Bad loans recovery grim, because they are concentrated among large companies, this time
Religare conducted a conference call, the key takeaway of which was that in the current cycle of bad loans, non-performing assets are not concentrated in smaller accounts (SMEs), as the last time. They are concentrated in large companies. This makes recovery more difficult. Due to the bloated ticket sizes, banks are deterred from turning hostile. Earlier, the ticket size was around Rs100 crore –1,000 crore. Today, many of the loan ticket sizes are around Rs5,000 crore. This makes the current scenario different as compared to the earlier downturns where stress was restricted to Small and Medium Sector industries (SMEs). Another key point is that earlier a large part of stressed SME loans was backed by real estate as collateral, which is not the case currently.
Postponement of stress recognition due to which solving the stressed assets problem has been delayed, is another key issue associated with the sector. Interest has been accrued over many years. The stressed non-fund exposure has not yet been fully recognised. These are currently being treated as restructured, Strategic Debt Restructuring (SDR) or 5:25 loans. It is a near-term risk for banks. According to experts, banks should ideally have a provision cover of 60-65% against these loans compared to the 40-45% coverage in place for public sector banks (PSU).
The impact of Asset Reconstruction companies (ARCs) to resolve the problem of stressed assets is limited, finds Religare. This is because they prefer to buy small to mid-sized companies with debt below Rs1,000 crore which are in the initial stages of difficulty. Thus, ARCs are unwilling to take loans of large distressed carriers, especially when promoter credibility is perceived to be lacking. Secondly, due to limited capital, ARCs cannot resolve the problem. Consider these figures. The total credit in the system is more than Rs70 trillion, while the total stress in the system is around Rs10 trillion. On the contrary, ARCs have a cumulative capital base of merely Rs4,000 crore.
Another problem is that ARCs and banks cannot agree on the level of haircut. Currently, the spread between bid-ask rates stands at around 25%. This implies that on average ARCs wanted a 50% haircut whereas banks were ready to yield only around 20%. ‘One needs to sell an asset when it is sick and not dead,’ as per one of the experts. The consensus among our expert panel was that the average haircut on troubled iron & steel sector accounts should be 40-50%. It should be 36-40% for power sector loans. It should be around 60% on construction loans, where a large part is non-funded. Experts from ARC’s believe that banks have been excessively optimistic about the realisation value of these assets.
Coming to different sectors, the steel sector is considered to be the worst. It has a humungous Rs3trillion – Rs5 trillion of stressed assets. The dependence on China and the low capacity of steel plants are a few reasons responsible for its woes. Another issue is one of promoter credibility in some large steel companies due to which many ARC’s are unwilling to work with them. The government has not been very keen on solving problems in this sector as opposed to the power sector.
In the Engineering, Procurement, Construction (EPC) sector, the total stress is around Rs3 trillion, out of which only Rs 700bn is fund-based. If the non-fund based exposure is increased, then the loss given default (LGD) will increase. Key issues in the construction sector include the build-operate-transfer (BOT) nature of most projects, and an inflated cost of assets due to the accumulation of interest over the last three years. When it comes to construction sector, the build operate transfer (BOT) nature of most projects is an issue. Diversion of bank funding to real estate development by promoters is another one. An inflated cost of assets due to the accumulation of interest is another problem.
“Provisions will likely stay elevated and bank P&L statements are unlikely to improve for 9-12 months at least”, according to one of the experts. In addition, some large accounts may also become NPA’s in the next 1-2 quarters.
The Non Performing Assets (NPA) resolution process is likely to remain protracted despite the upcoming bankruptcy law. Setting up of infrastructure which includes setting up of national company law tribunals (NCLT) across India and training of judges is likely to take time. The Bankruptcy Code, which bears a strong resemblance to Chapter 11/9 of US bankruptcy law, tries to addresses the inefficiencies in the system by defining specific timelines for various processes.