International financial services firm Morgan Stanley said it expects the formation of bad loans to decline 40% this financial year, based on industry feedback.
“Our view is that new NPL (non-performing loans) formation will decline by ~40% YoY in F17. It will still be high, but given the surge in F16, it should decline meaningfully this year. However, in most of our meetings, banks were reluctant to guide towards a sharp decline. We may still end up with >4% of system loans turning bad this year (current base case in our estimates is 3-3.5%)m” it said.
Morgan Stanley gave the update after meeting with banks, NBFCs, rating agencies, policy makers and investors at its 18th annual India summit.
“Private corporate lenders were confident about the watch lists — and we’ll likely start getting clarity on pace of provisioning in F1H17. On SOE banks, the concerns were around provisioning for the NPLs announced and how it will affect profitability even when NPL formation slows,” it said.
Morgan Stanley also said there was a question about how and when bad loans on public sector (state-owned) banks will be disposed off.
“Incentive to dispose of bad loans at SOE (state-owned) banks is not high,” the firm said.
“The loan officers at these banks are wary of approving disposals with any meaningful loss. This puts them at risk if there is any future assessment by vigilance committees (SOE loan officers don’t have any material variable pay and can’t be fired, so they have no incentive to take risk).”
In addition, these state-owned banks don’t have required insurance coverage to recoup their losses. “SOE banks are sitting on fairly low coverage. If they sell at big discount, the P&L impact would be material.”
“Even private banks mentioned that there have been cases where banks agreed on NPL disposals but then the disposals got stuck due to risk aversion at SOE banks. The lack of recoveries is evident in low level at SBI (lowest recovery level since F2010). This clearly increases the loss given default,” it added.
However, said the firm, the mood among investors was optimistic.
With the economy showing signs of recovery, there was significant interest in banks, it said.
However, Morgan Stanley said it continued to be ‘underweight’ on public sector banks under coverage “as bad loan problems will likely drag on and profitability will stay low.”
Foreign investors continue to like private lenders, and focus was on growth outlook at retail and assessment of watch list at corporate lenders, it added.
“We like private lenders, with top picks being Axis Bank, HDFC Bank, IIB, Kotak and Yes. NBFCs will also likely gain share and show reasonably good growth in their segments. Our top pick in this space is SKS.”