Indian Banks: Sadly Things are Looking More “Subdued”

It's Not Cricket!

Bloomberg reported 3 March that “India Needs `Bad Bank' to Clean Up Soured Debt, Rating Firms Say”

Things are looking mighty “subdued” as careful observers might say.

Some quotes from Bloomberg followed by (AA) comments.

Bloomberg

Stressed assets -- made up of bad loans, restructured debt and advances to companies that can’t meet servicing requirements -- have risen to about 16.6 percent of total loans in India, the highest level among major economies, data compiled by the nation’s Finance Ministry show.

AA is puzzled.  I would think that “advances to companies that can’t meet servicing requirements” would qualify as “bad” loans.  And that restructured debt that was performing, i.e., meeting servicing requirements would not be bad debt.  On the other hand if restructurings were “cosmetic” in nature, then they are indeed bad loans.  If loans aren’t performing, they’re “bad” loans.  If loans are restructured at lower rates perhaps even below market rates but are performing, shouldn’t banks bear this cost? 

Bloomberg

Ratings companies including Fitch Ratings Ltd have come out in favor of setting up a state-backed “bad bank” to tackle India’s ballooning stressed assets problem, a move resisted by Raghuram Rajan, the former governor of the Reserve Bank of India.

Seems to AA if banks’ “bad” loans are ballooning, the country probably already has more than one “bad” bank, particularly when one factors in the comments in the article about “hiding” bad loans, failing to take tough decisions.   

Bloomberg

The RBI completed its audit of the nation’s 50 lenders last year, forcing them to lay bare previously hidden non-performing loans.

That sounds like rather “bad” behavior to AA.

Bloomberg

Banks had been reluctant to offer discounts to offload bad loans even where they are clearly worth much less than their book value because such sales “invite the attention of anti-corruption agencies making bank officials reluctant to sign off on them,” Fitch analysts including Guha wrote in a Feb. 23 note.

AA wonders if the anti-corruption agencies should look earlier in the loan cycle, e.g., at initial underwriting and subsequent “hiding” stages?  Also are bankers looking for the “bad” bank to make “bad” pricing decisions and buy the duff loans at prices higher than their fair value?  Thus, bailing out the banks’ previous bad behavior?  Perhaps this explains former Governor Rajan’s reluctance.

Bloomberg

Bankers selling bad loans to a national bad bank won’t be questioned, as this institution will be empowered by the government to take tough decisions,” said Rajesh Mokashi, managing director at CARE Ratings Ltd. in an interview. A bad bank will also bring to an end to fear of “witch-hunting” of lenders, if any, by anti-graft agencies, he said.

Is this an admission by bankers that they are restricted from taking “tough” decisions?  Or that they are incapable or unwilling to take “tough” decisions?  If either, then a sale to a bad bank does nothing to change this “bad” behavior and is likely to lead to a repeat of bad loan creation by these same banks that can’t or won’t take “tough” decisions.

Bloomberg

With more than $180 billion in stressed assets, the government and regulators have to evaluate all avenues including a bad bank to drive better recovery rates,” said Nikhil Shah, managing director at Alvarez and Marsal, a firm that specializes in turnarounds.

AA wonders how selling duff assets to an asset manager--or “bad” bank, if you prefer--improves recovery rates.  Does this mean that banks are unwilling to take hard decisions or aren’t allowed to?  If so, what guarantee is there that the “bad” bank will?   If the fundamental problem is a slow moving erratic legal process, will the fact that the plaintiff is now a “bad” bank really speed up the legal process?  Or is the idea to buy the duff loans from the banks above market, thus improving their “recovery” rates and stick the “bad” bank with the losses?

All in all not a very pretty picture.  Subdued indeed.

But every situation has both positive and negative possibilities.  As this post about comments from the head of a distinguished bank in a  neighboring country shows, attitude can play a key role

Analyzing KHCB's Financials -- Credit Metrics Part 1

Choose Your P's or C's

Today we'll turn our attention to the heart of KHCB's business--its lending and leasing activity.

Provision Coverage

KHCB Provisions – Amounts in Millions of BHD
	3Q16	2015	2014	2013	2012	2011
FA	358.7	318.7	295.8	253.6	245.7	201.6
Provisions	17.3	13.8	13.7	16.3	16.4	18.1
% FA	4.6%	4.1%	4.4%	6.0%	6.3%	8.2%

1. Provision percentage is calculated on gross portfolio.  Provisions/ (Net FA + Provisions). 
2. Note:  KHCB does not calculate provisions on its Leasing Assets, but rather measures the equivalent of “credit” risk in terms of impairment to value of the asset.  This is based on the assumption that KHCB can repossess the asset from a defaulting borrower and lease it to another with no loss of principal.  But note that bank management may have more discretion in determining impairment of a LA than loan impairment with a FA.
3. Over the period KHCB’s FA provisions have been declining as a percentage of outstanding FA.
4. If the credit quality of the portfolio is high, then a lower provision makes sense. 
5. If the quality appears to be less than robust (another euphemism), then perhaps the decline in provision coverage is more a matter of earnings management than credit management.  Lower provisions equal higher net income all other things being unchanged. 

Let’s dig a bit deeper to examine the credit quality of KHCB’s portfolio to see if we can form a view on which of these two is more likely the cause. 

Renegotiated Loans

1. As we discussed in reviewing ADCB, a timely renegotiation of a loan could prevent it from becoming past due and potentially impaired.  Thus, renegotiation can be a tool to manage earnings by lowering provisions as well as to legitimately restructure loans.  
2. As KHCB states in its 2015 AR, Note 31 Credit Risk page 61:  “Exposures classified as neither past due nor impaired financing facilities include facilities renegotiated during the year amounting to BD 49,276 thousand (2014: BD 32,910 thousand) that would otherwise be past due as per their original repayment terms. Italics are AA’s. 

So what has been the trend over the 2011 to 2015 period?

KHCB Renegotiated Loans -  Millions of BHD
	2015	2014	2013	2012	2011
Amount	49.3	32.9	17.5	54.4	41.2
%  LA & FA	12.7%	9.7%	6.1%	20.4%	19.3%

1. There has been a consistent renegotiation of significant percentage of the portfolio each year, except in 2013 when KHCB took significant provisions.   
2. Side note the portfolio increased from BHD 213 million in 2011 to BHD 360 million in 2016. A key question and one not answered by available information is how many of these renegotiations, if any, are for loans that were in the portfolio in 2011 and how many reflect newer loans?  The answer to which would provide indications on whether KHCB’s underwriting standards were or are lax or there were persistent depressed economic conditions in Bahrain.  Another question would be if the same loans have been renegotiated more than once. 
   
3. On that score, if you’re reading along with AA in KHCB’s 2015 AR, a side note.  AA believes the following sentence in the Renegotiated Loans note has been misplaced.  “Of the total past due facilities of BD 60,758 thousand (2014: BD 35,785 thousand) only instalments of BD 30,204 thousand (2014: BD 14,108 thousand) are past due as at 31 December 2015”.  That is, it does not refer to renegotiated loans but to all loans and is no doubt an attempt to put a good face on things.  What it does say is that roughly 50% of the payments had been missed on 2015 PDNIs and 40% in 2014.  I don’t know about you but AA isn’t comforted by that information.  That level of past dues raises serious questions why these loans are not impaired.  More on that to follow.  
   

From the info we do have it looks like KHCB has ongoing weakness in its portfolio.

  

In following posts, we'll look at other portfolio credit metrics to try to determine if there are other signs of weakness.