Watch out for banking stocks! Bad assets are set to triple

Non-performing assets, or bad loans, of banks in India are set to triple by March 2014, according to the latest report by CLSA.

The warning comes amid a bleak background of sluggish credit demand, increasing risks of defaults and need for restructuring assets (to extend credit periods to allow problem borrowers more time to repay their loans).

The brokerage also slashed earnings estimates for the entire sector by 3-9 percentage points for the year ending March 2012 as well the 12 months after that.

The reasons for the downgrade are not hard to understand.

India’s growth is slowing, policy decisions are stalling and fewer projects are taking off.

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Given these conditions, credit growth will, naturally, be hampered, since the corporate sector accounts for 70 percent of bank credit. The brokerage expects credit growth will slow to 16 percent this financial year (April-March) from 21 percent last year.

That figure has been estimated keeping in mind that growth in loans taken for working capital would be in line with nominal GDP (gross domestic product) growth (real GDP growth plus inflation).

In contrast, there will be few borrowers for long-term projects, which generate maximum fee income for banks, the brokerage noted. That could mean a hit on fee income for banks such as State Bank of India, ICICI Bank, HDFC Bank and Axis Bank.

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Already, high interest rates and a slowing economy could make repayments difficult and slippages more likely. The problem could even get sector-specific since small- and medium-scale enterprises are typically more vulnerable to defaults if interest rates rise.

It is in this context that CLSA expects NPAs to triple taking gross NPA ratio from 2.4 percent at the end of March 2011 to 4.6 percent by March 2014 and therefore, cut earnings estimates by 3 percent for the year ending March 2012 and 9 percent for the year ending March 2013.

CLSA also reduced the target prices on all banks by up to 15 percent, with a more negative bias towards public-sector banks.

ICICI Bank and HDFC Bank remain the top picks of the brokerage. It remains negative on all public-sector banks including SBI. The only exception is Bank of Baroda, on which it still remains bullish.