight a few key findings below:
• Projects with captive coal at least risk: Despite the strong demand outlook, unless a
company is able to sell above INR3.5 / unit – power is a loss-making proposition, as per
industry experts. In the current context of lack of adequate domestic coal supply and
higher cost of imported coal – projects with captive coal supply (either domestic /
international) are at least risk.
• Banks/ FIs exposed to stand-alone promoter projects at higher risk: Banks /
NBFCs exposed to projects from large sponsor groups with a diversified project base
(geographically, fuel supply-wise, etc) are at relatively lower risk compared to those that
have taken an exposure to single projects.
• Collaterals generally do not extend to non-project assets like coal mines: Even in
cases where the project sponsor has a captive coal mine, most of the financial
institutions have collateral specific to the power project and have no lien on the mine as
collateral – if structured otherwise, the project specific risk would have been much
lower for the financial institution.
• We estimate 30% of upcoming capacities from IPPs to possibly get restructured
in FY13/FY14: approximately 20 GW of the ongoing capacity addition to be
restructured – should translate into approximately INR700bn of loans to be
restructured. However, one may see the start of the restructuring cycle only towards 3Q
CY12. The following table gives a rough back-of-the envelope ROA impact for the
entire banking sector. Most of the lenders expect the impact of restructuring to come
only after H2FY13 and FY14. The typical moratorium period could be 12-18 months
which would entail 10-12% haircut on present value losses. We summarise the
expected impact on sector RoAs from possible restructuring in the table below.
• Near-term projects more likely to get restructured: Projects most likely to come up
for restructuring are those that are likely to be completed in the near term. So if fuel
linkages, transmission grid and associated problems are not sorted out early enough,
these exposures may come up for restructuring. On this basis – a capacity of 6-8 GW
(INR270-360bn) is likely to come up for restructuring most likely around late CY12.
• 55-65% of plant load factor (PLF) sufficient to service debt: Most of the banks we
spoke with said they expected the borrowers to be able to service debt payments even
if their plants were running at 55-65% PLF.
• SEB loss concerns overdone: A majority of bankers believed that concerns around
SEB losses were overdone. Some stated that tariff reforms were being considered
seriously, with the finance ministry recently conducting a meeting with relevant
stakeholders, asking SEBs to hike tariffs or face curtailment of bank. They pointed out
instances of recent tariff hikes in some of the weaker SEBs although we believe more
needs to be done to address the situation.
• Disbursals on existing sanctions appear largely on track: Although no new
sanctions are happening at the moment, the disbursals for sanctioned projects were
largely on track. Most lenders continue to disburse loans to projects with power
purchase agreements (PPAs) and coal linkage in place even if the coal linkage is
based on letter of assurances LoAs and not fuel supply agreements. The sector could
well see 20% loan book growth just on existing sanctions until FY13F.
Estimation of credit cost impact of IPP lending for banks
Based on the above findings we have analysed approximately 60 upcoming IPP projects
with achieved financial closure to assess the broad quantum of restructuring for banks
under our coverage. A few words on our methodology:
• For each of these projects we have listed four key risk factors – 1) Fuel linkage,
2)certainty of off take through either PPAs or captive demand, 3) progress on
regulatory clearance like environment and land acquisition and 4) exposure to loss
making SEBs. We have given significantly higher weights to the first two parameters.
• We have used publicly available information from credit rating notes, company
postings, government notifications and press releases to arrive at an assessment of
each project for each risk factor on a ‘good’, ‘bad’ or ‘ugly’ scale. Using the weights we
have computed an overall score on the scale for each project.
• Based on publicly available information on the lenders to these projects, we have tried
to assess the proportion of “good”, “bad” or “ugly” projects in the power sector portfolio
for each of our coverage stocks.
• Finally applying a 100% probability of “ugly” projects getting restructured and 50% to
the “bad“ ones, we have tried to arrive at the proportion of loan book that could possibly
get restructured over the next three years.
• This exercise is not exhaustive in any sense and we have used our subjective
assessment for the risk status of every project which can change rapidly. We believe
the underwriting standards differ across banks and this analysis enables us to get an
indicative proportion of a particular bank’s book under stress rather than paint the entire
banking sector with a broad brush.
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