Mumbai: India’s state-run banks’ restructured loans are souring at a record pace, threatening their appetite for new lending with profitability already at a seven-year low.

Reworked assets that turned bad almost doubled to Rs57,000 crore ($8.9 billion) in the year ended 31 March, industry data show. There’s another Rs2.9 trillion in the category, which must be reclassified as delinquent or healthy within two years. Macquarie Group Ltd. has called this debt a ticking time bomb. Standard & Poor’s predicts a record portion will fail in the year ending March 2016 as Fitch Ratings Ltd. sees lenders’ return on equity falling to the least since 2006.

“A further rise in soured restructured loans is inevitable," Deep Narayan Mukherjee, a senior director at Fitch’s India Ratings and Research Pvt in Mumbai, said in a 27 May phone interview. “We aren’t seeing any signs in macro economic developments that will help loan repayments."

Bank credit has been the missing link as Prime Minister Narendra Modi strives to revive growth in Asia’s third-largest economy. Lending increased 10.5% in the 12 months through 1 May, Reserve Bank of India (RBI) data show, rebounding from February’s 8.88%, which was the slowest pace since 1994.

Smells bad

Banks previously had to provision for only 5% of loans identified as restructured versus upwards of 15% for those classified as bad. The RBI then ruled that, as of 31 March, banks must consider any loans they reorganize as bad and make a 15% provision immediately. The outstanding restructured loans, equal to about Rs2.9 trillion, weren’t affected.

RBI governor Raghuram Rajan has proposed penalties and incentives to get lenders to move faster in containing soured debt in an effort to bolster the financial system. He explained his hard line on classifying delinquencies during a speech in the western state of Gujarat in November.

“A nonperforming loan by any other name smells as bad," he said. “Forbearance allows banks to postpone provisioning for bad loans. So when eventually the hidden bad loans cannot be disguised any more, the hit to the bank’s income and balance sheet is larger and more unexpected."

India’s state-owned lenders account for more than 70% of all loans and their credit profiles will take longer to improve because they are tied to corporate balance sheets, Moody’s Investors Service said in a 13 May report.

‘Severe pressure’

“State-run banks’ profitability will be weak with return on assets staying flat in the current fiscal year because their exposure to vulnerable sectors is high," Pawan Agrawal, Mumbai- based chief analytical officer at Crisil Ratings Ltd., the local unit of S&P, said. “Their ability to raise capital to support business growth is under severe pressure because of the nonperforming assets burden."

The cost to protect the debt of State Bank of India against nonpayment using credit-default swaps has risen 3 basis points this month to 153 basis points as of 27 May, according to data provider CMA. Its $1.25 billion of 4.125% notes due 2017, sold to investors at a spread of 375 basis points over Treasuries in July 2012, are now at a 139 basis-point premium from a low this year in March of 132.7 basis points.

The rupee has weakened 2.1% against the greenback this quarter, making it the third worst-performing currency in Asia after the Thai baht and Japanese yen. Ten-year sovereign bond yields have fallen 9 basis points to 7.649% over the period.

Iron, steel

Worst hit may be iron and steel companies, Macquarie said in its 21 May report titled: Restructured Loans: A Ticking Time Bomb? That industry accounts for close to 20% of restructuring cases by value. Loans amounting to more than Rs30,000 crore have gone bad over the past three to four years, the Sydney-based investment bank said, citing local press reports, with about 70% of the stress coming from iron and steel, infrastructure, textiles, shipping and construction.

“About 40% of standard restructured loans to infrastructure, iron and steel companies will slip into nonperforming assets in the coming quarters," P Karthikeyan, a Chennai-based banking analyst at Cholamandalam Securities Ltd., said by phone 27 May. “Provisions for these bad loans will jump many fold and weigh on profits unless the government and regulators come up with new measures." Bloomberg

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