The problem with bad loans

The health of the banking sector is deteriorating. India needs robust insolvency laws

Sunil B.S.   First Published: Thu, Aug 23 2012. 07 30 PM IST

pdated: Thu, Aug 23 2012. 07 36 PM IST

The sharp economic downturn has once again brought the problem of bad loans to the forefront.

In its annual report released on Thursday, the Reserve Bank of India (RBI) pointed out that the health of the banking system is linked to the credit cycle. “Financial institutions tend to overstretch their lending portfolio during economic booms and tend to retrench the same during economic downturns,” it said.

The market is often abuzz with speculation about the inability of some overleveraged business groups to service their bank loans. India has traditionally had a system that tries to help companies in financial distress, making it easy for them to restructure loans. Even RBI has pointed out that the ability of Indian banks to maintain asset quality is “partly on account of the policy of loans restructuring”.

While bad assets of Indian banks have grown 46% in the fiscal year ended March 2012, the growth pace of credit has been at 17%. On 31 March, gross non-performing assets (NPAs) of the banking system amounted to Rs.1.37 trillion and restructured assets Rs.218 trillion.

To reduce the adverse effects of economic downturns on companies and lenders, corporate debt restructuring (CDR) was introduced by RBI in 2001. Despite success in helping companies emerge out of financial troubles, there are several shortcomings in this mechanism. India continues to miss strong insolvency laws.

Restructuring often involves extension of maturities, lower interest rates, debt forgiveness, among others, in case a firm is unable to repay its debt. Further, loans may or may not get classified as NPAs after they are restructured. A working group set up by RBI to review existing guidelines on loan restructuring has recommended increasing the provisions for accounts which get the asset classification benefit on restructuring. Hence, such restructuring places huge stress on the resources of banks

Such restructuring has also attracted criticism about being partial towards big companies. RBI deputy governor K.C. Chakravarty, in a recent speech, raised an important question: Are small and marginal borrowers discriminated against by the banks? An economic downturn is likely to affect smaller companies more adversely than larger ones, so smaller borrowers should be having a greater share in restructured accounts. The data with RBI does not show this.

The soft corner which Indian banks have for large companies is also highlighted by a recent report by Credit Suisse Group AG, which pointed out that the exposure to 10 large industrial groups constitutes 13% of the entire Indian banking system’s loan assets.

In the absence of effective laws on insolvency, many firms who can’t repay their debts for reasons beyond their control remain orphans, and banks are forced to restructure their loss-making assets at a cost. The Sick Industrial Companies Act (SICA), 1985, enabled sick firms to approach the Board for Industrial and Financial Reconstruction (BIFR) to help them revive.

Under the SICA provisions, a company is classified as sick if it has a track record of erosion of net worth over five years. But what is required is a law, which can detect that a company is going through financial difficulty in earlier, and then attempt to revive it. The lack of infrastructure has resulted in bankruptcy procedures under BIFR to take a long time, something which needs to be addressed. Also, steps should be taken to prevent misuse of BIFR provisions by companies that, under section 22 of SICA, seek immunity from creditors after cooking their accounts; this has plagued efficiency at BIFR for long.

Also asset reconstruction companies (ARCs), which were established by the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, to acquire, manage and recover illiquid loans or NPAs from banks have failed to take off in a big way. The appetite of Indian investors for securities issued by ARCs is weak, and remains limited to short-tenor papers and those with high ratings. A major hindrance in the way of development of securitization in the country has been high stamp duties. Moreover, the Indian credit markets are closely regulated and loans typically don’t trade on a secondary market, unlike developed countries.

These laws are also tilted in favour of creditors whose major goal remains short term, which is to recover their debts. What is needed are sound insolvency laws in our country along the lines of chapter 11 in the US, which can protect firms and help them adopt a suitable strategy to emerge out of financial difficulties.

http://www.livemint.com/Opinion/FF0FFDxOooUbUDEcAWDHmI/The-problem-with-bad-loans.html

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A reconstruction boom?

For the first time, that there exists a legislative framework that allows ARCs to focus on revival and reconstruction.
Haseeb A. Drabu .

By allowing asset reconstruction companies (ARCs) to convert a company’s debt into equity, the framework of management of non-performing assets is likely to undergo a fundamental change.

Amendments to the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI) that allow these changes can potentially alter the landscape of asset reconstruction.

Till now, banks and lenders in general had access and recourse only to the assets of the borrowers. The debt of a company was directly linked to the physical assets created by it. Equity was kept out of these arrangements unless it was specifically earmarked or borrowed against. It was not available for recovery of overdue debts.

With the new amendment passed by both Houses of Parliament, debt and equity have been made fungible as far as recovery from defaulting companies is concerned. ARCs have been given complete and unbridled access to the equity of a defaulting company. With no restrictions on it, either in terms of size or type, this amounts to powers of changing the ownership and, with that, the management and leveraging not just of financial equity but also the business, brand and other types of equity of a company. This has enormous implications not only for lenders and borrowers but the entire financial architecture of the economy.

The biggest problem for ARCs was their ability to extract value from assets. Apart from all the litigation, procedural problems and unreal pricing of impaired assets by banks, ARCs often face a situation where the value of the asset is lower than that of the debt of the defaulting company. In such a case, the enterprise value of a company is less than its asset value. As such, ARCs can’t make much from the assets that they buy.

Despite a situation where the rate of growth of non-performing assets (NPAs) has been higher than the rate of growth of credit and the consequent high levels of NPAs, ARCs have been asset-starved for the past two years. No wonder then that despite permitting the formation of securitization companies and asset reconstruction companies in 2003, the market for impaired assets in India is far from developed.

Even though a number of ARCs have been set up that have been purchasing NPAs from banks, they haven’t been able to develop a robust stressed asset market or an active distress and restructured debt paper market in India. At best, ARCs have functioned as asset-recovery centres that are primarily into asset stripping rather than asset reconstruction and business revival.

This amendment which gives them recourse to equity has the potential to trigger the development of a healthy market for non-performing and impaired assets. The move seems to have been timed well. It comes at a point when the gross non-performing assets of the banking system are at a decadal high and are likely to be around 4% of the gross advances at the end of this fiscal. If one adds restructured assets, one-time exemptions and evergreen ones, the level is almost twice as much. Seen from a stressed asset market perspective, it is a business worth Rs 5 trillion.

If private equity participants—globally there are specialist distressed asset private equity firms—can team up with local ARCs, this can be a great business opportunity. Not only that, it will also be a systemic gain as their ability to turn around companies will be much higher as India seems to be nearing the end of the downturn. This is an ideal time for investments in distressed assets. From next year, interest rates will start declining and as and when growth picks up, the pricing of these assets will improve faster than their prospects of revival.

At the transactional level, the ability to convert debt into equity will be especially useful as it will reduce interest costs for companies. This is a frequent reason for firms getting into default. In addition to this, reconstruction and revival becomes easier with innovative and quick structuring of the debt component.

These possibilities, including those of changing owners, promoters or managements, will enable ARCs to offer better packages to banks for bad loans.

Now, for the first time there exists a legislative framework that allows ARCs to focus on revival and reconstruction. The efforts will be, or rather should now be, on buying an impaired asset based on business viability, using specialized skills and tools to turn it around and then reselling the stake the moment the company recovers. Apart from making profits for themselves, ARCs will have contributed to the national economy by preventing capital waste.

Haseeb A. Drabu is an economist, and writes on monetary and macroeconomic matters from the perspective of policy and practice. Comments are welcome at haseeb@livemint.com. To read Haseeb A. Drabu’s earlier columns,go towww.livemint.com/methodandmanner-

http://www.livemint.com/Opinion/bsS1xllKPFzCj95WqqoSxN/A-reconstruction-boom.html

Asset reconstruction firms expect boost in business

According to a Bill passed on Monday, these firms can convert part of their debt into shares of defaulting companies.
Dinesh Unnikrishnan 

Updated: Wed, Dec 12 2012. 12 42 AM IST

Mumbai: Asset reconstruction companies (ARCs) that purchase bad loans given to sick units from commercial banks are likely to see a revival in their business, once the Enforcement of Security Interest and Recovery of Debts Laws (Amendment) Bill 2011 comes into effect.

The Bill, passed by the Lok Sabha on Monday, allows ARCs to convert part of the debt into the shares of the defaulting companies and purchase the sticky assets of multi-state cooperative banks, among other things.

The actual implementation of the new rules may not take place immediately as the Bill is yet to be cleared by the Rajya Sabha, the upper house of Parliament, following which the Reserve Bank of India (RBI) will announce detailed guidelines.

Chiefs of leading asset reconstruction companies are optimistic that the provision to convert debt in distressed companies to equity will make such purchases more attractive as equity ownership will give more control to them in the operations of companies besides yielding higher returns once the companies turn profitable.

For companies too, conversion of debt into equity will be beneficial as their interest payment burden will come down.

“It’s indeed a big positive for ARCs,” said P. Rudran, managing director and chief executive officer of Arcil, India’s largest ARC. “This will enable us to do actual reconstruction of businesses for the eligible firms. ARCs will be able to take equity ownership in such companies and exit at a later stage by earning an upside on the equity, when the unit turns profitable.”

Another key provision of the debt recovery Bill allows banks to accept immovable property of defaulting companies to realize claims.

ARCs are currently not allowed to directly pick up stakes in stressed units whose loans they buy from commercial banks or other financial institutions. Instead, they typically facilitate the bringing in of long-term capital to these firms.

According to Rudran of Arcil, the provision to allow banks and financial institutions to file caveats and to be heard in debt recovery tribunals before any stay is granted will ensure that the process of law is not misused by unscrupulous borrowers to delay settlements and payment of dues.

“When you are reviving a running company, you are investing in a sick unit. ARCs always wanted to have equity relationships in companies which have a potential to revive but it was not allowed,” said P.H. Ravikumar, managing director and chief executive officer of Invent Assets Securitisation and Reconstruction Pvt. Ltd. “The new provisions will help ARCs to focus more on reviving the units rather than just buying out the bad assets.”

Ravikumar is optimistic that the provisions in the new law will help Indian ARCs buy more assets and enhance their ability to revive sick units in a slowing economy. Birendra Kumar, chief executive officer of International Asset Reconstruction Co. Pvt. Ltd, said more clarity will come only after the Reserve Bank announces the norms.

Slowing global exports, high inflation and high interest rates have hit the earnings of most industrial units, especially small and medium enterprises, in Asia’s third largest economy. This has impacted the ability of many companies to repay loans to commercial banks.

However, despite the rise in non-performing assets (NPAs), the business of ARCs is not swelling. Even Arcil, the largest among the ARCs, added just Rs.200 crore to its books this fiscal. For the other two ARCs, there have been hardly any deals in the current fiscal. Arcil has assets under management worth Rs.6,200 crore, Invent has bought assets worth Rs.2,500 crore, while International has principal outstanding assets of Rs.4,000-Rs.4,500 crore. Analysts said the business prospects of ARCs look bright in India, given the stress in the economy and the rise of bad loans and restructured assets. Gross NPAs of 40 listed banks rose by 47% to Rs.1.6 trillion in September from Rs.1.1 trillion in the year-ago period, with state-run banks leading the pack.

Analysts expect at least 25-30% of the restructured assets to turn bad in the absence of a major pick up in the economy, which grew at 5.3% in September quarter. Total restructured assets under the so-called corporate debt restructuring mechanism touched Rs.1.9 trillion on a cumulative basis till September. “It is boom time for ARCs, given the rise in bad loans in the banking system,” said Abhishek Kothari, research analyst at Violet Arch Securities Ltd.

“Post the new regulations, there is a likelihood of more bad loans being sold to ARCs as they will be keen to take equity relationships, which will reward them at a later stage, when valuations go up.”

http://www.livemint.com/Politics/xtLcRxhvhTqpwySmiABmYM/Asset-reconstruction-firms-expect-boost-in-business.html

Help to speed up NPA recovery, Pranab tells DRT chiefs

 SPECIAL CORRESPONDENT, THE HINDU

Problem of increasing NPAs has to be addressed on a priority basis.

                   

Finance Minister Pranab Mukherjee, on Wednesday, asked chiefs of debt recovery and appellate tribunals to suggest ways and means of expediting the release of bank resources locked up in the form of NPAs (non-performing assets). 

Addressing the first conference of chairpersons of DRATs (debt recovery appellate tribunals) and presiding officers of DRTs (debt recovery tribunals) here, Mr. Mukherjee pointed out that there could be no fresh lending unless there was recovery of earlier loans and, therefore, the problem of increasing NPAs of banks had to be addressed on a priority basis.

Even as the government has advised banks to closely monitor their NPAs, Mr. Mukherjee argued that the role of DRTs was all the more important as they were the part of mechanism for recovery of loss of assets by banks by way of bad loans.

Asking the tribunal chiefs to come out with ‘concrete suggestions' to improve their functioning and help in speedier recovery of bank debts, Mr. Mukherjee noted that the conference was being held at a time when the Indian economy was faced with various challenges.

In the event, although the slowdown in the GDP growth rate, coupled with the widening fiscal and current account deficits were a matter of concern, there “is no need to press the panic button as he has full faith in the capacity and abilities of our people as well as in the resilience of the Indian economy to overcome successfully such challenges.”

Highlighting the positive aspects of the economy, Mr. Mukherjee asserted that with strong basic fundamentals and high rate of domestic savings and investment, along with a reversal in the tight monetary policy, among others, taking the economy back to the path of higher growth, maintaining a moderate rate of inflation, narrowing the current account deficit and restricting the fiscal deficit to two per cent of GDP were much achievable.

The Finance Minister also argued that it was on account of the well-placed regulatory mechanism and effective functioning that banks were not adversely affected by the international financial crisis.

On the contrary, the role of banks was such that they helped in minimising the impact on the economy. In such a scenario, the role of DRTs “is all the more important in helping out the banks to deal with mounting NPAs/loss assets,” as DRTs could ensure effective and speedy recovery of public money.

Keeping this important aspect in view, as per the relevant legislation on recovery of dues, the endeavour of tribunals should be to decide cases in 180 days, but the DRTs had not been able to adhere to this time line. Mr. Mukherjee said the pendency of cases in tribunals was about 67,000 cases, involving an amount of Rs. 1.36 lakh crore as on March 31, 2012. “This is a matter of great concern,” he said.

http://www.thehindu.com/business/article3498324.ece?homepage=true