SBI and other state run banks will stop lending to lower rated borrowers
State Bank of India (SBI) credit rating was downgraded by Moody’s. The credit rating agency downgraded SBI’s bank financial strength rating (BFSR) by one notch from C- to D+. The credit rating of SBI stood at Baa3 while its hybrid debt rating was lowered by one notch from Ba2 to Ba3. The downgrade hit the stock price hard with the SBI stock price falling by over 4% on the news. The bank the went into a communication overdrive with media statements on the fact the government will recapitalise the bank by December 2011 or latest by March 2012. The bank also went on to speak about its non performing loans (NPA), which came under a cloud due to the downgrade. NPA’s, according to the bank, are under control and that the banks credit growth for this fiscal year to date was only 5%. The banking industry credit growth as of September 2011 was at around 20% and SBI has been going really slow on credit due to worries of NPA’s.
The furore over SBI downgrade will make the bank go really slow on credit growth and will in fact push up borrowing costs sharply higher for lower rated credits. The reason is that SBI will now lend only to highly rated companies given the worries of NPA’s on its books. The other state run banks will also follow the footsteps of SBI and look at lending only to highly rated credits. No state run bank chairman will want to be called by the Finance Minister if a bank is downgraded by rating agencies.
The lower rated borrowers will have to go to private sector banks or foreign banks or non banking finance companies for borrowing and these entities will ask for extra spreads as they know that one large segment of lenders i.e. state run banks will not lend to these companies.
The current borrowing cost for a AAA rated borrower in the bond market is around 9.6% to 9.7% for a two to five year maturity period. NBFC’s rated AA- and below are borrowing at levels of 11.5% to 12.5% for two to five year maturity period depending on the name. The spread between a AAA rated borrower and a AA rated borrower is 200bps. This spread will go up further if state run banks stop lending to borrowers rated AAA or AA + and below.
The market at present is extremely wary of lending to lower rated borrowers especially for mid and small cap companies. The reason is the proliferation of scams that has caught many lenders off guard. CBI raids on promoters, tax raids, scams etc. are all taking its toll on risk appetite of lenders. The fact that many companies are forced to go into the unstructured lending market to borrow money at usurious rates of interest is itself a cause for concern for lenders. Paying high interest on fresh borrowing will force many companies to defer interest and principal payments to their lenders, especially in such times when the economy is going through a flux of high interest, high inflation and falling growth expectations.
Moody’s has inadvertently pushed up borrowing costs in the economy for lower rated borrowers, which could potentially go into a self-fulfilling cycle of more downgrades for companies if credit is not made available by banks who in turn fear rating downgrades.