The deterioration in credit profiles of public sector banks due to higher level of stress could get reflected in ratings/outlook change announcements for some of these banks over next few days, once rating reviews are concluded, cautioned credit rating agency ICRA.

The agency assessed that a higher level of stress is likely to significantly impact earnings and solvency profile of public sector banks (PSBs) over the next two-three years.

“Additionally, adverse capital market conditions have reduced the prospects of mobilising capital from non-government sources, while there has been no material success in mobilising capital through Additional Tier-I (AT1) instruments.

“All these factors contribute to deterioration in the credit profile of PSBs, which may get reflected in ratings/outlook change announcements for some of these PSBs once rating reviews are concluded,” said ICRA.

The agency observed that credit profiles of PSBs have worsened because of higher-than-anticipated stress, slower-than-expected pace of recovery, and weak outlook for several credit-intensive sectors.

Asset quality to remain weak In light of the challenges facing PSBs and their higher exposure to stressed sectors, ICRA said their asset quality indicators are likely to remain weak over the next one to two years. It reasoned that it would be a challenge to reduce the pace of fresh non-performing asset (NPA) generation, as well as recover a large stock of gross NPAs and standard restructured advances, estimated at around 13.3 per cent as on December 31, 2015.

PSBs’ gross NPAs in percentage terms increased to 7.1 per cent as of December 2015 from 5.6 per cent as of September 2015. Their gross NPAs in percentage terms are expected to worsen further in the fourth quarter, on account of the asset quality review exercise, ICRA said.

Dilution in earnings Higher-than-expected slippage in asset quality has led to significant dilution in earnings, in relation to the risk (annualised operating profit in relation to net NPAs dropped to 47 per cent in Q3 FY16, from 71 per cent in Q2 FY16). Additionally, according to the agency, sizeable net NPAs (4.3 per cent as on December 31, 2015) and other weak assets (standard restructured advances of around 6.2 per cent and some other weak standard assets) are likely to keep credit costs elevated over the next two to three years.

This will lead to pressure on earnings, and subsequently on internal capital generation as well as PSBs’ ability to raise capital from non-government sources.

Further, PSBs’ net NPAs in relation to net worth, have increased to 47 per cent as of December 2015, from 35 per cent as of September 2015, weakening their ability to withstand unexpected losses, it added. PSB’s aggregated Tier-I capital is estimated at around 8.2 per cent as of December 2015. In light of expected low internal capital generation (less than 5-6 per cent over the next 12 months), limited visibility on PSBs’ ability to raise capital from non-government sources, as well as investor appetite for AT1 issuances, ICRA expects dependence on the Centre for fresh capital to be very high.

Tier-1 requirement In ICRA’s estimate, Tier-I capital raising requirement during FY16-FY19 for majority of PSBs is more than 150 per cent of the current market capitalisation.

In light of the pressure, even to maintain a credit growth of 10-12 per cent per annum during FY16-FY19, the agency estimates that PSBs will need to raise core tier-I capital of ₹1.6-2.4 lakh crore and AT1 capital of ₹1.0-1.1 lakh crore during FY16-FY19.

If the Centre restricts its capital infusion plan to ₹70,000 crore for FY16-FY19, several PSBs could have restricted growth, leading to further pressure on their credit profile, it added.

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