While distressed assets and delinquent accounts continue to erode banks’ profitability, very few favour offloading bad loans to asset reconstruction companies (ARCs)
Banks have been dealing with non-performing loan (NPL) recovery for quite some time now. Tough economic conditions brought upon by the financial meltdown contributed to rising NPL numbers of banks. The gross NPLs in the Indian banking system have increased about 22% from $12 billion in FY08 to $14 billion in FY09. However, instead of giving way to opportunities for NPL sales, the impact of recession on pricing has only made it more difficult to strike good deals with ARCs.
Banks are not selling bad loans to ARCs in good measure. The economic downturn marked a significant change in the way banks dealt with bad loans. Banks alleged that ARCs were asking for unrealistic discounts on substandard assets. They would rather attempt at recovering the money themselves than sell such loans to ARCs at hugely discounted prices. A senior official at a leading foreign bank explains, “The reason why this is happening is because there is a wide wedge between valuation that banks place on their assets and what ARCs are willing to pay. Typically the ARC would look at the liquidation value of the asset. The bank, on the other hand, would place it as a going concern as it has seen the company’s operations. Also ARCs are keener in buying assets where the security is more tangible, like property or fixed assets, as against working capital. Banks’ valuation of fixed assets is much higher.” A PricewaterhouseCoopers report ‘NPL Asia’ confirms, “A relatively weak market environment after the economic downturn, reduced investor risk appetite, and issues relating to valuations were some of the key factors that affected the activity level.”
Some ARCs were asking discounts as steep as 70%-80% on some sour commercial loans at the height of the recessionary phase. This was not a viable option for the banks as they had a feeling that recovery was still possible eventually. Says the bank official, “In case of distressed assets merely two-three years old, banks would not be willing to accept such discounts. But if nothing works out for five years, obviously 10%-20% salvage of value isn’t a bad deal. But the same discount offered earlier wouldn’t make sense.”
ARCs on their part claim that banks have unreasonable value expectations, on the basis of prices realised from isolated cases of recovery. This claim is also somewhat justified, given that ARCs also need to make profits, which are highly uncertain in this kind of business. The bank contact said, “Unlike a manufacturing business, the business of loan recovery involves high degree of uncertainty in terms of profit margins. Their model of business would not allow such small margins; hence they have to ask for higher margins.”
Also, when banks offload their bad loans to an ARC, it usually issues them security receipts (SRs) rather than paying cash upfront. Banks only make money through these SRs as and when the ARC recovers these stressed assets. Banks instead prefer to restructure loans and salvage value from distressed assets themselves or liquefy through the auction route and get cash upfront. CARE Research reports that India’s 12 leading banks have restructured loans worth around Rs32,530 crore in Q1FY2010 alone, to help them contain their NPA levels. This was in response to an RBI guideline, permitting accounts which were restructured prior to 30 June 2009 to be treated as standard accounts. However, a part of these restructured assets are expected to slip going forward. The PWC report states that NPL activity typically picks up in the second half of the financial year (ending March 2010) and many banks, including Bank of India, Bank of Baroda, UCO Bank, Dena Bank, Central Bank of India, State Bank of Hyderabad, State Bank of Bikaner and Jaipur and State Bank of India, have indicated their intentions to undertake portfolio auctions (largely corporate) in the next few months.
With banks frowning upon ARCs and restructuring assets on their own accord, ARCs like ARCIL will be under pressure to generate business. According to reports, ARCIL has acquired retail loans worth $330 million to date. However, bulk of these loans comprise of bilateral acquisitions from ICICI Bank, which has always had its own motives behind pushing bad loans to ARCIL.
Banks should also realise that in some cases, ARCs are much better at extracting the last pound of flesh, as they are more empowered to negotiate with borrowers and have better recovery processes in place. For banks, recovery of NPLs is a protracted process and they have to be wary of taking a hit to their image while initiating recovery proceedings.
–Sanket Dhanorkar [email protected]
Bank shares surge on assurance that the government’s stimulus measures would continue into the next fiscal
The Indian stock market gained for the fourth consecutive session on Monday, on the back of strong global cues and prime minister Manmohan Singh’s assurance on Sunday that financial reforms would be accelerated and the government’s economic stimulus measures would continue into the next fiscal year. The Sensex closed at 16,499, gaining 340 points, while the Nifty rose 102 points to 4,898.
Banking stocks were among the top gainers on Monday as the prime minister asserted that growth in the next fiscal year, assuming a normal monsoon season, was expected to be more than 7.0% compared with a 6.5% forecast for the current year. State Bank of India (SBI) rose 5%. Bank of Baroda (BoB) and Punjab National Bank (PNB) were up 3% and 2%, respectively, on news that they have entered into an agreement with T Rowe Price to sell a 6.5% holding each in UTI Asset Management Company and UTI Trustee Company.
Sensex heavyweight Reliance Industries (RIL) was up 3% on reports that the firm is planning to acquire some of the assets of US petrochemical major LyondellBasell, which is undergoing reorganisation under the protection of a US court.
Telecom stocks fell on worries that the ongoing price war would result in a sharp fall in revenues and profits. Reliance Communications was down 2% while Bharti Airtel declined 4% after chairman Sunil Mittal told the media that the company was not actively seeking acquisitions, after talks for a tie-up with South Africa’s MTN collapsed recently.
On Sunday, the prime minister had stated that the government would push through legislative changes in the insurance sector to attract more foreign investment. He added that the government would push through stake sales in profitable state-run firms, implement measures to deepen the corporate bond market, strengthen the insurance and pensions sectors and improve the futures market for better price discovery and regulation.
By December 2009, the government plans to introduce bills proposing to raise the foreign stake limit in insurance companies to 49% from the present 26% and to open up the pension sector to private and foreign firms. It will also propose a law to cut its holding in top lender State Bank of India to 51%.
The timing of the withdrawal of the economic stimulus measures would be decided when it becomes clear the economy is recovering, but there will be no fresh stimulus, finance minister Pranab Mukherjee said on Sunday.
Asian markets ended in the green on Monday on strong global cues. The key benchmark indices in China, Hong Kong, Japan, South Korea, Singapore and Taiwan were up by between 0.28%-2.25%. Praising China’s economic performance in the past year during the global financial crisis, Moody’s Investors Service raised the outlook on China’s A1 rating to positive from stable. The agency said the country’s strong credit fundamentals would resume its improving trend as the economy emerged from the effects of the global recession.
— Swapnil Suvarna [email protected]