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Chennai, NFAPost: India Ratings and Research (Ind-Ra) says that the operating buffers (pre-provisioning operating profit – PPOP) of the top five private sector banks by advances size, constituting 25% of overall banking and 75% of private bank space, could decline by up to 15% yoy in FY21 (FY20: PPOP/average advances: 4.9%).

This would decrease the ability of banks to withstand credit costs without capital erosion. This would be an outcome of (i) lower portfolio yields due to an increase in slippages, (ii) lower loan growth due to slow originations and limited enhancements, (iii) lower fee and other income as origination and transaction volumes ramp-up over FY21, (iv) slower pace of repricing for deposits in the marginal cost of lending rate (MCLR) regime than that for advances, (v) higher liquidity deployed in low earning government securities or under reverse repo, the rating agency said.

Of the top five private banks, Ind-Ra rates HDFC Bank Limited at ‘IND AAA’/Stable/‘IND A1+’, Axis Bank Limited at ‘IND AAA’/Stable/‘IND A1+’, Kotak Mahindra Bank Limited at ‘IND AAA’/Stable/‘IND A1+’ and IndusInd Bank Limited at ‘IND AA+’/Negative/‘IND A1+’.

Material Impact on PPOP: Ind-Ra expects the PPOP of private banks to be about 80bp lower than their steady state PPOPs (FY20: 4.9%) in FY21.

Rise in Delinquent Assets would be NIM Dilutive: Ind-Ra expects that the impact of the GDP destruction and slowdown on the economic activities on the banking sector in the aftermath of COVID-19 will not be benign. The sector was putting its house in order after the last six painful years on the corporate side. However, the challenges on the non-corporate side (retail, SME and agri) were already showing up (including in retail) as we entered into the pandemic. The pandemic is likely to aggravate that stress. Ind-Ra also expects that the percentage portfolio under moratorium for these private banks would have increased by May 2020.

Ind-Ra’s analysis also suggests that the slippages for FY21 would be around 5% for these banks, as against 2.3% in FY19 and 2.7% in FY20 (net slippages would be lower), if refinancing remains a challenge. As per Ind-Ra’s scenario analysis, at 5% gross slippages, these banks’ net interest margins (NIMs) could contract by 4%.

Excess Liquidity deployed Largely in Low Yielding Alternatives because of Limited Deployment Avenues: The deposit flow has continued to be robust. The growth in deposits for these top five private banks in FY20 was 18.8% yoy (FY19: 18.5%) while the loan growth declined to 15.0% (19.1%). Additionally, the Reserve Bank of India has injected Rs 1.7 lakh crore of liquidity into the system over the last six months through open market operations and secondary market purchases.

The banks have largely placed the excess liquidity in low-duration government /top-rated corporate securities (not loans), reflecting higher credit risk perception and widening duration spreads. Additionally, they have moved a large amount of the surplus liquidity into reverse repo where the rates have declined by 215bp in the last one year, yielding 3.35%. With the banks’ cost of funds is between 5%-6%, this could result in a a negative carry.

Sharp Reduction in MCLR Rates: While most banks have reduced deposit rates, the impact on cost of funds would be gradual as the incremental funds are raised at lower rates. One-year MCLR for these banks have reduced by 10-60bp in the last three months. Many banks have 30%-60% of lending linked to MCLR; this impacts NIMs immediately as the income falls for the entire portion of advances. The banks with a higher proportion of low-cost current account savings account deposits will be lesser impacted and vice versa. Ind-Ra has assumed that 50% of non-CASA deposits could be repriced immediately, but the balance would be repriced only over the next two years. Under these assumptions, PPOP could impacted by around 15bp yoy in FY21.

Slowing Unsecured Product Origination Could Impact NIMs: Over FY17-FY20, the net advances of these five private banks and bank credit grew at a CAGR of 15.7% and 9.1%, respectively, while the unsecured retail portfolio grew at a CAGR of  21.8% for the same period (May 2020 loan growth: down 9.4% yoy). These banks have increased the proportion of unsecured retail portfolio over the same period; while they had already started tightening filters pre-COVID, Ind-Ra expects the pace of originations to come down materially.

The unsecured retail portfolio is a higher yield portfolio with lower credit costs than overall portfolio. This will have a material impact on fee income as well as NIMs. In Ind-Ra’s opinion, the yields on unsecured retail portfolio are between 10% and 14%. If the unsecured retail portfolio declines by 5%, the impact on PPOP is likely to be 5-10bp.

TLTRO Operations May Partially Offset NIM Pressure: The Reserve Bank of India has conducted long-term repo operations (LTRO) of about Rs 2.38 lakh crore, including TLTRO1.0 and 2.0 totalling to Rs 1.12 lakh crore. While banks’ participation was wide for TLTRO 1.0, TLTRO 2.0 attracted lower participation. Deployment of these funds in various typical treasury avenues or lending to largely AAA corporates could provide the banks with nearly risk-free returns on these funds. This could partially offset the pressure on NIMs and operating buffers, Ind-Ra said.

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