How NPAs affect your investments
NPA. We’ve all been hearing this term in some news or the other for the past month or so. A number of questions arise, what is this ? why is it in the news ? can it affect my investments in any way ? Read on for the answers.
What is NPA ?
NPA stands for Non Performing Assets. The RBI states that an asset becomes non performing when it ceases to generate income for the bank. The best example of this from a banking perspective could be a loan given to a defaulter. Profitability of the banks is hit due to these bad loans which could have otherwise been utilised to generate an income from other borrowers. In addition to this, the bank’s capital decreases as the asset quality deteriorates thereby curbing their ability to give loans to other borrowers.
Why is it in the news ?
The Indian economy today faces weak loan growth and high NPAs; a nexus between the banking system and stressed borrowers is mostly blamed for this crisis. The rising NPAs have set the alarm bells ringing.
As the Public Sector Banks are passing through a difficult phase due to the peaking levels of Non Performing Assets which stood at 7.34 Lakh Crore at the end of September 2017.
The ballooning bad loan problem has shown a steep rise over the last 5 years with an average increase of 9%. Much higher than that of other developing economies such as China, Brazil and South Africa which are all below the 4% mark, considered to be a safe zone.
How do NPAs affect the banks ?
Interest Income is the first account that gets hit whenever an asset is declared non performing.
The principal, or money used by banks to finance loans, comes largely from the bank’s depositors. Banks borrow the money deposited by account holders and loan it to their customers. It is imperative for the bank to recover the money, because it’s not the bank’s money in the first place. When a borrower defaults on loan payments, the bank is unable to recover the principal. Unrecoverable principal must be replaced by the bank to keep its depositors’ funds intact.
If I gave a friend some money and he didn’t return it back, I would be hesitant while lending someone money the next time.
Similarly, banks also tighten their credit policies which may hamper economic growth as it will make it difficult for some promising businesses to obtain loans.
So who are these bad borrowers ? (other than Mr. Vijay Mallya of course.)
After the collapse of the leading investment bank Lehman Brothers in September 2008, growth seemed to be impossible. However the Indian government took many measures to insulate itself from the effect of this financial crisis by reducing interest rates to a historic low.
The increased liquidity and governments policy for economic growth led to large corporations conceiving major project proposals in capital-intensive sectors such as power, ports, airports, housing and highway construction. However these projects failed to materialise and banks found their loans getting sour.
Textile, Aviation, Mining, Infrastructure contribute to most of the NPA. Since most of the loan given in these sector are by PSB, They account for most of the NPA.
According to the RBI, just 12 companies are estimated to account for 25% of the gross NPAs, and were identified for immediate bankruptcy proceedings, while there are 488 others which have been given six month time to restructure their debt or be dragged to National Company Law Tribunal (NCLT).
Despite the various filters banks use before lending such as previous credit profile, if the loan seeker has defaulted in the past, the cash flows and the future outlook of income stability and reliability, there are a few too many errors.
Public Banks, possibly under political and economic pressure gave loans to a lot of companies who defaulted. In some cases such as infrastructure, there was a subtle and not-so-subtle nudge by the government, the majority owner of these banks. Besides, most of these banks also have a herd mentality. Once one bank gives a loan to one particular sector, others follow it almost blindly in search of balance sheet growth. The need to diversify its assets to different projects and promote economic growth may also play a factor in a banks decision to grant loans.
Secondly, Farm loan waivers impact public sector banks the most due to their high exposure to agriculture and farmer loans. Though the government reimburses farm loan waiver, such schemes create second order impact in terms of impaired credit discipline and low loan availability.
The research firm also said that frequent farm waivers create expectations of future waivers and can be a serious disincentive in loan repayments.
What has the RBI done to counter it ?
RBI introduced number of measures in the last few years which include tightening the Corporate Debt Restructuring (CDR) mechanism, setting up a Joint Lenders’ Forum, prodding banks to disclose the real picture of bad loans, asking them to increase provisioning for stressed assets, introducing a 5:25 scheme where loans are to be amortized over 25 years with refinancing option after every 5 years, and empowering them to take majority control in defaulting companies under the Strategic Debt Restructuring (SDR) scheme.
The Government has launched ‘Mission Indradhanush’ to make the working of public sector banks more transparent and professional in order to curb the menace of NPA in future.
Government has passed the Insolvency and Bankruptcy Code(Amendment) Bill which will bar wilful defaulters, defaulters whose dues had been classified as non-performing assets (NPAs) for more than a year, and all related entities of these firms from participating in the resolution process. Of course it does seem unfair for someone bidding for their own item after they failed to maintain it and driving the bids up.
Prompt Corrective Action Plan is set up to ensure that banks don’t go bust, RBI has put in place various trigger points and parameters to evaluate, monitor and take corrective actions to control banks which are fundamentally week and struggling to maintain profitability and a return on its assets. PCA had been recently initiated against Bank of India which is buried under huge bad loans and a negative return on assets.
How should all this affect your investment decisions ?
The efforts taken by the government to recapitalise the Public Sector Banks are hopeful and the restrictions placed by the RBI may help in the growth of profitability.
Many Public Sector Banks are trading below their intrinsic value and price to book ratios below industry average. It would be a good option to accumulate these at a fairly attractive price levels.
The solving of the NPA issue via debt recovery and recapitalisation will increase the capital of the banks and encourage them to increase their loan books. We at Trading Sense believe that such corrective policies can add value to the stocks of these Public Sector Banks.
