Look before you leap: It’s risky to be loan guarantor

Standing guarantee for your friend’sdebt may also affect your own credit worthiness
By Falaknaaz Syed Oct 28 2011 , Mumbai

Ravi Prasad is a worried man. His Rs 40 lakh home loan application has been rejected by a leading private sector bank. Reason, he was the guarantor for a friend for the same amount since the past five years. As a guarantor for his friend’s home loan, Prasad is legally bound to pay off the debts if his friend defaults.

If you stand as a guarantor for someone’s loan, be it a home loan, education loan or even a personal loan, it means that you agree to be responsible for the repayment of the person’s debt in case of a default. It implies that you are equally responsible for paying off the loan. According to home loan contracts, the liabilities of a guarantor are similar to that of a borrower.

Financial Chronicle gives you a snapshot of the possible situations that could arise if you agree to be a guarantor for someone’s loan and the risks involved.

RBI gets tough on prepayment penalty, discriminatory rates

George Mathew
Posted: Thu Oct 27 2011, 00:44 hrs Mumbai  

After waiting and watching for quite some time, the Reserve Bank of India (RBI) has finally decided to get tough against the discriminatory pricing of loans and the huge prepayment penalty — up to 2 per cent of the outstanding loans — being charged by some banks. 


The RBI has decided to set up a Working Group to look into principles governing proper, transparent and non-discriminatory pricing of credit. This panel is expected to look into different rates for old and new loan customers. Banks and housing finance firms charge different rates for their old and new loan customers. While old customers usually get the stick of high rates, new customers are wooed with carrots like waivers of charges, lower rates and other incentives. The fleecing of customers in the form of penalty on foreclosure or prepayment of loans and different interest rates for old and new loans has been going on for quite some time. 

Dues from defaulters: Govt seeks first right of claim

New Delhi, Oct. 27: 

The Government has included a provision in the Enforcement of Security Interest and Recovery of Debts Laws (Amendment) Bill 2011, which will allow it to have the first claim on dues from defaulting borrowers from the sale proceeds of any asset seized by banks from them.

An Income-Tax Department official said that a total of Rs 3,700 crore is due as direct taxes alone from sick industrial units whose cases are pending before the Board for Industrial and Financial Reconstruction (BIFR).

The Financial Services Secretary, Mr D. K. Mittal, told Business Line that “Government dues have a bigger profile than the dues to banks. More people get affected because of Government dues.”

Government dues involve income-tax, capital gains, Excise and Customs duties, beside sales tax/VAT at the State level. The Bill is to be introduced in the winter session of Parliament.

It seeks to amend the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act 2002 and the Recovery of Debts due to Banks and Financial Institutions (RDBF) Act 1993.

Initially there were differences between the Revenue Department and the Financial Services Departments over the proposal. The former was in favour, but the latter was not. But finally the former won the day, sources added. 

At present, in the case of sick companies and matters filed before the BIFR, the Government has to wait for the BIFR's order on whether it or banks get the dues first. There is no estimate of the dues for the cases pending before the Debt Recovery Tribunals (DRTs).

Prepayment penalty on home loans on way out, RBI indicates

Borrowers wanting to prepay home loans can look forward to some relief as RBI today indicated that it would scrap prepayment penalties charged by banks.

"It is proposed to implement the recommendations of the Damodaran Committee, on which a broad consensus has emerged, as also the action points which were identified by the IBA (Indian Banks' Association) and BCSBI (Banking Codes and Standards Board of India) in the last Banking Ombudsmen conference," RBI said in its mid-year credit policy review.

The Banking Ombudsmen at their conference in September recommended abolition of pre-payment charges on home loans taken under floating rates by customers.

Banks may also offer long-term fixed rate housing loans to customers, Ombudsmen had suggested. They also said lenders may address their asset liability mismatch (ALM) issues by taking recourse to interest rate swaps (IRS) market.

Floating rate loans pass on the interest rate risk from banks, which are much better placed to manage it, to borrowers and, thus, banks only substitute interest rate risk with potential credit risk, the Ombudsmen noted.
Damodaran Committee which was set up by the RBI suggest improvement in banking services had also suggested removal of pre-payment charges.

Some of the private sector lenders charge up to 2 per cent of outstanding loan on foreclosure.
Public sector banks by and large do not levy any prepayment charges when the amount is paid by borrowers from their own sources.

The National Housing Bank (NHB) has already directed all housing finance companies to desist from imposing a prepayment penalty on home loan borrowers.

Banks to decide on ending loan pre-payment penalty

By Falaknaaz Syed Oct 23 2011 , Mumbai 


Close on the heels of the National Housing Bank (NHB) waiving off prepayment penalty on old home loan borrowers and pressure mounting from the Reserve Bank of India (RBI) on banks to follow suit, the management committee of Indian Banks’ Association (IBA) will be meeting on October 25 to decide on the next course of action.

The RBI is already contemplating such a move and had said that it will wait for the comments from IBA on its proposal to do away with prepayment penalty on floating rate home loans. Recently, the Banking Ombudsmen Conference suggested that banks should not impose prepayment charges on loans with floating rate of interest.

Foreclosure Homes Account for 28 Percent of Q1 2011 Sales

May 25, 2011
By RealtyTrac Staff

Average REO Discount 35 Percent; Foreclosure Discount Drops to 9 Percent
Average Time to Sell at 176 Days for REOs; 228 Days for Pre-Foreclosures

IRVINE, Calif. – May 26, 2011 — RealtyTrac® (http://www.realtytrac.com/gateway_co.asp?accnt=137300), the leading online marketplace for foreclosure properties, today released its Q1 2011 U.S. Foreclosure Sales Report™, which shows that sales of bank-owned homes and those in some stage of foreclosure accounted for 28 percent of all U.S. residential sales in the first quarter of 2011, up slightly from 27 percent of all sales in the fourth quarter of 2010 and the highest percentage of sales since the first quarter of 2010, when 29 percent of all sales were foreclosure sales.
The average sales price of properties in some stage of foreclosure — default, scheduled for auction or bank-owned (REO) — was $168,321, down 1.89 percent from the fourth quarter of 2010 and down 1.46 percent from the first quarter of 2010.

For banks, recovery of bad loans remains a challenge

T. S. Krishnamurthy

Debt Recovery Tribunals, BIFR have not served their cause well

The downgrading of State Bank of India (SBI) by credit rating agency Moody's and the consequent turmoil in the stock market is a much-talked-about issue currently.

The downgrading is mainly due to SBI's Tier-1 capital adequacy ratio coming down to 7.6 per cent against the norm of 8 per cent.

This is a direct consequence of the increase in gross non-performing assets (NPAs) to 3.52 per cent and the consequent higher provisions to be made.

Though the case of SBI is the talking point now, the rise in NPAs is a phenomenon afflicting all banks.

In an earlier article ( Business Line, September 4, 2011), the broad reasons for the spurt in NPAs and the difficulties faced by banks in recovering bad loans through the SARFRAESI (Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest) Act were highlighted.

Relief for home loan borrowers

The National Housing Bank has asked housing finance companies to refrain from levy of penalty on preclosure of floating rate loans.

For those millions of home loan borrowers who were sulking at their decision to go for floating rate of interest, and who found their own interest rates being regularly reset even as new borrowers were being assiduously besought with lower rates, the order from the National Housing Bank that regulates Housing Finance Companies (HFCs) on treating both sets of borrowers equally should have come as a surprise.

The National Housing Bank, in a major relief to home loan customers, also asked the HFCs to refrain from levy of penalty on preclosure of floating rate loans, even if this was made from borrowed money (generally a euphemism for fresh loans at lower interest rates from a rival lender).

While the decisions have been welcomed by the real estate industry and the borrowers, the HFCs aren't really pleased.

In an interview to Business Line, Mr Srinivas Acharya, Managing Director, Sundaram BNP Paribas Home Finance Ltd, Chennai, expressed the fear that ‘home loans would be operated as demand loans with frequent shifts of home loans'. He argued that ‘there is a certain degree of unfairness' in that, while there are restrictions on charging a foreclosure premium on the asset side for HFCs; these will continue to pay premiums on foreclosures on the liability side.

FORECLOSURES

Currently, the HFCs see foreclosures to the extent of 10 per cent of the portfolio in a year. Already, foreclosure of home loans from own savings is exempted from penalty. Therefore, he didn't see much additional impact beyond, say, 0.075 per cent of the portfolio. While he didn't see this as a major source of income, this penalty always served as a ‘deterrent against poaching of customers'. As regards interest rate equalisation between old and new customers, he said this wasn't a major problem and will get settled with time. The real issue was there was no similar condition on lenders to HFCs!

On being asked if he feared there would be a shift from HFCs to banks because of this order since the National Housing Bank order would apply only to HFCs, Mr Acharya didn't view this ‘as a threat'. HFCs primarily thrive on their quick ‘turn-around time' and better understanding of the business and customer service. Some movement may be there, but that would only be an immediate reaction in the short term, he felt.

As to HFCs raising the interest rates for new borrowers so as to mitigate the impact of the order, he said the ‘interest rates would be guided more by ‘demand-supply' factor and the impact wouldn't be serious for HFCs who have borrowed on variable rate terms.

He felt that while there may be some rush for refinancing of higher cost home loans with cheaper loans, this would settle down. More than the bigger players in the industry, the smaller players are niche players and therefore won't be affected. As a result, his own company may not be impacted by more than Rs 3-4 crore this year. This wasn't a major component of its overall income and he said that ‘a HFC should thrive on continuity of a good customer rather than short-term gain from foreclosure premiums!'

Mr Acharya argued that this was ‘more a populist kind of measure', as home loans attract a lot of attention and touch the retail end of customers. Even the Competition Commission of India (CCI) had upheld the appropriateness of foreclosure premium. While conceding that there might be some fringe players charging premiums at exorbitant rates, that really may not be the case in his own company. Moreover such players charging premium at exorbitant rates could be controlled.

PREMIUM

He felt that there could ‘be a mandated rate of premium' rather than removing it altogether. Removal of foreclosure premium, if at all, should have been done across the financial sector, both for lending and borrowing, and not just for HFCs alone.

Mr. Acharya also felt it would be far more prudent ‘to chase a known customer with proven repayment record rather than go after a new home loan customer with all the uncertainties!', he added.

In an impact analysis of National Housing Bank's decision, IDFC Securities said that the regulatory arbitrage between banks & HFCs wasn't ‘likely to sustain'. At present, these norms apply only to HFCs, and not banks. RBI had earlier suggested, but not mandated, these terms for banks. However, it expected RBI also to follow suit.

Referring to the practice of financiers offering a lower rate for new home loans (for old borrowers) to attract business, it felt that the financiers would have to increase the interest rates for new loans more (by 100-150 bp). However, they could establish a credit profile of customers to mitigate the impact, offering some flexibility in pricing.

IDFC Securities expected new home loan rates to rise from the current levels and settle somewhere between the prevailing new and old home loan rates. With the cost of a new home loan rising, the growth in new home sales and mortgage portfolios would suffer.

Waiver of prepayment charges constitutes a very small part of financiers' income. But waiver increased borrowers' ability to refinance their existing loans. This could place players with a stronger liability franchise in an advantageous position vis-à-vis less competitive players, it concluded.

Mr. S. S. Asokan, Executive Director, Shriram Properties Ltd, Bangalore, said that at a time of rising interest rates, this will greatly help the borrowers and facilitate greater housing loan disbursals by the HFCs.

Foreclosure Activity Hits Record High in Third Quarter

U.S. Foreclosure Activity Sets New Quarterly Record, Up 23 Percent From Q3 2008

IRVINE, Calif. – Oct. 15, 2009 — RealtyTrac® (www.realtytrac.com), the leading online marketplace for foreclosure properties, today released its U.S. Foreclosure Market Report™ for Q3 2009, which shows that foreclosure filings — default notices, scheduled auctions and bank repossessions — were reported on 937,840 properties in the third quarter, a 5 percent increase from the previous quarter and an increase of nearly 23 percent from Q3 2008. One in every 136 U.S. housing units received a foreclosure filing during the quarter — the highest quarterly foreclosure rate since RealtyTrac began issuing its report in the first quarter of 2005.

Foreclosure filings were reported on 343,638 properties in September, a 4 percent decrease from the previous month but a 29 percent increase from September 2008. Despite the monthly decrease, September’s total was still the third highest monthly total since the RealtyTrac report began in January 2005, behind only July and August of this year.

“Bank repossessions, or REOs, jumped 21 percent from the second quarter to the third quarter, corresponding to jumps in defaults and scheduled auctions in the previous two quarters,” said James J. Saccacio, chief executive officer of RealtyTrac. “REO activity increased from the previous quarter in all but two states and the District of Columbia, indicating that lenders may be starting to work through some of the pent-up foreclosure inventory caused by legislative delays, loan modification efforts and high volumes of distressed properties.”

Report methodology
The RealtyTrac U.S. Foreclosure Market Report provides a count of the total number of properties with at least one foreclosure filing reported during the month or quarter — broken out by type of filing at the state and national level. Data is also available at the individual county level for both Q1 2009 and March 2009. Data is collected from more than 2,200 counties nationwide, and those counties account for more than 90 percent of the U.S. population. RealtyTrac’s report incorporates documents filed in all three phases of foreclosure: Default — Notice of Default (NOD) and Lis Pendens (LIS); Auction — Notice of Trustee Sale and Notice of Foreclosure Sale (NTS and NFS); and Real Estate Owned, or REO properties (that have been foreclosed on and repurchased by a bank). If more than one foreclosure document is filed against a property during the month or quarter, only the most recent filing is counted in the report.

U.S. Foreclosure Market Data by State – Q3 2009

(NOTE: Click on a column heading to sort)

Rate Rank	State Name	NOD	LIS	NTS	NFS	REO	Total ▴	1/every X HH (rate)	%Change from Q2 09	%Change from Q3 08
--	United States	153,255	188,986	263,957	94,590	237,052	937,840	136	5.40	22.50
3	California	111,741	1	87,377	0	50,935	250,054	53	-1.52	18.60
4	Florida	1	95,790	1	39,403	21,729	156,924	56	-0.71	23.27
2	Arizona	20	0	36,176	0	14,146	50,342	53	5.07	24.55
1	Nevada	19,949	0	16,329	0	11,647	47,925	23	9.68	58.88
10	Illinois	0	18,585	1	8,980	9,704	37,270	141	13.68	30.29
8	Michigan	11,454	0	10,575	0	14,997	37,026	122	9.50**	22.31**
7	Georgia	53	1	22,088	0	11,243	33,385	119	6.69	25.06
28	Texas	86	4	17,256	0	12,492	29,838	316	11.27	8.72
13	Ohio	0	12,137	0	8,707	8,801	29,645	171	-4.73	-11.71
15	New Jersey	0	11,816	0	3,878	2,414	18,108	193	44.59	1.20
16	Virginia	51	1	10,136	0	6,499	16,687	196	8.24	4.14†
9	Colorado	41	0	11,437	0	4,787	16,265	131	11.43	12.53
39	New York	0	11,048	1	2,316	1,877	15,242	521	11.55	5.28
12	Maryland	3	6,795	0	5,795	2,210	14,803	157	58.83	85.64
34	Pennsylvania	1	4,961	0	5,232	3,973	14,167	387	7.16	15.48
17	Mass.	1	7,779	0	3,159	1,728	12,667	215	17.53	34.81
20	Indiana	0	2,362	0	4,504	5,235	12,101	230	-12.75	-15.77
19	Wisconsin	1	5,899	0	2,661	2,620	11,181	229	11.17	105.16
22	Tennessee	4	1	4,730	0	6,153	10,888	250	3.92	-9.09††
18	Minnesota	31	0	5,450	0	5,139	10,620	217	16.27	100.26
23	Washington	0	0	6,142	0	4,233	10,375	264	-7.32	33.00
11	Oregon	108	2	7,033	0	3,175	10,318	156	7.09	76.59
36	North Carolina	1,028	4	4,158	0	4,628	9,818	420	28.86	-5.99
6	Utah	3,515	0	3,564	0	2,474	9,553	97	13.24	96.28
30	Missouri	24	0	4,470	0	3,398	7,892	335	8.26	-11.17†
24	South Carolina	1	3,695	1	1,153	2,696	7,546	268	10.99	59.74
5	Idaho	2,916	0	3,021	0	594	6,531	97	28.06	153.53*
32	Alabama	8	0	3,808	0	2,135	5,951	359	-7.07	173.86*
21	Arkansas	339	0	3,002	0	1,837	5,178	249	11.59	39.61*
25	Connecticut	0	3,422	0	408	1,283	5,113	281	68.86	10.00
29	Oklahoma	744	843	396	1,980	1,069	5,032	323	64.66*	22.02*
37	Louisiana	0	762	0	2,092	1,132	3,986	466	21.30*	98.70*
31	Kansas	0	538	0	1,129	1,735	3,402	358	39.71	47.08
41	Kentucky	1	1,050	0	1,126	1,102	3,279	581	15.30	12.45
14	Hawaii	449	0	1,499	0	795	2,743	185	29.02	141.46
40	Mississippi	4	1	841	0	1,374	2,220	565	50.51*	241.01*
35	New Mexico	0	890	0	837	456	2,183	395	9.20	84.69*
43	Iowa	1	0	658	0	1,292	1,951	681	17.81	31.91*
27	New Hampshire	14	0	1,372	0	558	1,944	306	-5.08	-2.21
26	Rhode Island	1	0	871	0	682	1,554	290	-6.33	-2.75
	District of Columbia	405	0	619	0	159	1,183	240	19.37	-11.05
42	Maine	0	234	0	577	242	1,053	662	27.02	33.12
38	Delaware	0	4	0	483	291	778	500	-8.79	-11.69
33	Alaska	9	0	534	0	221	764	369	29.93	36.43
45	Nebraska	241	247	12	6	229	735	1,062	75.84*	-29.67
48	West Virginia	6	0	287	0	277	570	1,549	67.16*	356.00*
44	South Dakota	0	110	0	105	149	364	981	127.50	205.88
47	Montana	1	0	19	0	273	293	1,486	94.04	-6.69
46	Wyoming	1	0	86	0	130	217	1,117	-4.82	-14.90
49	North Dakota	0	3	0	59	52	114	2,724	29.55	-20.28
50	Vermont	2	1	7	0	52	62	5,023	342.86	169.57

*Actual increase may not be as high due to data collection changes or improvements
**Collection of records classified as NOD began in August 2009 because of change in state law
† Collection of some records previously classified as NOD in this state was discontinued starting in January 2009
†† Collection of some records previously classified as NOD in this state was discontinued starting in September 2008

Amendments to SARFAESI Act to clear recovery processes: BA Prabhakar, Bank of India

In an interview with ET Now, BA Prabhakar, ED, Bank of India, gives his views on the amendments made in the SARFAESI Act. Excerpts:

What is your first take of the amendments and how they speed up the process of actually recovering bad debts and bringing down NPAs?

The details of the proposed amendments are not very clear but what we read from the press is that it is more about the procedural issues that are involved in the invoking of the SARFAESI Act. We understand that it enables the government to create an electronic registry for all the mortgages created. It is also going to simplify the approval process that banks have to obtain from the District Magistrate or the Metropolitan Magistrate before they really go ahead with the action. But we do not have the full details about this proposed amendment.

If you could highlight with an example, about how this act which came into place in 2002, will really help banks in bringing down their NPA levels and speeding up the process of recovery for bad debts?

It has definitely helped the banks improve the recovery performance. We need to differentiate the NPA recovery in 2 ways. One is: If the NPA has to be recovered through sale of securities, then definitely this act has been helpful to the banks. But if we are looking to NPA recovery, then we have to wait for the whole environment to improve and the economy to perform better. Then only much of the NPAs can be recovered.

Most of the NPAs fall in the category which are subject to the stresses in the economy and what you can recover from sale of security is not a very significant portion. What we are finding is in many of the recovery actions taken by us, we find that the borrowers immediately go to the courts, put stay orders, even though banks are allowed as per the act to sell the securities. So the whole process of vacating the stay will take time. So these are some of the bottlenecks which are being streamlined now. 

Would this in anyway facilitate faster recovery and favourable decisions from the debt recovery tribunal if I can use that term loosely because we see that forms are significant portion of NPAs for the PSU banks as well because we were given to understand that this would help faster auctioning of properties to recover the debts which was not possible in the past, is something like that going to happen?

Yes, it will definitely improve the faster recovery. There is no doubt about it.

This would be by virtue of special courts being set up or more powers being granted in the favours of the lenders which is the banks at the current point of time?

It will be removing some of the procedural bottlenecks which are there in the present provisions.

Currently what percentage of your NPAs are problematic or mortgaged against assets which you think will be helped if you could give us an amount since you gave us the 2 types of NPAs to monitor for recovery, what percentage do you think would get help under this act?

Maybe about 20% to 25% of the NPAs could fall under the securitisation act recovery actions that can happen, about 20% to 25% is what could be there.

Govt paves way for easy loan recovery by banks

BS Reporter / New Delhi October 14, 2011, 3:35 IST


The Cabinet on Thursday cleared two amendment Bills paving the way for banks to recover loans from errant borrowers. The move would also help the financial institutions to reduce their non-performing assets and release funds for home, retail or corporate credit needs.

The Bills to amend the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (Sarfaesi) Act and Recovery of Debts due to Banks and Financial Institutions (RDBF) Act were listed in the Budget for 2011-12 as one of the financial sector reforms that the government would carry out this fiscal.

Cabinet nod to bring IIFCL under RBI regulation

The Union cabinet in a decision on Thursday approved the proposal to bring India Infrastructure Company (IIFCL) within the regulatory oversight of the Reserve Bank of India, as is the case with other non-banking finance companies in the country.

This would bring IIFCL on par with the special funding agencies of the government such as Power Finance Corporation and Rural Electrification of Corporation. The proposal implies the IIFCL would have to become compliant to RBI’s capital adequacy norms prescribed for NBFCs. RBI presently prescribes a minimum tier-I capital (paid-up equity plus general reserves) of 12 per cent. This ratio is expected to be reached within three years after the NBFC registration.

ASSOCHAM opposes new classification norms for NBFC NPAs

New Delhi: Industry body ASSOCHAM has opposed the government’s classification of non-performing assets (NPAs) belonging to non-banking financial companies (NBFCs) which provides for secured and unsecured advances if the overdue period exceeds 90 days.

Under the existing norms, an unsecured asset overdue beyond 90 days and a secured asset overdue beyond 180 days are treated as NPAs.

Reconstructing asset reconstruction firms

Asset reconstruction companies can buy the bad assets from banks by paying cash or offering security receipts that get redeemed a few years later

Banker’s Trust | Tamal Bandyopadhyay


My last week’s column, “What ails asset reconstruction firms?” evoked strong reactions from various quarters. While some bankers feel I was unnecessarily harsh on banks and did not understand the “spirit” of securitization (whatever that means), a few others are not surprised with my ‘findings’ as the practice of financial incest has been rampant since the inception of the industry. The column was the first of a two-part series on the subject that I had planned. Before writing the concluding part, I have discussed the issues with four senior professionals of the Indian asset reconstruction industry, including S. Khasnobis, former managing director and chief executive of Asset Reconstruction Co. (India) Ltd (Arcil), the country’s oldest and biggest asset reconstruction firm.

In the first quarter of fiscal 2012 ended June, the non-performing assets, or NPAs, of 11 banks with maximum stressed loans rose by Rs15,425 crore. Since fiscal 2010, these banks have added almost Rs83,000 crore worth of bad assets. With interest rates rising and the economy slowing, more and more corporations will default on bank loans. But not too many banks are selling their bad assets to asset reconstruction companies, or ARCs. Why? Many of them are restructuring stressed assets by giving borrowers more time to repay, while a few are disbursing fresh funds to the stressed accounts to pay up the bad loans.

ARCs can buy the bad assets from banks by paying cash or offering security receipts (SRs) that get redeemed a few years later. Typically, banks look for higher valuations while accepting SRs against bad assets, and discounts are steeper for cash deals. Overall, banks are not too willing to sell bad assets to ARCs and there are many reasons behind that. When a bank parts with an asset to an ARC, it has to set aside money or make full provision between the book value of the loan and the value at which it is sold to an ARC. This impacts the bank’s profitability. Typically, banks make full provision for a bad asset over three to four years. This means they can postpone the impact on their profits by carrying the bad assets on their books for a few years and sell them to ARCs as a last resort of recovery when no more fresh provisions are required.


Besides, banks enjoy the same powers that an ARC enjoys even though, operationally, they may lack the expertise to recover bad loans. So most banks attempt to recover a bad loan or rehabilitate the stressed borrower on their own and when they fail to do so, sell the bad assets to ARCs.

Finally, there is always a gap between the value that banks expect from bad assets and the price ARCs are willing to offer. The driving factor here is the cost of funds. While banks discount the future expected realizations from recovery at about 10% a year, ARCs insist on at least 20% discount. This means over three years, while bank wants to recover Rs70 from an asset worth Rs100, ARCs quote a price of around Rs40. Besides, banks need to pay them a management fee that varies between 1% and 2% of the size of the asset in case of sale through SRs. Most banks find such a hefty discount unacceptable; they also do not realize that the longer they delay the transfer of assets to ARCs, the faster is the fall in the final realizable value.

Banks auction bad assets to ARCs, but do not offer any floor price for such auctions. Often, after receiving price quotes from ARCs, they withdraw the assets from auction and start negotiating with the borrower for a settlement, using the highest bid as a floor. The auction of bad loans for many banks is not a part of the process of selling such loans, but a price discovery method to bargain hard with the defaulter for recovery.

While banks are allowed to take profit from the sale of bad assets (if the sale price consideration is higher than book value), in case of a settlement with the defaulter borrower, such profit from the sale of assets to ARCs cannot be booked even if it is paid in cash. They money thus generated needs to be kept as a cushion against future provisions. This is also a disincentive for banks to sell NPAs to ARCs.

Regulatory aspects

Let’s look at the regulatory aspects of the industry. The Reserve Bank of India (RBI) issued the final guidelines for ARCs in April 2003 after the Parliament passed the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, and subsequently several changes were made. The norms allow the acquisition of financial assets both on the books of ARCs as well as under a trust structure outlined in the Act. There are 14 ARCs in India and about 98% of the assets that they have acquired are through the trust structure. This means ARCs do not own the assets but they manage the assets of the trust. In that sense, they cannot have NPAs on their books; but RBI norms insist that when they are not able to recover the bad assets in accordance with the plan envisaged, they need to classify them as NPAs and this means they cannot earn their management fee on such assets.

Incidentally, SRs are subject to declaration of net asset value (NAV) every six months, based on ratings by ratings agencies; and SR investors (including ARCs for their own investments) are required to book losses in case of a drop in NAV.

The capital requirement for ARCs is also an issue on which the industry is divided. Going by RBI norms, an ARC needs to follow 15% capital adequacy till it has Rs100 crore capital. This means that for every Rs100 worth of bad loan bought, they need to have Rs15 capital. This norm is relaxed once an ARC has Rs100 crore capital, but all ARCs must pick up at least a 5% stake in the SRs that they sell against the bad assets.

Many say that ARCs should have more capital and invest more in SRs as they will be more aggressive and diligent in recovery when they have more skin in the game. Often when they buy bad assets and offer SRs, the valuation is too high and ARCs strike deals knowing fully well the SRs will not fetch such a high price at redemption and seller banks will lose. They will not do so if they hold a larger part of the SRs. But there is a strong opposite view too: since ARCs are managing the trusts, why do they need to have hefty capital? Also, why do they need to invest in SRs? After all, they are playing the role of asset management companies (managing bad assets); and the mutual funds that follow the same principle do not require a big capital base and they do not need to make own investments.

ARCs are being created to clean up the banking system and prevent capital infusion in banks (as banks need to set aside money for bad assets, they need more capital when bad assets grow), and if ARCs themselves need hefty capital, the purpose of their creation is not well served.

Instead, RBI needs to broaden the investor base in SRs. Currently, qualified institutional buyers, or QIBs, such as banks and insurance firms, are allowed to subscribe to SRs which are rated instruments. Foreign investment in such instruments is capped at 49% and no individual foreign institutional investor, or FII, can hold more than 10%. Perhaps, the regulator feels that a larger role for foreign investors will encourage them to take over sick Indian firms through the back door. But such apprehensions have no basis as most defaulters are in bad shape and they cannot attract serious investors. Foreign investors should be allowed to play a larger role in investing in SRs floated by the trust and encouraged to get actively involved in the recovery process, the way a private equity fund handholds the promoters of a firm in which it invests. Foreign distressed-debt investors are specialized institutions who like to have a significant stake in a trust or scheme with some control.

Recovery models

Typically, ARCs follow three models of recovery. The first is the asset stripping or the vulture model. In this case, they shut the unit’s functioning and strip the assets to recover money.

The second model is the arbitrage model. In this case, ARCs add very little value; they acquire an asset from a bank at a price and go back to the same borrower and settle at a higher price, creating a spread by virtue of their superior negotiating skills with the borrower. This also explains why banks use ARCs as a price discovery platform and then go back to settle with the borrower themselves using the ARC-quoted price as a floor.

The last model is the revival model that involves the restructuring of financials, processes and the infusion of long-term funds. The mere acquisition of an asset doesn’t revive an account. Apart from arranging funds, ARCs should also be allowed to take equity exposure in a sick company by converting a part of the debt for speedy recovery. While dealing with a listed entity, any such exposure will attract the so-called takeover code of the market regulator that makes an open offer mandatory for any acquisition of a 25% stake or more in a company; for unlisted entities, it can be a contract between the company and ARC.

The Securitisation Act allowed ARCs to change or take over the management and sale, or lease, of the business of the defaulting borrowers; but RBI took seven years to actually empower them, that too in a truncated manner. They can take over the management, but cannot lease the business as yet.

There have been very few cases where the business has been taken over, but the powers to do so act as a threat and make the recovery process relatively easier.

The rogue borrowers always want to oppose any recovery move; there have been thousands of cases in which they have dragged ARCs to court to delay the process.

Technically, the borrowers are required to offer one-fourth of the dues to legally challenge any recovery move, but this norm is not always followed. Besides, ARCs are allowed to acquire only secured NPAs from the Indian banking system, leaving the other debt-holders to proceed under civil court procedure.

There are many other issues that RBI should look into to make the asset reconstruction industry work well, such as allowing the transfer of assets among ARCs and permitting them to offer working capital support to industrial units under revival; but no model will work unless the banks themselves appreciate the importance of selling bad assets and stay away from financial incest.

The concept of securitization has not taken off as banks that sell their bad assets to ARCs often insist that these cannot be mixed to create a pool.

This means ARCs need to hold bad assets of individual banks as separate pools under a trust, and the banks are subscribing to SRs of their own assets. In other words, the banks are simply removing the bad assets from their loan books and bringing them back as good assets through their investment books (that hold SRs). Arcil, I am told, has set up at least 350 trusts, and many of them are seller-specific trusts. This practice might prove to be the proverbial last nail in the coffin of India’s asset reconstruction industry if it dies a premature death.

There is a clear conflict of interest as the banks are holding the dual role of owners as well as beneficiaries—sellers as well as investors in SRs. They are also the major shareholders in some ARCs. One way of reconstructing ARCs could be by capping sponsor banks’ exposures at 10% and keeping the nominees of the sponsors out of the acquisition and resolutions committees of the firms.

The representation of banks as a class of shareholder in the board of ARCs should also be capped. This is not a unique idea as in credit information bureaux, too, no bank is allowed to hold more than a 10% stake. This, along with an expansion in the investor base in SRs will help ARCs securitise bad loans in the true sense of the term. Let the banks focus on their main business of lending, and ARCs on recovery.

And till such time the industry fully understands the nuances of bad asset buys and recovery, no new ARC should be allowed to set shop.

Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as Mint’s deputy managing editor in Mumbai. Your comments are welcome at bankerstrust@livemint.com

Moody's downgrade of SBI triggers bond price correction

Bonds prices corrected on the back of bank and fund buying as traders weighted the possibility of a pause in policy rate hikes by the Re serve Bank of India.

The purchases took up the price of the 10-year 7.8 per cent coupon security due in 2021 to Rs 95.48 (par value Rs 100) or a yield of 8.50 per cent.

Intra-week, the security had hit a low of 8.55 per cent (Rs 95.18). Traders said the re covery was prompted largely by provident funds purchas es. Although provident fund elevated bonds, yields were still at six basis points off the previous week's 8.44 per cent (Rs 95.86).

What ails asset reconstruction firms?

Banker’s Trust | Tamal Bandyopadhyay

 

Asset reconstruction firms in India, through a trust, buy stressed assets of banks and financial institutions at a discount, recover them, and earn a fee for managing the trust

Banks make U-turn on prepayment

Resistance prompted by fears of liquidity mismatch; banks now want charges capped, not waived
Joel Rebello & Dinesh Unnikrishnan


Banks are lobbying hard against a move that was supposed to improve ties with customers—the abolition of penalties on the early repayment of floating rate home loans. Weeks after agreeing to waive the prepayment charges, banks now say they should be capped, but not waived.

The Indian Banks’ Association (IBA) lobby group has written to the Reserve Bank of India (RBI) arguing against the move, fearing mismatches in liquidity owing to early payment.

The IBA note, sent to RBI in the second week of September, was in response to recommendations made by a central bank-appointed committee on customer service in banks. Based on this, banks had adopted a charter of 10 action points early September to improve customer service, at the annual conference of banking ombudsmen in Mumbai.

The action point in question said: “Banks must not recover prepayment charges in floating rate loans.”