REC, PFC, IREDA, PSU bank stocks drop; what is keeping investors worried?

The Nifty PSU Bank index fell 3.7 per cent on Monday (May 6) after the Reserve Bank of India (RBI) issued new rules for projects under implementation. All 12 stocks on the Nifty PSU Bank index closed lower. 

Further, infrastructure related NBFC stocks, such as REC, IREDA and PFC, also plunged, finishing the day 4-9 per cent lower. 

What are RBI's new draft guidelines for projects under implementation?

On May 3, the RBI published draft guidelines on 'Prudential framework for Income Recognition, Asset Classification, and Provisioning', pertaining to advanced projects under implementation. 

With these guidelines, the regulator significantly enhanced the provisioning requirement during the construction phase of a project from the extant 0.4 per cent (0.75 per cent for CRE residential housing projects and one per cent for CRE non-residential housing projects) to five per cent, for all existing and fresh exposures. 

How will the increase in provisioning impact PSU Banks?

According to Zee Business research, the move is likely to affect PSU banks' net worth by 1.5 per cent to 3 per cent.

Further, changes in provisioning will impact the net worth of the banks which will take a toll on the return on equity and CET1 ratio, according to the research.

The CET1 ratio compares a bank's capital against its assets.

Moreover, the impact of this move on the net worth of the private banks can range from 0.4 per cent to 0.8 per cent and that of PSU banks will range from 1.5 per cent to 3 per cent. The credit costs are also expected to increase by 10-15 basis points (bps). 

Most PSU banks will have to provide for additional provisioning in the range of 10-30 bps from FY25-27E, said Rahul Malani, Deputy VP-Research at Sharekhan by BNP Paribas.

Malani, however, added that it is not large. 

JM Financial estimates the incremental credit costs for PSU banks in the range of 12- 21 bps.

"It is not a very big negative for PSU Bank stocks, REC, PFC, and IREDA and the correction is unwarranted as the increase in provisioning is the counter cycle for buffer. Additionally, as the project moves from the construction stage to the operational stage the risk reduces significantly and the provision percentage can be brought down," said Kaitav Shah, Lead BFSI Analyst at Anand Rathi Institutional Equities.

Shah said this is a prudent measure by the RBI. These are draft guidelines that may water down as the framework is set, the analyst added.  

What lies ahead for PSU Banks? 

According to Sharekhan, the balance sheet of PSU banks has strengthened after COVID-19, however, growth in infrastructure funding in recent times has been muted. However, the brokerage remains positive on PSU banks as it reckons large negative cuts are unwarranted given guidelines and the impact will not be large.

JM Financial reckons this significant increase in provisioning requirement will result in lower returns for lenders in project finance and reduce incremental appetite for such exposures if implemented in its current form.

Anand Rathi believes that PSU banks look good from a near-term perspective because of their bond inclusion, treasury gains, and fair asset quality.

How will the move affect PFC, IREDA and REC?

According to IIFL Securities, there will be no impact on the return on equity (RoE) of NBFCs, though infrastructure-focused NBFCs could be impacted. 

Infrastructure-focused NBFCs, such as REC, PFC, and IREDA, can see a potential hit of 200-300 bps to their capital ratio. The valuation of these NBFCs can also be potentially impacted as the adjusted net worth will be 8-13 per cent lower, according to the brokerage.

Catch all the highlights of the May 6 session on Dalal Street here. For all other news related to business, politics, tech and auto, visit Zeebiz.com.