Bubble In Indian Banking Industry?

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On 21st Sep, market was most volatile in last four years. Sensex jumped up and down more than 1000 points intraday. It all started after 12pm and next three & half hours were completely roller coaster ride. Many blue chip stocks were hit and more predominantly Non Banking Finance stocks (NBFC). There are talks about bubble in Indian financial sector and likely repetition of 2007 crisis in India. Lot of this noise is based on gut feeling and not well placed. In this article, we look at various events happening inside our financial industry that are weighing down on the sector.

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Trouble at IL&FS

IL&FS (Infrastructure Leasing & Financial Services) is one of the stalwarts of financing & developing infrastructure projects across the country since 1987. This year June, company failed to payback on its commercial borrowings to the tunes of ₹450 Crores. Over next two months, every major rating agency started to downgrade IL&FS credit worthiness making it difficult to raise fresh loans. IL&FS as group company has more than 150 subsidiaries out of which only 3 are listed. The parent firm itself is not listed making it very complicated to analyse its financial health.

Situation at IL&FS is tricky as it does not have enough liquidity to safely honor its future commitments. Given the scenario, company is going to sell off some assets to generate cash. However such panic sales often lead to haircuts by buyers. Over next few months, IL&FS will keep financial sector on the edge. LIC (Life Insurance Corporation) is the main promoter having 25% of the shares, followed by Orix Japan at 23%, Abu Dhabi Investments holding 12%, HDFC holding 9%, Central Bank of India holding 7% & SBI holding about 6%. IL&FS is seeking to raise fresh loan of ₹3000 Crores from LIC & SBI while at the same time trying to sell assets to improve balance sheet. Fund houses having significant exposure in their debt funds to IL&FS are Motilal Oswal, Tata, DSP & Principle. Their NAVs have fallen badly post June default while maturity is still some time away. Avoid these debt mutual funds to be on safer side.

RBI says No to Yes Bank

Another financial biggie, Yes Bank which has been struggling with NPA (Non performing assets) of late, has been asked by RBI to cut short its CEO Mr Rana Kapoor’s term from 3 years to just 4 months. Rana Kapoor has been at helm at Yes Bank since beginning and is seen as central person in company’s strategies.

If one looks carefully at Yes Bank, it has been under trouble for last two years or so. As part of our advisory service, we were closely tracking Yes Bank as our next potential stock only to realize that something is wrong as one after another things were going bad for the bank. In Sep 2016, Yes Bank tried to sell QIP (preferential shares) valued at $1 billion to raise fresh capital which failed miserably. A day before QIP was called off, Rana Kapoor himself tried calling bankers aboard at 4am to get full subscription for the issue but it eventually failed and bank called off this sale.

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Credit: Bloomberg

Again in 2017, RBI pulled up Yes bank for hiding its bad loans or NPAs in their filing to the regulators. RBI observed almost four times under reporting to bad loans by Yes Bank which was a serious issue. Later Yes Bank recognized more NPAs after being pin pointed. These are serious lapses for a big listed bank. This is reflecting in the stock prices as it has plunged by almost 40% in last one year alone.

Bad Health of Public Sector Banks

Undoubtedly the biggest hole in the ship, PSUs continue to bleed as NPA woes are refusing to go down anytime soon. NPA is classified when a loan is not paid back over 90 days of being due. Lot of water has passed since Raghu Ram led RBI started cracking down on PSU NPAs a few years ago. As per reports, overall gross NPA of Indian Banks is about ₹7.9 lakh crores out of which Public Sector Banks own ₹6.8 lakh crores, a whopping 86% of total national NPAs. This is almost twice the size of Sri Lanka’s GDP. This is going to put public sector banks under lot of stress in future and will reshape banking industry for sure. With liquidity crunch and stalled growth, some of PSUs will get merged or dissolved with other bigger PSUs. The market pie will shift from public banks to private bank in the next decade as they will capture new plus existing clients from public banks. While schemes like Jan Dhan may have swollen up public sector bank accounts, most of them are non operative and non value addition to the bank.

Recent Events

Last Friday, Sep 21st afternoon, we saw a mini meltdown in banking sector stocks. It started in morning with RBI ruling on Yes Bank to cut short the tenure of it’s CEO. Yes Bank fell a massive 29% within a day. IL&FS continued to spook the market with it’s subsidiary stocks falling another 10-15% in the day. During afternoon, DSP mutual fund tried to sell corporate bonds of Dewan Housing Finance at relatively higher yields of 11%. With rising interest rate scenario, there are not enough buyers in bond market to purchase long tenure bonds which is likely to fetch lower returns. This resulted in a small chaos in bond system with Dewan Housing being the primary name whose bonds were being sold, caught in cross fire. This quickly spilled over to equity market as well. People panicked & assumed that something bad is happening with Dewan Housing as well. Stock plunged 60% only to recover later after management came on news channels and assured investors. Stock ended with mild recovery from -62% to -42% loss by the end of the day. The impact was evident on other housing finance stocks as well. Piramal Enterprises, Indiabulls Housing finance also fell by 20-30% on the news.

Conclusion

There is panic among investors about banking stocks for sure but as Warren Buffet said “Buy when everyone is fearful”. It can be a good opportunity to buy in a phased manner. A few quality banking stocks are falling due to contagion effect. There is nothing wrong in their fundamentals and next quarter results will take their stock price back to normal levels. However, if you already have higher exposure to banking stocks try to keep your overall exposure within limits. Also, do not expect a V shaped recovery as interest rates are rising globally. This means cost of funds is going to increase for the bank and they will have to pass it to customers or shrink their wafer thin profit margins. In both cases, there will be little slowdown in banking industry until interest rates find a stable base.

The real bubble, if any, in Indian banking sector lies within PSU Banks the likes of IDBI, Bank of India, etc. They are loosing almost 25 paise on each rupee. Still we see people doing fixed deposits with PSU banks without worrying about the outcome possibly due to government assurance. However, please beware that only upto ₹1 lakh is secured by RBI for every fixed deposit held within public banks. Anything more than that is at risk as there is no security nor obligation from RBI or government.

We have been publishing regular update on Indian Banking Industry especially PSU Bank situations, you can visit our earlier article on the same by clicking here & here.