Bad-Loan Ultimatum in India Sees Default Risk Climb Most in Asia

  • Bank of India’s CDS jumps as spreads widen on dollar bonds
  • RBI has given banks until March 2017 to clean up bad loans

Investors are starting to show nerves over the Reserve Bank of India’s ultimatum for state lenders to clean up their rising pile of bad loans this fiscal year.

Bank of India’s credit-default swaps jumped 31 basis points in the past month, the most among Asian banks, after it was one of three lenders downgraded by S&P Global Ratings on May 30. Yield premiums on dollar bonds of the Mumbai-based company, Indian Overseas Bank and Syndicate Bank climbed to the highest in at least four months after the action.

“It’s one of the most trying times for the public sector banks and how they handle this will be crucial for their future survival,” said Rajesh Mokashi, deputy managing director at CARE Ratings Ltd. “I see a substantial jump in non-performing loans for most banks for the year to March 31, 2017.”

RBI Governor Raghuram Rajan, who will hand over the reins to an as-yet-undecided successor in September, has given lenders until March 31 to clean up stressed loans that surged to 11.5 percent of their assets last fiscal year. The rating downgrades will make it harder to raise capital for India’s state-owned commercial lenders, which issued no dollar bonds this year, versus $895 million in the first half of last year.

Bank of India, Syndicate Bank and Indian Overseas Bank didn’t respond to e-mails and phone calls seeking comment.

S&P cut credit ratings of Bank of India and Syndicate Bank to a junk BB+ from BBB- on May 30, while lowering Indian Overseas Bank’s grade to BB from BB+.  State Bank of India, the nation’s largest lender by assets, has a BBB- rating from S&P, the lowest investment-grade.

Spreads on Bank of India’s 3.625 percent dollar-denominated notes due 2018 touched 232 basis points on Monday, the highest in four months, while Indian Overseas Bank and Syndicate Bank also saw yield gaps rise, data compiled by Bloomberg show. The premium over Treasuries for 3.25 percent notes due 2018 of State Bank of India touched 153 on June 24, the highest since April 11.

The average yield spread on Indian dollar debt jumped early in 2016 before narrowing to 301 basis points on Thursday, compared with 322 at the start of the year, according to JPMorgan Chase & Co. indexes. Privately owned ICICI Bank Ltd. raised $700 million via 4 percent 10-year notes in March, while its smaller counterpart Axis Bank Ltd. sold $500 million of 2.875 percent green bonds in May.

India’s banks will require about $140 billion in capital by 2019 to comply with the stricter Basel III norms, Fitch Ratings Ltd. estimated in December. Rules requiring government stakes of at least 51 percent have curtailed state banks’ ability to sell shares.

“The two weaklings in the credit profiles of these banks remain asset quality and capital,” said Srikanth Vadlamani, senior credit officer at Moody’s Investors Service. “Through this crisis of bad loans, we haven’t seen their liquidity and funding profiles deteriorating” because of access to deposits and rupee bond markets, he added.

Profitability will remain very low because the three lenders will need to make very high provisions for bad loans, he said. Return-on-equity, a gauge for profitability, for India’s banking system fell to 4.8 percent in the year to March 31, the lowest in at least 18 years, data compiled by the RBI shows.

“Banks cannot kick the can down the road any more,” said Rethish Varma, head of research at Bengaluru-based Aditya Trading Solutions Ltd. “Until they address the asset quality issues and improve profitability, investors will be jittery about lenders in India.”

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