Yields at 2009 High as RBI Tells Banks to Ready for Defaults: India Credit

Relative borrowing costs for India’s companies reached a two-year high after the central bank raised benchmark interest rates more than economists forecast and asked lenders to set aside more money to cover potential defaults.

The difference between three-year yields for the highest- rated company debt and government bonds widened to 188 basis points yesterday, the most since June 2009, according to data compiled by Bloomberg. The average rate for AAA borrowers of 9.56 percent compares with 3.26 percent in China and 1.38 percent in the U.S.

Banks will need to set aside cash for 25 percent of loans that have been classed as “doubtful” for up to one year from 20 percent earlier, the Reserve Bank of India said yesterday after raising borrowing costs 50 basis points. Mumbai-based IndusInd Bank Ltd. and Pramerica Asset Managers Pvt. predict corporate borrowing costs will reach 10 percent by June.

“There is a limit to which rates can be passed on to borrowers without triggering defaults,” Jagdish Pai, Bangalore- based executive director at state-run Canara Bank, said in an interview yesterday. “We are reaching those levels.”
Earnings Impact

India’s benchmark government bonds dropped yesterday as the Reserve Bank lifted the repurchase rate, at which it lends, to 7.25 percent. Seven of 25 economists in a Bloomberg survey had predicted the move, while the rest forecast a quarter-point increase. The yield on the 7.8 percent note due April 2021 rose nine basis points, or 0.09 percentage point, the most since the security started trading on April 11, to 8.23 percent, according to data compiled by Bloomberg.

The rate on ICICI Bank Ltd.’s 7.2 percent rupee notes due in May 2015 increased two basis points to 9.35 percent and the yield on HDFC Bank Ltd.’s 7.5 percent security maturing June 2015 climbed one basis point to 9.34 percent, according to data compiled by Bloomberg. Lenders will need to set aside cash for 40 percent of loans classified as “doubtful” for three years, the Reserve Bank said.

“There will be a net impact on earnings in the short term” for banks, said Sampath Kumar, an analyst at Mumbai-based brokerage India Infoline Ltd. “But it eventually means the banks will have better balance sheets.”

The new provisions will hurt some industries more than others, according to IndusInd Bank. Property developers are set for “large-scale distress” sales as they need to repay 1.8 trillion rupees ($40.4 billion) of debt in the coming two to three years, according to the local unit of London-based Knight Frank LLP.
Real-Estate Sector

“The RBI’s objective is to prepare banks if there is an economic downturn and non-performing loans balloon,” J Moses Harding, a Mumbai-based executive vice-president at IndusInd Bank, said in an interview yesterday. “The degree of impact will be higher for some sectors such as real estate and consumer durables.”

The central bank is monitoring real-estate prices in Mumbai, Governor Duvvuri Subbarao said at a press conference yesterday. The weighted average price of homes in the nation’s commercial capital rose to a record 9,234 rupees a square foot in the first quarter even as sales dropped to lowest since 2009, Mumbai-based Liases Foras Real Estate Rating & Research Pvt estimated.

The central bank is “fairly liberal” with debt provisioning and made it easy for lenders to restructure non- performing loans, Anil Agarwal, an analyst at Morgan Stanley, wrote in a report dated May 2. Restructuring typically requires banks to change the lending terms or replace an existing loan with new debt when a borrower struggles with the repayment.
Rupee Performance

“Banks have been on a restructuring spree for the last two years,” Agarwal wrote. “On these restructured loans, the provisioning requirement can be as low as 1 percent. Even when loans become NPLs, banks are required to make only minuscule provisions.”

India’s rupee has advanced 0.4 percent this year as three increases to the repurchase rate since Dec. 31 added to the currency’s yield appeal. The rupee fell 0.4 percent yesterday to 44.52 per dollar. The difference in yields between the nation’s government debt and U.S. Treasuries due in a decade has widened to 497 basis points from a nine-month low of 436 reached April 8.

India’s bonds are down 0.5 percent this month after a 1 percent drop in April, the worst performance among 10 Asian local-currency debt markets outside Japan, indexes compiled by HSBC Holdings Plc show.

The increase in provisions is unlikely to hurt banks as most lenders have sufficient capital, according to state-run Union Bank of India. The percentage of lenders’ capital to risk- weighted assets, or the capital adequacy ratio, must be at least 9 percent, according to the central bank.
‘Well-Capitalized’

“The banking system is well-capitalized to manage any default risks,” S.C. Kalia, Mumbai-based executive director at Union Bank, said in an interview yesterday.

Five-year credit-default swaps on State Bank of India, the nation’s largest lender that some investors regard as a proxy for the sovereign, has climbed three basis points this year to 164 basis points, according to CMA in New York. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

“Because of the rate hike, if there is a slowdown in growth and if there is a huge impact on a particular sector, there is a possibility” companies will have trouble repaying debt, Mahendra Jajoo, the Mumbai-based head of fixed-income investments at Pramerica Asset Managers, a unit of Newark, New Jersey-based Prudential Financial Inc., said in an interview yesterday.