Mumbai: Restructured loans are defaulting at a record rate at Indian banks amid forecasts the worst economic slowdown in a decade will deepen, according to the investment banking unit of the nation’s biggest lender.

As much as 20% of renegotiated credit in India’s banking system is now classified as in default, according to SBI Capital Markets Ltd. Such loans, which give borrowers a moratorium on payments, longer maturities or lower interest rates, more than doubled since 2009 to 2.5 trillion at the end of June, data from the Corporate Debt Restructuring Mechanism show.

Bad loans are rising as Goldman Sachs Group Inc. predicts India’s economy will grow 4% this fiscal year, after a 5% gain in the prior period that was the smallest since 2003. The yield on State Bank of India’s 9.95% rupee debt due 2026 rose 74 basis points this quarter to 9.54%, the most since the notes were issued in 2011. That on Bank of China Ltd’s 2020 dollar bonds fell 57 basis points to 4.09%.

“Nobody expected the slowdown to last this long while recasting the debt," Supratim Sarkar, head of structured finance in Mumbai at SBI Capital, a unit of government-owned SBI, said in an interview on 23 September. “Restructured loans are slipping into the non-performing category at a faster pace than ever before. I expect this to pick up further."

Funding costs

Asset quality at Indian banks is deteriorating as a surge in funding costs hurts the repayment ability of businesses already bearing the brunt of the economic slowdown. Five-year bond yields for top-rated local companies have jumped 156 basis points since the end of May to 9.82%, as the central bank created a cash crunch to stem a plunge in the rupee. Three-month commercial paper rates rose 150 basis points to 9.95%.

Soured debt swelled to 3.92% of total loans at the end of June, the highest level in at least five years, from 3.4% at the end of March, RBI data show. The ratio was 6% for restructured credit. The increase is threatening to erode earnings at Indian banks, which are required to set aside more cash as risk provisions against non-performing assets.

“Return on equity at local lenders, which tracks profit generated with shareholders’ funds, may fall below 10% in the year to March from a five-year low of 12.8% in the previous period," Vibha Batra, co-head of financial-sector ratings in New Delhi at a unit of Moody’s Investors Service, said in an interview on 21 August.

‘Limping along’

“Indian banks are going through a difficult phase," Saurabh Mukherjea, chief executive officer for institutional equities at Mumbai-based Ambit Capital Pvt. Ltd, said in an interview on 23 September. “Three years into a downturn if the borrowers are limping along, it is only to be expected. This will worsen if the cost of financing is rising."

Moody’s Investors Service lowered this month the ratings on SBI’s senior unsecured debt and local-currency deposits to Baa3 from Baa2. The rating company also cut the outlook on the lender’s financial strength to negative from stable. The credit assessor’s concern about SBI is misplaced because the lender has adequate capital, Mumbai-based chief financial officer Arundhati Bhattacharya said in a 24 September phone interview.

Bank bond risk in India is rising. Credit-default swaps insuring SBI’s debt against non-payment for five years have risen 121 basis points from the year’s low of 174 in May, according to data provider CMA. The contracts climbed 106 basis points last month in the biggest surge since October 2008.

Stressed assets

Fitch Ratings cut state-owned Indian Bank’s debt ranking to BB+ from BBB- on 23 September, while reducing the viability rating of government-controlled Punjab National Bank and Bank of Baroda to BB+ from BBB-.

Fitch expects that asset quality at Indian banks, particularly state-owned ones, will worsen, resulting in a larger amount of stressed assets than initially forecast and the amount would peak only in year ending March 2015, analysts at the ratings company led by Singapore-based Ambreesh Srivastava said in a statement on the same day.

Restructured loans jumped 50% for the 10 largest state-owned banks in 12 months to 31 March, compared with a 36% increase in bad loans, according to Fitch. An average 7.2% of state-run lenders’ loans were restructured as of 31 March, central bank data show. The ratio was 4% on average for the biggest private-sector banks, including ICICI Bank Ltd and HDFC Bank Ltd.

Rajan’s plan

Raghuram Rajan, who took charge as India’s central bank governor on 4 September, has said he will focus on strengthening the financial industry and signaled measures to make it easier for banks to curb bad loans and lend to non-state sectors of the economy. He also called for a reduction in their requirement to invest in government debt to free up more money for funding companies and projects. The steps will have a major long-term impact on the earnings of financial institutions, according to JPMorgan Chase and Co.

RBI also plans to ease restrictions on the expansion of branch networks, according to Rajan.

India’s BSE Bankex, a gauge of 13 banking stocks, surged 9.3% on 5 September, the biggest rally since May 2009, after Rajan outlined plans to reinforce the financial system.

While RBI’s proposals will help, policies with wider economic impact such as steps to boost the infrastructure sector and capital injections into state banks are required for bigger improvements in the financial system, according to SBI Capital.

Lanco, Educomp

The latest RBI measures stress on a clean-up of banks’ books but the big push can only come through bank recapitalization, SBI Capital’s Sarkar said. As the moratorium on interest payments gets over, more restructured loans are falling into the non-performing category.

SBI Capital is currently helping companies including Lanco Infratech Ltd, Educomp Solutions Ltd and Bombay Rayon Fashions Ltd recast loans, according to Sarkar. Banks have to set aside more money as provisions for bad loans than restructured loans.

Yields on lenders’ local-currency bonds have climbed since May. The rate on five-year notes ranked AAA by local companies has increased to 9.64% from 7.96% as of 31 May, according to indicative rates compiled by Bloomberg. Ten-year government yields added 146 basis points in the same period to 8.71%. The yield on the benchmark 7.16% sovereign notes due May 2023 fell one basis point on 27 September, while the rupee weakened 0.7% to 62.4975 per dollar.

The extra yield on SBI bonds due 2017 over US Treasuries has climbed to 336 basis points from this year’s low of 229 in February, data compiled by Bloomberg show. That on ICICI Bank Ltd’s 2018 debt rose to 346 from 242.

“The run rate of slippages from restructured loans at many banks have crossed 30%," Nitin Kumar, a Mumbai-based banking analyst at Quant Broking Ltd, said in an interview on 27 September. “Our concern is that the ability of many of those lenders to raise capital to absorb the mounting losses remains constrained in current economic scenario."

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