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Event update: Financials - Impact on financials

The budget is positive for life insurance, neutral for general insurance as of now, negative for banks and NBFCs and negative for mutual funds. Also the market was expecting more sops for affordable housing which did not come through. Budget outperformers: Life insurers, MMFS. Budget underperformers: State owned banks, AMCs.

Banks: Negative on the margin due to higher yields and high NPLs on MSME – Prefer private to state owned banks

1) MSME lending – the NPLs in this segment for state banks are high:

• Banks have been asked to focus on MSME lending. The FM has promised an NPL scheme for SMEs. We await details. If such a scheme is akin to a waiver, it will be negative for state banks that have set targets for MSME lending.
• The concessional tax rate of 25% has been extended to more SMEs. For this purpose all SMEs with turnover of Rs2bn will now enjoy a concessional tax rate of 25% versus the earlier turnover cut off of Rs0.5bn. This will benefit the entire class of micro, small and medium enterprises which accounts for almost 99% of companies filing their tax returns.
• It is proposed to onboard public sector banks and corporates on Trade Electronic Receivable Discounting System (TReDS) platform and links this with GSTN. Online loan sanctioning facility for MSMEs will be revamped for prompt decision making by the banks.
• The Budget has allocated Rs37.9bn to MSME Sector for giving credit support, capital and interest subsidy and innovations.
• It is proposed to set a target of `Rs3 trillion MUDRA for 2018-19 after having successfully exceeded the targets in all previous years.

We note that the above schemes are for state owned banks. The NPL experience on the MSME loans for state banks has been disappointing. SBI has NPLs of 11% on its SME portfolio and BoB has NPLs of 18% on the MSME portfolio. The government’s focus on the MSME sector gets highlighted not only in the Budget but is also highlighted in the recapitalization speech by the FM where he mentioned that of the incremental lending capacity of Rs5 trn likely to be generated by the recap, a large portion will go towards MSME funding.

2) Higher MSP to help not only state banks but also HDFC Bank, MMFS, SHTF: Credit target to agri sector has been increased to Rs 11 trn from Rs10 trn yoy. The MSP on Kharif crop has been raised to 1.5x production cost which is positive for farm incomes and rural spend. This is positive not only for asset quality of farm loans for state banks but even for private banks like HDBK who are big on agri. It will also benefit NBFCs like MMFS and SHTF.

3) Higher recap amount for FY19 is due to spill over of Rs100bn from old Indradhanush plan: The government has provided Rs650bn towards bank recap in FY19. Recently the government already allocated Rs800bn towards recap. The total of the two years is Rs1.45trn against the earlier announced Rs1.35trn of recap. We note that the figure for FY19 includes Rs100bn from the old Indradhanush plan, so there is no increase in recap over the previous announcements. As background, the Indradhanush plan was announced in Aug 2015 with a total proposed capital infusion of Rs700bn for state banks over four years from FY16-FY19 with Rs100bn of allocation planned for FY19.

4) Deepening the bond market:

• The FM announced that SEBI will consider mandating (beginning with large Corporates), to meet about one-fourth of their financing needs from the bond market.
• Corporate bonds rated ‘BBB’ or equivalent is investment grade. In India, most regulators permit bonds with the ‘AA’ rating only as eligible for investment. It is now time to move from ‘AA’ to ‘A’ grade ratings. The government and concerned regulators will take necessary action.     

5) Fiscal spends and rise in bond yields will hurt banks and NBFCs:

The fiscal spend and resulting rise in inflation and bond yields will hurt investment portfolios of banks especially state banks. It will also hurt the borrowing cost of NBFCs.

6) Tax changes for the bankruptcy code in line with expectations: As expected, changes to existing tax provisions have been made to ensure that the insolvency process moves smoothly.

1. a) Budget allows carried forward loss to be deducted from book profit even if unabsorbed depreciation is zero while calculating MAT:

Section 115JB of the Act, provides for levy of a minimum alternate tax (MAT) on the “book profits” of a company. In computing the book profit, it provides, inter alia, for a deduction in respect of the amount of loss brought forward or unabsorbed depreciation, whichever is less as per books of account. Consequently, where the loss brought forward or unabsorbed depreciation is Nil, no deduction is allowed. This non-deduction is a barrier to rehabilitating companies seeking insolvency resolution. In view of the above, it is proposed to amend section 115JB to provide that the aggregate amount of unabsorbed depreciation and loss brought forward (excluding unabsorbed depreciation) shall be allowed to be reduced from the book profit, if a company’s application for corporate insolvency resolution process under the Insolvency and Bankruptcy Code, 2016 has been admitted by the Adjudicating Authority.

1. b) Benefit of carry forward and set off of losses now allowed to the new buyer of a stressed company but only after proper hearing by Principal Commissioner

Section 79 of Act provides that carry forward and set off of losses in a closely held company shall be allowed only if there is continuity in the beneficial owner of the shares carrying not less than 51percent. of the voting power, on the last day of the year or years in which the loss was incurred. In general, the case of a company seeking insolvency resolution under Insolvency and Bankruptcy Code, 2016, involves change in the beneficial owners of shares beyond the permissible limit under section 79. This acts as a hurdle for restructuring and rehabilitation of such companies. In order to address this problem, it is proposed to relax the rigors of section 79 in case of such companies, whose resolution plan has been approved under the Insolvency and Bankruptcy Code, 2016, after affording a reasonable opportunity of being heard to the jurisdictional Principal Commissioner or Commissioner. This amendment will take effect from 1st April, 2018 and will, accordingly, apply in relation to assessment year 2018-19 and subsequent assessment years It is also proposed to amend section 140 of the Act so as to provide that during the resolution process under the Insolvency and Bankruptcy Code, 2016, the return shall be verified by an insolvency professional appointed by the Adjudicating Authority under the Insolvency and Bankruptcy Code, 2016. This amendment will take effect from 1st April, 2018 and will, accordingly apply to return filed on or after the said date.

Nothing on affordable housing – negative on sentiment for the smaller housing finance companies: The government has already focussed on affordable housing over the last 18 months. There were no further incentives to this segment in the current Union Budget. The market was expecting more sops.

General Insurance:

1) Health Insurance: Higher pie may not necessarily mean higher profitability: The FM announced a flagship National Health Insurance scheme which will cover around 100 million "vulnerable" families. The health coverage of the scheme will be up to Rs 0.5 M  per family per year for secondary and tertiary hospitalisation. There will 500M beneficiaries according to the FM. The current health insurance cover for the entire nation is estimated to be Rs300billion and roughly covers 27% of the Indian population. Then new scheme proposed in the budget suggests a cover of Rs25bn which is as large as 8% of the existing cover for the nation.

While increase in the health insurance pie is beneficial to all existing players, we need to wait for scheme details before concluding whether the private players will participate. The details of the scheme with regard to 1) pricing 2) tendering – whether the government will follow the same bidding process like it follows for crop insurance 3) premium payment – will the government pay premium on day one or not – if it does not collection of premium becomes an issue 4) hospital coverage – given that the new policy will cover vulnerable family what kind of hospitals are covered will be important. Private players will be cautious this time because one of the earlier health schemes of the previous governments – RSBY – was not economically viable. State insurers will be the key participants we believe in this new scheme.

2) Merger of weaker state insurers will reduce competitive intensity and benefit existing players: The government plans to merge the three general insurers with weak profitability – National, United and Oriental. The plan is to list the consolidated entity. Consolidation and listing will help improve pricing discipline and profitability of all players.

Life Insurance benefits from no increase in corporate tax and no LTCG on ULIPs : This segment is the key beneficiary of the budget because the much expected increase in corporate taxation for life insurance did not come through which is a relief. Also, the long term capital gains tax, LTCG does not apply to ULIPs of life insurance, making ULIPS more attractive relative to units of equity mutual funds. ICICI Prudential Life has the highest share of ULIPs and is a key gainer.

Negative for AMCs due to LTCG: LTCG of 10% of equity oriented schemes both on dividend distribution and capital gains is negative for mutual funds.

We note that there is scope to modify provisions of the Finance Bill till the budget is actually passed.