Pawan Agarwal of CRISIL Ratings tells CNBC-TV18 that the pressure on asset quality of banks is set to intensify as the effect of rising non-performing assets fully hits the system. "Over the last year or so, we have seen a combination of profitability, weaker outlook on demand and weaker liquidity impact corporates, which is reflecting into defaults," he said.
CRISIL recently released a report which stated that corporate default rates were at a 10 year high of 3.6%.
Due to the high default rate, Agarwal says they as a ratings agency saw more number of downgrades than upgrades. "For the entire year, the entities that defaulted were about 188 of which more than 100 were in the second half," he said.
He goes on to say the textiles sector and the construction and engineering space saw the maximum number of downgrades.
Going forward, Agarwal says the power sector is likely to see pressure, due to which we are likely to see some restructuring.
Below is an edited transcript of his interview with Latha Venkatesh and Gautam Broker. Also watch the accompanying video.
Q: Your report clearly says that the default rate is at a 10 year high of 3.4%. Do you think it's peaking off now and as the rate cutting cycle starts we could have the default rates gradually begin to come down or do you think the pressures will continue and it's not going to come down in a hurry?
A: Our report covers about 9,000 rated entities, which represent nearly 40% of the banking industry. So it clearly is a very representative sample of what we are seeing as credit quality of corporate India. What we are seeing is that in 2011-2012, we clearly saw pressure on credit quality enhance, in the second half especially which is where the cycle conclusively changed towards more number of downgrades. We saw the number of downgrades that we were doing is more than the number of upgrades and that is something that we are seeing continuing now on a month-on-month basis.
For the entire year, the entities that defaulted were about 188 of which more than 100 were in the second half.
Typically defaults are a leading indicator of what is likely to be for the banking system because for NPAs really take about 90 days of curative period after the first default and the ratings really are the reflection of the first point of time when an entity defaults. So really some of this pressure is yet to be played out or reflected fully. Not all the defaulting entities will turn NPAs, but this is just an indicator that tells us that the pressure on the system continues to be high for now.
Q: This statement that it is a 10 year high means this is the worse since FY03 or FY02. If that is the case, how are banks and would you expect more downgrading of banking institutions?
A: We are talking about default rates from a 10 year perspective, so this is the highest after FY03. The first part of this last decade was a period of very rapid good economic growth rate where default rates were very low, and when the economic crisis came in during 2008-2009 corporate India was helped by the restructuring window that RBI provided. So that really helped offset some of the cash flow pressures that the companies were facing.
Over the last year or so, what we have seen is a combination of profitability, weaker outlook on demand and weaker liquidity impact corporates, which is reflecting into this default study.
Yes, this is already leading into higher NPAs for banking industry. If you look at December 2011, our estimate was that NPAs were already at 2.9%. The number of cases cumulative quantum-wise, if you look restructuring, are already estimated at about 3.3% and are likely to rise in the near term. So yes the pressure on banking asset quality will intensify.
For now what holds up the credit ratings of banks is really the capital comfort that we have. The ability of the capital which is available for the banking sector is sufficient to be able to absorb this pressure in the near term.
Q: Did you witness any particular trend across sectors? Any particular sector that you feel would be weak and companies in that sector will underperform?
A: If you look at the sample of entities that faced a maximum number of downgrades last year, the three sectors that topped the list were textile, construction and engineering. These are the sectors where you not only have a high-level of debt, you also have a weaker demand coming in. So this is essentially where the pressure is likely to continue for a while.
Some sectors which are likely to continue to be under pressure are power sector, where we will see some amount of restructuring that will happen in the state power utility domain. We will see some pressure on the real estate, especially for companies that are highly indebted as well as are in commercial real estate space.
Q: Are you getting the sense that we are still young in the downgrading cycle and there is more to come or we are in the mature phase and perhaps things will bottom out?
A: I think in the near term our estimate is that the number of downgrades will continue to outnumber the number of upgrades. One of the indicators that tells me that is the fact that we have more number of ratings that are on negative outlook today. 6% of our entities that carried long term ratings are on negative outlook, which is higher than the 3% entities that are on a positive outlook. So clearly it is an indicator to us which means that we will continue to see more number of downgrades.
The pressure is likely to remain till such time that we are able to see more clearly the outlook on demand and I think that is where one of the key monitorables for us is. Second monitorable for us is going to be clearly the liquidity aspect, which is at what point of time access to funding becomes easier and less costly?
Q: Do you think it's going to be a vicious cycle because the default rate is high and asset quality pressures persist, liquidity will remain tight or do you think because the budget measures there have been relaxation of rules for foreign funding some of that part will be alleviated?
A: I think the cost and access to funding aspect has been tight now for well over a year and I think that sustained level of pressure on liquidity is one of the reasons why we see the translation into credit quality. Till such time that some of the inflationary pressures in the economy subside, some of the risks in terms of foreign exchange volatility reduce, it is likely that the liquidity position will not improve to a comfortable level. However, it is likely to certainly become better compared to where it is today.
Source: http://www.moneycontrol.com/news/market-outlook/pressureasset-qualitybanks-to-intensify-crisil_690308.html
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