About a fourth of the restructured micro, small and medium enterprises (MSME) loans could slip into non-performing asset (NPA) category and the absolute quantum of NPAs may rise in the retail segment, providing opportunities for asset reconstruction companies (ARCs), per a ASSOCHAM-CRISIL Ratings report.

The stressed assets opportunity is shifting from corporate to retail and MSME loans, it added.

The report said asset quality of the financial sector is at its healthiest in recent times, specifically because of the sharp reduction in NPAs in corporate loans, indicating that opportunity for ARCs in corporate loans is perhaps at a cyclical low.

“That said, retail assets, which have garnered more interest from ARCs in the past couple of years, continue to offer a meaningful opportunity. As do loans to MSMEs,” according to the report put together by CRISIL Rating team led by Krishnan Sitaraman, Senior Director and Deputy Chief Ratings Officer.

Post-pandemic recovery

For banks, gross NPAs are expected to decline 90 basis points (bps) year-on-year (y-o-y) to about 5 per cent this fiscal, and by another 100 bps to a decadal low of about 4 per cent by March 31, 2024, riding on the post-pandemic economic recovery and higher credit growth, according to CRISIL Ratings’ estimates.

The biggest improvement will be in the corporate segment, where gross NPAs are seen falling below 2 per cent next fiscal from a peak of about 16 per cent as on March 31, 2018. The proposed sale of stressed assets to the newly formed National Asset Reconstruction Company Ltd (NARCL) should also support reduction in gross NPAs.

This follows significant clean-up of books by banks in recent years, as well as strengthened risk management and underwriting, which has led to higher preference for borrowers with better credit profiles

Gross NPAs in the MSME segment, which suffered the most during the pandemic, may rise to 10-11 per cent by March 2024 from about 9.3 per cent as on March 31, 2022.

“While relief measures did help contain asset quality deterioration last fiscal, the segment saw the most restructuring, at about 6 per cent, compared with about 2 per cent for the overall banking sector. About a fourth of the restructured accounts could slip into NPAs,” the report said.

Unsecured loans may see pressure

The retail segment has maintained steady asset quality with gross NPAs expected to be rangebound at 1.8- 2.0 per cent over the medium term

“While the impact of higher interest rates and inflation on cash flows of individual borrowers will need to be monitored, almost half of the retail loans are home loans, where borrowers that banks cater to have relatively better credit profiles.

“That said, segments such as unsecured loans may see some pressure. Also, while retail NPAs are expected to remain steady on a percentage basis, the absolute quantum of NPAs may rise given the sharp growth in the portfolio, thus providing opportunity for ARCs,” per the report.

Overall, this means there may be fewer opportunities for stressed asset players in the large corporate segment over the medium term. The MSME segment, however, continues to offer opportunities. On the retail side as well, certain segments, especially unsecured loans, could see more offers for sale.

‘Asset quality is cyclical’

“Between banks and NBFCs, the latter are becoming increasingly active as sellers, and this is expected to continue in the wake of the revised Income Recognition, Asset Classification and Provisioning (IRACP) norms.

“Nevertheless, it must be noted that over a longer period, asset quality is cyclical, and if the past is any indication, NPAs are expected to go up again after the current decline continues and they bottom out.” the report said.

As growth picks up and banks move out of their extremely cautious stance towards the corporate segment in recent years to meet credit demand and as leverage levels among borrowers go up, NPAs are likely to rise again, offering an opportunity for stressed assets players. The same holds true for NBFCs, too.