>INDIAN BANKS: How intense is the credit cycle and what is factored in ?

Our detailed corporate health check for ~3500 listed companies indicates that the credit cycle is getting deeper with breadth of mid and small cap companies facing stress increasing at a brisk pace along with an elongated down cycle, leading to higher ultimate delinquencies. But the good part is asset for large caps (excl. Infra, ~60% of debt) have held up relatively better and more importantly, stress sectors have already seen large scale recognition, either as NPA or restructured asset. We do not see a significant rebound in the credit cycle near term and hence, prefer ICICI/Axis, where corporate underwriting has been robust and our sensitivity analysis indicates 15% upside even considering ~15-20% write-offs. PSU banks’ adj. valuation is undemanding indicated in our rating upgrades in some PSU names after 4Q12 but the BUY case for PSU banks is more contingent upon a fast recovery
and more importantly front ended monetary easing.


 Corporate health check – Analysing pain points: We ran a detailed Interest coverage (IC) analysis of all listed companies to understand breadth/depth of the credit cycle. The bad news: (1) IC, for mid corporate and SMEs, has come to levels below 08-09 levels with increasing intensity - 25% of mid and SME companies with IC of <1x. (2) The bigger worry is that IC for mid and small caps have remained low for 3-4 quarters now and elongated stress time leads to ultimate delinquency. The good news: (1) Some pockets in large caps are seeing some incremental stress but overall IC levels remain comfortable and this reduces asset quality risks as they constitute ~60% of the total Rs15trn of industrial credit we analysed.


 What levels of stress is recognized/discounted? Though the credit cycle is building up, segmental data provided by SBI/PNB indicate that 10-25% of total exposure in some stress sectors has already been recognized (either NPA or restructured), though intensity continues to increase. Engineering/construction still remains vulnerable as stress recognition remains lower than stress indicated by our IC analysis.


 Factoring risks not captured through our IC analysis: Infra risks/delays are still to hit P&L and hence, our IC analysis does not capture Infra/power risks. Our bottom-up analysis indicates that ~20GW of thermal plants face fuel/off take issues (~20% of capacities commissioned in 09-15E). Though we expect large restructuring in private power space, strong promoter financials in some cases, extension of loan tenure and most importantly systemically acceptable level of cost of power produced (Rs3.1-3.2/unit) even assuming 25% imported coal blending, will significantly limit ultimate delinquencies.


 Stress testing- ICICI/Axis remain top Buys : Our stress test indicates that valuations for ICICI/Axis is ~15% lower than their LT averages after considering ~15-17% hit to book values. The hit on PSU banks book is larger at ~30% of book given NPA shortfalls and higher restructuring, but that seems to be fcatored to some extent in valuations. The credit cycle is getting elongated and challenging and easing modetary stance now will bring some relief to asset quality.


To read report in detail: INDIAN BANKS