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Tackling the asset-quality problem

"The reduction in asset-quality problems is likely to start with a lag of one-two quarters and that too gradually," says Sanjay Parekh of Reliance Mutual Fund

In this interview with Kumar Shankar Roy, Sanjay Parekh, Senior Fund Manager - Equity Investments, Reliance Mutual Fund talks about the state of Indian banking

Tackling the asset-quality problem

Banking stocks have had a roller-coaster ride. Just when you thought things could not get worse, public-sector banks (PSBs) have stumped everyone and revealed ever-increasing staggering losses due to bad loans. Sanjay Parekh, fund manager of the country's biggest pure-play banking-stocks fund, Reliance Banking Fund, sees more pain on the asset-quality front in the near term. In an interview with Kumar Shankar Roy, Parekh says that the fund, which has assets under management of over `2,000 crore, is bullish on private banks. His reason: even the private banks which have higher stress in the corporate books are better placed than PSBs on account of continuity in leadership, more agility and no requirements for capital, among other factors. He also likes the new niche banks because of the large opportunity waiting to be tapped and faster growth potential.

The finance minister, Arun Jaitley, has gone on record saying that banks' non-performing assets (NPAs) have reached peak levels. Is the banking sector really out of the woods? How deep does the rut go?
We feel that in the near term, there can be more pain on the asset-quality front as the resolution is taking time. However, one needs to watch key developments like deleveraging of stressed business groups; benefits of the minimum import price (MIP) for the steel sector; benefits to the state electricity boards due to the Ujwal DISCOM Assurance Yojana and hence higher purchase of power from power generating units; unclogging of the stuck-up projects; and the overall recovery in economy. All these developments can lead to a reduction in the asset-quality problems. However, the reduction in asset-quality problems is likely to start with a lag of one-two quarters and that too gradually.

We have seen PSU banks raking up huge losses due to provisioning for bad loans. What ails the banking system, especially PSBs, and when can we expect a revival that is not just led by the base effect?
Post the asset-quality review by the RBI, it's clear that the size of the problem is large. It's visible in the steep increase in stressed assets and higher provisioning, resulting in the losses. While this does give confidence now, with more sanctity to the book value, the adjustments required to get to the adjusted book value have surely increased substantially. Also, the return on assets (ROA) and the return on equity (ROE) are likely to be sub-optimal for PSU banks due to asset-quality problems, lower credit growth and lack of good avenues to lend. Further majority of PSBs will need capital in the next 12-24 months in addition to capital infusion from the government. So, there have been downgrades across the board in terms of book value, adjusted book value, ROA and ROE of PSBs.

Your top five holdings are in the private-banking space. How have private banks managed to weather the banking problems plaguing PSBs? Are private banks the only investible theme in the country's banking space right now?
Our top holdings in the private-banking space include HDFC Bank, ICICI Bank, Axis Bank, Yes Bank and IndusInd Bank. We believe markets have appropriately rewarded the banks in the private-banking space where the asset-quality problem is significantly less as compared to PSBs. Even the private banks which have higher stress in the corporate books are better placed than PSU banks, since they have continuity in leadership, are more agile and can work towards the resolution of stress. They don't have an immediate need for capital. Also, their respective retail parts of the business have done quite well and displayed a lot of strength and above-average growth rate, which, in our view, is not adequately appreciated.
We feel while PSU banks have their own challenges, the larger ones with strong CASA [the ratio of deposits in current and savings accounts to total deposits] franchise and balance sheet to withstand the pain of stress on their books, along with some scope for value unlocking through sale of strategic investments, are better off than their peers in the PSU space. The leaders in the PSU-banking space also have asset-quality problems but are better placed than their peers in that space.

What are the key indicators that serve as a sign for good times for the banking sector per se?
Key monitoring factors would be deleveraging by large stressed business groups, pick-up in credit growth, normal monsoons, benefits of MIP to the steel sector, overall pick-up in the economic activity and improvement in other macro indicators like gross-domestic-product (GDP) growth, Index of Industrial Production (IIP) growth rate, fiscal deficit as per target, improving current-account-deficit situation, control in Consumer Price Index (CPI) inflation and strong foreign-currency reserves.

Will the bankruptcy law help banks get more juice from bad loans or distressed firms than what they get at present?
The bankruptcy law will help, but it will take time to get implemented - at least one year. Also, key will be faster execution to arrive at a resolution.
One clear positive is the RBI and the government, and now through the Bank Board Bureau, are working in a cohesive manner on an urgent basis to resolve the issue. There is a clear sense of urgency to reduce the stress on the asset-quality front.

How do you find the new niche banks (some have started operating while others are coming) as investment targets? How are they, potentially speaking, better than wholesale-banking plays?
Some of the recently listed banks which were predominantly into microfinance earlier have now also received the licence for small-finance banks. They are expected to do well since they cater to under-banked areas and also have the low ticket-size advantage. The opportunity is clearly large and hence growth rates can be quite good in this space.
However, when they transition into a bank from being a non-banking financial company (NBFC), they will certainly have challenges to raise CASA at reasonable levels. Further, as they diversify the book in other products and grow, execution will be the key. Their ROA and ROE will certainly come down. However, we need to watch the pace of decline and how they stack up with growth.

This column appeared in the August 2016 Issue of Wealth Insight.