Pipeline to Profits

Indian pipeline manufacturers are benefiting from large-scale US gas pipeline expansion

Welspun Gujarat Stahl Rohren surprised the market with the news that its oil & gas pipeline order book size has crossed Rs10,000 crore. Jindal Saw Pipes (JSP) is also reported to have pending orders worth $750 million (Rs3,750 crore). PSL, another pipeline company, is also running a strong order book...

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Banks unwilling to offload bad assets to ARCs

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]
 

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Cost pressure on fertiliser companies to increase if natural gas is not made available to them
Fertiliser companies are staring at heavy losses if they are denied natural gas from Reliance Industries. RIL is producing 40 million metric cubic metres per day (MMCMD) of natural gas. Anil Ambani has also made a claim of 28 MMCMD per day. NTPC has also claimed 12 MMCMD to run its 4,000 MW power project. That will leave fertiliser companies with no input from Reliance Industries.
 
Fertiliser companies having annual capacity of 7.5 million tonnes based on natural gas could be hit by a major crisis if they are not given natural gas, which is used as a fuel and raw material. On an average, about 950 to 1,000 cubic metres of gas is used for each tonne of fertiliser. Around 20% of natural gas is used as feedstock and 80% is used as a fuel. 
 
In fact, the Government of India, in its policy decision, insists that fertiliser industry is the first priority for natural gas industry. According to Rashtriya Chemicals & Fertilisers (RCF), Mumbai, public sector fertiliser companies use 20 MMCMD of natural gas. On the question of what impact would be there if RCF is not given any gas allotment, RCF CEO, US Jha, refused to make any comment as this matter will be discussed in the Supreme Court.
 
Already eight fertiliser units are closed in Barauni, Sindri, Haldia, Gorakhpur, Talchar, Ramgundm, Korba and Durgapur. If gas is not made available to fertiliser companies, more units may see closure and that may in turn see sharp rise in fertiliser subsidies. Fertiliser subsidies were around Rs 46,000 crore in 2007-08 and are likely to cross Rs 1,00,000 crore this year.
 
In addition to natural gas, fertilisers can be made from heavy oil and coal. Heavy oil and coal options are very expensive as compared to natural gas. Heavy oil conversion to fertiliser plant will consume 30% more energy and coal conversion to fertiliser plant will consume 70% more energy. Investment cost in heavy oil and coal plants are also very expensive. Heavy oil plant is 40% more expensive and coal based plant is 140% more costly. Production cost as compared to the cost of natural gas is also very high. Heavy oil plant production cost of fertiliser is 20% more and for coal it is 70% .  So if natural gas is not made available to fertiliser plants, cost pressure on other options will create huge losses to the country.  
– Dhruv Rathi [email protected]
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