Retail loan quality under a cloud

Recent research has called into question the quality of the retail asset portfolio of banks, with new concerns about delinquencies in the retail advances.

Research by rating agency Crisil has estimated total outstanding retail lending at around Rs 5,50,000 crore for banks alone and estimates that the proportion of gross non-performing assets (NPAs) to retail advances will rise to 4 per cent in March 2009, from 2.7 per cent in March 2007.

Of this, ICICI Bank alone has retail loans amounting to Rs 1,34,754 crore and SBI accounts for Rs 88,300 crore. Though the chances of the delinquencies triggering a credit crisis may be overblown at this stage, nevertheless, Crisil highlights that it is a cause for concern. The period from 2003 to 2007 saw easy credit availability and low interest rates, which saw banks, non-banking financial companies (NBFC) and housing finance companies (HFC) managing rapid growth in their retail portfolios.

With the boom phase at its end, the reasons cited for the rising defaults now are several: higher unsecured loans, lowering of credit standards for tapping more customers, though they may be in higher risk categories, and rising interest rates. The situation is especially grim in tier 2, tier 3 areas as well as rural regions.

Home, car loans relatively safe

The Crisil report has studied retail assets encompassing mortgage loans, cars and commercial vehicle loans, two-wheeler loans, loans against shares, personal loans and credit card loans. The yields range from 10-15 per cent on home loans to 32-40 per cent on credit cards, for most banks, with other loans falling between these two extremes. The cost of credit also increases from home loans (0.5-1.5 per cent) to credit cards (7-10 per cent).

The report suggests that secured lending is 80 per cent of the total retail lending and that housing finance is the safest among the retail assets, followed by the new car loans. But the other secured loans such as tractors, used cars, light commercial vehicle (LCV) and loans against shares have higher frequency of slippage.

Gross NPAs in home loans are expected to be 2.7 per cent in 2008-09. The rising interest rates have led to increased pressure on home loans as customers have had to pay a 26 per cent higher EMI in 2008 than in 2003. This severely hit the savings of households, with a larger proportion of earnings going into paying the EMIs.

Crisil has indicated that if banks with secured loans feel that the NPAs are on the rise, they can take recourse to the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interests (SARFAESI) Act, 2002 to limit the loss.

The SARFAESI Act enables banks to securitise asset reconstruction of secured loans and enforcement of security without the intervention of court.

Though the unsecured credit is 20 per cent of total retail lending, it has increased from 6 per cent in 2004, which is cause for concern.

Concerns about declining asset quality also seem to be echoed by the recent financial results of banks. Almost all private banks have seen a rise in their NPAs sequentially from the March quarter to the June quarter in 2008.

Larger banks such as ICICI Bank and HDFC Bank have seen the NPA rise in the June quarter. Axis Bank has seen a rise in NPAs due to higher credit card slippages. Recovery of assets has also become challenging in light of the recent Supreme Court ruling against measures taken by the recovery agents. Banks also don’t want to weaken their reputation by involving in tough practices to facilitate recoveries.

These developments may prompt banks to discontinue loans or products with higher susceptibility to default (the recent move by ICICI Bank on two-wheeler loans is an instance) or to make these products highly inaccessible.

India’s ‘Sub-prime’

According to Crisil, unsecured loans to high-risk individuals (small-ticket personal loans) and a portion of credit card portfolio can be classified as ‘sub-prime’ in Indian context, though these loans constitute a small part of the total retail advances and the yields on these loans are also high.

The proportion of these ‘sub-prime’ loans is almost 30 per cent of the total unsecured loans. At this level, high credit risk is adequately compensated by the yields on these loans.

Crisil expects a further decline in asset quality in these segments owing to over-leverage by customers and the entry of players into under-banked geographies.

Outlook

Banks, NBFCs and HFCs that are concentrating on a single-asset class might be more vulnerable than the ones with diversified portfolios.

Many banks have revised their growth targets and are concentrating on improving credit quality, rather than growing the loan portfolio. Banks have already started discontinuing small-ticket personal loans, have increased the rate on other personal loans, and have cut down on two-wheeler lending. Credit cards are the biggest cause of concern for most banks and as they charge very high interest rates compared to other lending, the slippages are high.

Until now banks have been aggressively growing in the card segment. Now, they will need to increase their credit assessment standards and offer credit cards to select customers.

A bank with higher retail portfolio (mostly private banks such as ICICI and HDFC) will have to take further hit on the profitability if the defaults and interest rate continue to rise.

Banks are betting on the younger generation and rising income levels/earning capabilities but may have to be cautious against the over-leveraging done by the customers.

A look at the quarter numbers shows that the GNPA (gross non-performing asset) proportion for all the private banks in the Bankex has increased.

The RBI has already warned banks with high credit-deposit ratio about the possibilities of asset-liability mismatch, which might lead to a liquidity crunch if the situation goes out of hand.