India Inc credit flow a trickle, bank profits under strain

The banking sector is set to face pressure on profitability as corporate spending slows and companies focus on deploying cash on the balance sheet to enhance productivity. Corporates are likely to utilise profits on their balance sheet and then if needed, borrow funds. Of the total estimated credit market of Rs 43,00,000 crore, corporates borrow 60 percent. The balance is shared by retail and agriculture.

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Corporate India is unlikely to increase capital spending in the year to March 2012, according to a survey by investment bank Morgan Stanley. “For a second successive year, corporate India is unlikely to raise capital spending by much. Our survey points to another year of tepid 10 percent growth in spending - compared to nominal GDP growth of 15.5 percent. Then again, this capex is concentrated on improving productivity rather than adding greenfield capacity,” the investment bank said.

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The slowdown in the credit growth is just one aspect. The other key aspect is that banks may have to restructure loans to certain vulnerable sectors over the next few quarters. This could mean accepting easier lending conditions and taking a hit on profits.

There is already an impact felt on the Street. Share prices of banks have fallen far more than the broader market. Over the past one month, the BSE Bankex fell 17 percent while the BSE Sensex was down 13 percent. This means the stock market expects significant slowdown in profitability of banks. Some banks have lost more value than others due to their exposure to vulnerable sectors.

Bank of India, Canara Bank, SBI, Bank of Baroda have been hit hard. Private sector banks like ICICI Bank and Axis Bank which have a focus on lending to the corporate sector over the past one year or so, have also witnessed their share prices fall by a fifth in just a month. (See table).

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In contrast, banks like HDFC Bank and IndusInd Bank have relatively outperformed. They lost only 9 percent and 11 percent of the value, respectively. A focus on retail banking - 50 percent of the total lending at HDFC Bank - and short-tenor wholesale lending that allows them to pass on any hike in interest rates to customers, makes them less vulnerable to any stress on profitability.

Investment bank Merrill Lynch conducted a stress test on Indian banks in case the US hurtles back to a double dip. The bank identified two key areas of concern that could influence restructuring of loans over the next two years - loans to small and medium enterprises (SME) and those to the infrastructure space.

Small and medium enterprises are more vulnerable to higher rates and weaker external demand. While actual valuations of the size of the SME segment may vary as per the definition of the banks, Merrill Lynch estimates that almost 25-30 percent of the total corporate loans - about Rs 6,00,000 crore - could be marked for the SME industry.

Merrill Lynch adds that SME sectors like textiles, parts of gems and jewellery; smaller engineering companies and also small-time real estate developers that are facing weak demand and cash flow pressures are more vulnerable to see defaults in the case of a US double dip.

Firspost had recently carried a report about smaller companies facing a spike in interest costs and an intense pressure on profitability in the June 2011 quarter in comparison to big players. This means the ability of smaller companies to withstand the slowdown was much less in comparison to large players.

The second worry that has been highlighted is that of restructuring of loans to the infrastructure sector. This means banks have to agree to easier lending terms, thus giving away profits.

In the case of the power sector, banks exposure is close to Rs 3,00,000 crore. According to Bank of America-Merrill Lynch estimates, about a third or Rs 1,00,000 crore is in projects under implementation. The investment bank believes that close to Rs 40,000 crore would be restructured over the next 2-3 years due to delays in implementation. This means banks would have to take a hit to that extent. Merrill Lynch believes that the direct impact on profitability would be about Rs 9,000 crore which is spread across 3 years across 15-20 lenders. A similar story is likely in the roads and aviation sectors.

“In aggregate, we could see fresh addition of Rs 1,40,000 crore worth of loans or 3.5 percent of loans being restructured by FY14,” adds Merrill Lynch.

The who’s who of the banking sector is set to get together in Mumbai on Tuesday for a Banking Summit organised by industry group FICCI and the Indian Banking Association (IBA). The agenda is expected to cover issues like improving the efficiency of the Indian banking system and enhance profitability of banks. Needless to say, there is a lot more to ponder over.