Record Rout in Government Banks as Buffers Drop: Corporate India

Shares of India’s state-run banks are trading near record-low valuations as concern grows about narrowing risk buffers and rising bad loans.

Indian Bank, United Bank of India Ltd. and Union Bank of India, have fallen more than 55 percent this year to Sept. 12, the most among the nine government banks that are leading declines for India’s 40 bank stocks. Shares of the nine lenders are all trading below the value of their assets amid lower-than-average capital adequacy levels and bad loan ratios that are about double those of private-sector lenders.

Banking Secretary Rajiv Takru fueled the S&P BSE Bankex index’s slump to a 19-month low two weeks ago after signaling the government may delay a capital infusion into the banks it controls. Takru’s retreat from earlier comments that India will inject as much as 140 billion rupees ($2.2 billion) by September comes at a time when default risk is rising in an economy that grew at the slowest pace in four years in the June quarter.

“The current slowdown in the economy will be deeper and more painful than we earlier expected,” Saswata Guha, a Mumbai-based director at Fitch Ratings’s India unit, said by telephone. “With the pain on asset quality expected to continue for at least another 12 months, provisions will go up, profits will fall and the viability ratings of state-run banks will see further downward pressure.”

Government lenders have historically been undercapitalized relative to their privately owned peers as a regulation requiring state ownership be maintained at 51 percent curtails the banks’ ability to raise capital by selling shares.

Stringent Rules

Capital adequacy ratios at the state-run banks according to the so-called Basel II rules were at an average 12.4 percent as of March 31, lower than the 13.8 percent mean for all banks in the country, data compiled by the central bank show. Indian banks started reporting ratios under the more stringent Basel III requirements only in June.

India has a minimum regulatory requirement of 9 percent. Chennai-based Indian Bank had a Basel II capital adequacy ratio of 13.1 percent as of June 30, exchange filings show. United Bank reported 11.7 percent and Union Bank’s capital ratio was at 11.1 percent, the filings show.

Indian Bank slumped 64 percent this year to Sept. 12 and trades for 0.3 times the value of its assets, data compiled by Bloomberg show. United Bank also has a price-to-book ratio of 0.3 times after sinking 59 percent. Union Bank is at 0.4 times following a 57 percent slide.

Risk Weightings

T M Bhasin, Indian Bank’s chairman, Archana Bhargava, United Bank’s chairman and Debabrata Sarkar, Union Bank’s chairman didn’t respond to an e-mail and two calls to their office.

Bank of India, based in Mumbai, has fallen 52 percent this year and trades at 0.4 times book. The company said it plans to exit accounts that attract higher risk weightings to improve its capital ratio to about 11.5 percent by March 2014, spokesman N. Venkatachalam wrote in a Sept. 7 e-mail.

By contrast, Kotak Mahindra Bank Ltd., the only stock among its peers to advance this year to Sept. 12 with a 7.8 percent gain, reported a capital adequacy ratio of 18.8 percent, exchange filings show. IndusInd Bank Ltd., the second-best performer with a 4.8 percent drop, had a ratio higher than 14 percent as of June 30. Both banks are not controlled by the government.

“I have been switching from the public sector to select private sector banks where the relative price to book is attractive,” said Chirag Setalvad, a fund manager with HDFC Asset Management Co., India’s biggest money manager.

‘Disproportionate Share’

Investors are favoring privately owned lenders on bets they can better absorb rising bad loans in India. The gross bad loan ratio at the state-run banks rose to 3.84 percent as of March 31, more than double of 1.91 percent at the private sector lenders, central bank data show.

India’s economy grew 4.4 percent in the three months to June 30, the least in seventeen quarters, government data showed on August 30. The ability of most Indian companies to generate cash and service debt is at the lowest level since 2008 as growth slows, Deep Narayan Mukherjee, a Mumbai-based director at Fitch’s Indian unit, said last month.

Bad loans at Indian lenders climbed to 3.9 percent of total lending as of June 30, the highest level in at least six years, from 2.4 percent in March 2011, according to an Aug. 22 report from the RBI. State-controlled banks account for a “disproportionate share” of the surge in soured debt, according to the report.

RBI Governor

Mumbai-based State Bank of India, the nation’s largest by assets, posted a 14 percent decline in net income for the quarter ended June 30 as bad loans climbed. Gross bad loans expanded to 5.6 percent of the total by the end of June, from almost 5 percent a year earlier, the filing showed.

Indian Bank reported a gross nonperforming loan ratio of 3.4 percent as of June 30, compared to 5.6 percent at United Bank and Union Bank’s 3.5 percent, exchange filings show. Kotak Mahindra Bank had a ratio of 2 percent, while IndusInd Bank reported 1.1 percent.

Respite may come from the Reserve Bank of India after new Governor Raghuram Rajan unveiled proposals to improve the banking system on his first day in office. There’s a need to cut the requirement for banks to invest in government securities to ensure lending to productive sectors of the economy, Rajan said Sept. 4.

‘Long-term Impact’

The central bank on Sept. 11 said it’s creating a database that will list liabilities of over 100 million rupees. Rajan earlier this month said the RBI will also look at ways to improve the recovery mechanism for bad loans and allow some lenders to open branches without seeking RBI approval.

The steps “will have a major long-term impact on bank profitability and growth,” JPMorgan Chase & Co. analysts led by Seshadri Sen wrote in a Sept. 4 report.

The Bankex Index has climbed 15 percent since Rajan’s comments. The extra yield on State Bank of India’s bonds due 2017 over U.S. Treasuries has fallen to 308 basis points from 418 on Aug. 20, which was the highest since the notes were issued in July 2012, data compiled by Bloomberg show.

Nitin Kumar, Mumbai-based banking analyst at Quant Broking Ltd., is more circumspect about the impact of the measures, some of which could be years away from being introduced. What’s needed are steps to reduce short-term borrowing costs that surged after the central bank started taking steps on July 15 to stem a slump in the rupee, Kumar said by phone on Sept. 5.

Three-month interbank borrowing rates surged to 11.6 percent on Sept. 4, the highest in almost 5 years, according to data from the National Stock Exchange of India.

Asset Quality

“There is no silver lining as far as asset quality is concerned,” Kumar said. “Falling capital ratios will make it tougher for banks to take the hit. There is no visibility as far as an end to the economic uncertainties is concerned.”

Option prices show traders are paying the most in two years to protect against losses in Indian stocks amid growing concern over the slowing economy. Puts with an exercise price 10 percent below the CNX Nifty Index cost 15.6 points more than calls betting on a 10 percent gain, one-month implied volatility data compiled by Bloomberg showed last week.

The average cost of insuring the debt of five Indian lenders against non-payment for five years using credit-default swaps jumped 94 basis points in 2013 to 348, according to data provider CMA. It is near the highest in more than an year, according to data compiled from prices quoted by dealers in privately negotiated markets.

India may delay injecting capital into state-run banks due to slumping stock prices, Takru, the Finance Ministry’s banking secretary, said Aug. 19 in an interview. The government, which usually infuses capital into lenders by buying their shares, doesn’t want to lose money as prices slide, he said at the time.

Risk Buffers

Takru had said on July 9 the government will inject as much as 140 billion rupees by the end of September to strengthen banks’ risk buffers and bolster credit growth.

CLSA Asia Pacific Markets cut their earnings estimates for Indian banks by as much as 14 percent for the 2014-2016 business years to account for the slowing economy and elevated borrowing costs, analysts led by Aashish Agarwal wrote in a Sept. 10 report. Government banks are most exposed because of their lending to smaller companies, they wrote.

“Slower economic growth and higher interest rates will put pressure on corporate profitability that will transpire into asset quality issue for banks,” the CLSA analysts wrote. State-run lenders “are most vulnerable.”

Before it's here, it's on the Bloomberg Terminal.