»5 Minute Wrap Up by Equitymaster

On This Day - 29 MAY 2018
The Tata Steel-Bhushan Steel Deal Could Result in 59% Gains from This Stock

Sarvajeet Bodas, Research analyst

Did you know that Japan is ranked number one in the world in resolving bankruptcies?

That's right.

As per a World Bank study, Japanese banks recover around 92% of the outstanding amount on defaulting loans. And that too, within just 6 months of the bankruptcy proceedings!

Compared to this, India's rank is 103. It takes around 4.3 years to resolve bankruptcies in India.

The recovery rate, at just around 26%, is one of the lowest in the world.

But that was in the past. Things are about to change for the better.

The government and the Reserve Bank of India (RBI) have finally decoded the banking sector's non-performing asset (NPA) problem.

Yes, it has taken a long time. But things have now started to turn around.

The biggest challenge was to acknowledge the sheer scale of the problem. Once this was done, the next step was to take strong action to solve the problem.

But this wasn't an easy task.

Banks tried their best to recover their money from defaulters but they couldn't. They didn't have the power to do so quickly.

Enter... The Insolvency and Bankruptcy Code (IBC).

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This is a game changer for India's banking sector. The IBC gave banks the power they needed.

Earlier, banks had to run after promoters to recover their money. Now promoters are running after banks and looking for solutions.

As per the RBI's financial stability report, more than 4,300 applications were filed in the National Company Law Tribunal (NCLT).

With this, banks have sent out a clear message - pay up...or be ready for bankruptcy proceedings.

Ten days back, we had a first taste of success after the banks successfully recovered Rs 352 billion following the successful resolution of Bhushan Steel. This implies a haircut of around 37% for banks.

Mind you, most banks had already made provisions for about 50% for Bhushan Steel's loan. Now with the successful resolution (with the recovery rate of ~73%), the proceeds from the sale will directly boost profitability of the banks.

This is good news for subscribers of Smart Money Secrets. Our recommendation last month, will benefit from this resolution.

This bank has already made 50% provision and with the successful resolution, it will write-back this loan from the provisioning. This means more profits and more funds available for further lending.

This is what the management said yesterday on a con-call:

  • "We are seeing some recovery, especially in the steel related cases. As you are aware, one case is already settled. Going forward, as more cases in NCLT get resolved, we expect repayments to start coming in. This will reduce gross NPA numbers".

The stock was up 1.5% on the day of the concall. Currently, this stock is still trading below our recommended price as the market awaited more clarity on the NPA issue.

However, with the recent concall, things are looking clearer now. From the current price, we believe, the stock has an upside of about 59%.

Clearly, the IBC is the biggest reform for the banking sector in a long time.

It's important to keep in mind, the code remains a work in progress. It has some teething troubles and requires constant tweaks, as indeed all new laws do.

We may not achieve Japanese levels of loan recovery. But, we have no doubt, India has made a good beginning of this front.

More importantly, lending in the next credit cycle will be more disciplined as a result.

Chart of the Day

Last year, India jumped up 30 places and into the top 100 on the World Bank's 'ease of doing business' index.

However, when it comes to resolving insolvency, India's rank is still low at 103, much below our neighbouring countries.

On both factors (i.e. recovery rate and the time to resolve a bankruptcy), India is slower than even its poorer neighbours.

India Lags in Resolving Insolvencies

However, going forward, the IBC framework will change India's position as it is a time-bound process.

Cases once admitted are to be resolved within 270 days; if not, companies go into liquidation.

We already had a taste of success with the successful conclusion of the Bhushan steel case.

Enthused by this success, the finance ministry expects banks to write back more than Rs 1 trillion after the resolution of all 12 big NPA cases that have been referred for insolvency proceedings by the RBI.

We believe, this can be a big boon for the banking sector and the Indian economy. This will not only help banks recover bad loans to an extent but also help bring back credit growth.

We recently recommended a company to our Smart Money Secrets subscribers which we expect to benefit immensely from the Bhushan Steel's recovery.

If you do not have access to Smart Money Secrets, you can sign up here...

Sarvajeet Bodas
Sarvajeet Bodas
Research Analyst, Smart Money Secrets

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