RBI changes provisioning norms for banks

The RBI recently amended norms relating to provisioning for banks. Banks have to make provisions for loans so that in case some of the loans go bad (i.e. the borrower delays payments or cannot pay), the bank can use these provisions as a cushion. These provisions are made out of the earnings of the bank for that year.

The technical term used for bad loans is non-performing loans (NPLs). Of course, there are several more terms like write-offs, loan losses, past due loans still accruing interest income etc. But for purposes of our current analysis, the term NPL would do.

In 2009, the RBI had mandated that all banks should have a minimum provision of 70%. This meant that if a bank had INR 100 crores of NPLs on its books, it should have (from its revenues each year), cumulative provisions of INR 70 crores to cover these NPLs. However, this was changed recently when the RBI declared that for loans made after Sep2010, the requirement would not apply.

What does this imply for an equity investor in the banking space?

From a bank’s performance perspective, it bring no dramatic changes, therefore long-term investors don’t really benefit (or gain) by this relaxation of norms.

For banks which have had historically low provisioning, they will now have to meet the 70% target only for loans made before Sep2010. Since provisioning comes out of earnings, it means that the EPS (earnings per share) of these banks will go up in the short-term – all of course at the cost of lower coverage for the last 2 quarters of FY11.

Among the larger banks, SBI and ICICI Bank have had below 70% provisioning. Axis bank and Bank of India have just about met the 70% coverage ratio. But banks like HDFC Bank, Yes Bank, Bank of Baroda, PnB and Canara Bank meet these coverage requirements more than adequately.

Interpreting RBI action
The relaxed provisioning norms for loans made after Sep 2010 may be part of preventive action taken by RBI to thwart the threat of NPLs given that rates have increased by 100-125 basis points between Sep 2010 and Mar 2011 and are close to/at their peak.

Impact of Egypt crises on Asian Paints is marginal

Asian Paints operates in Egypt through a company called SCIB Chemicals SAE in which Asian Paints has a 60% shareholding. Due to the recent crises in Egypt, Asian Paints had temporarily closed two of its plants. However, with effect from yesterday, the company has partially restarted its operations in its two plants in Egypt.

From company reports, we note that the middle-east (ME) region accounted for 9.6% of revenues and 7.5% of PBIT for Asian Paints as of 1HE FY11.The Egyptian market has performed well in the ME region and therefore is important to Asian Paint's international operations. Per analyst estimates, ~5% of total revenues are attributable to Egypt. Thus, the impact of the crises due to a few days of plant shut down in Egypt looks marginal for Asian Paints.

The company has been aware that political conditions in Egypt could go awry. In one of the reports dated Nov 2010, the company has identified an operational risk by stating that, " market conditions in Egypt are expected to remain tough due to forthcoming elections." Hence, the company has not been caught unawares and unprepared for the situation.

Asian Paints currently trades at a historical PE of 28x. With street estimates for growth in EPS at 29%, this implies a forward PE of 23x. At current levels of INR 2,500, the stock continues to look attractive.