In 2016, banks will continue to kick the bad loans can down the road - Vivek Kaul's Diary
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In 2016, banks will continue to kick the bad loans can down the road

Jan 7, 2016

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In June 2015, the Reserve Bank of India(RBI) came with the strategic debt restructuring(SDR) scheme. This scheme allows the banks to convert a part of the debt owed to them by corporates into equity and is actively being used to kick the bad loans can down the road.

As the RBI notification on the SDR scheme pointed out: "It has been observed that in many cases of restructuring of accounts, borrower companies are not able to come out of stress due to operational/ managerial inefficiencies despite substantial sacrifices made by the lending banks. In such cases, change of ownership will be a preferred option."

Under the corporate debt restructuring scheme banks restructured loans by lowering the interest rate charged to the borrower or the borrower was given more time to repay the loan i.e. the tenure of the loan was increased, among other things.

But the restructuring did not help with a good portion of the restructured loans between 2011 and 2014, turning into bad loans. Crisil Research puts the number at 40%.


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Further, as Parag Jariwala and Vikesh Mehta of Religaire Institutional Research write in a research note titled SDR: A band-aid for a bullet wound: "Indian banks went on a massive restructuring spree over 2012-2013 and 2013-2014. The corporate debt restructuring (CDR) cell received 530 cases till March 2015 from banks looking to restructure debt aggregating to Rs 4 lakh crore without classifying these accounts as NPAs."

But this did not work. As Jariwala and Mehta point out: "On the whole, the success of CDR packages in rehabilitating stressed assets remains in question - the failure rate for the above restructured cases has increased to ~36% in September 2015 from 24% in September 2013. Out of the 530 cases received, close to 190 cases aggregating to Rs 70,000 crore have exited CDR due to repayment failures." Most of these failures have been with regard to loans where banks had entered into a moratorium of two years with corporates, for repayment of principal amount of the loan.

One of the reasons for the failure of CDR has been the lack of interest and cooperation from the promoters who had taken on bank loans. Their intention has been to default on the bank loans they have taken on. SDR has been initiated to address this problem. As Ashish Gupta, Prashant Kumar and Kush Shah of Credit Suisse write in a research note titled Failed CDR now SDR: "SDR allows banks to convert part of their debt to equity to take controlling stake (at least 51%) in the stressed company and thereby, banks can effect change in ownership wherever existing management is not performing. This gives banks significant power while dealing with non-performing or non-cooperating promoters."

The idea with SDR is to convert the weak bank debt into equity and then sell the equity to a new promoter, and recover the money owed to the banks by the corporate. As the RBI Annual Report for 2014-2015 points out: "RBI and SEBI have together allowed banks to write in clauses that allow banks to convert loans to equity in case the project gets stressed again. Not only will such Strategic Debt Restructuring give creditors some upside, in return for reducing the project's debt, it can also give them the control needed to redeploy the asset (say with a more effective promoter)."

SDR allows banks to postpone asset classification of a loan for a period of 18 months. This means that if a loan is in the process of turning into a bad loan and the bank has converted that into equity, it does not need to categorise that as a bad loan.

Also, the equity shares post conversion are exempt from following the "mark to market" rule. This means if the share price of the company falls below the price at which the debt was converted into equity, the bank does not need to book the difference as a loss during the 18-month period.

SDR essentially gives a bank (actually to the consortium of banks to whom the money is owed by the corporate, and which is referred to as joint lenders' forum) a period of 18 months to look for a buyer for the company which they have taken over.

The question is will it allow banks to recover the loans that they have given to corporates and which are now in a risky territory? As the Credit Suisse analysts point out: "There has been a significant pick-up in activities under the SDR route over the past few months, with the banks invoking SDR in case of nine accounts with debt of ~Rs57,000 crore (~1% of system loans,). Majority of these accounts have been restructured earlier and have failed to achieve the targets set during the restructuring. Also, with their restructuring moratoriums now ending many would have been on the verge of turning non-performing assets."

What does this mean? It means banks have tried rescuing the loans they had given to corporates by restructuring them in the past. And they have failed at it. Now these restructured loans are being put through strategic debt restructuring and being converted into equity. If the option of strategic debt restructuring wasn't available to banks, they would have had to possibly recognise these loans as bad loans.

The Religaire analysts estimate that banks will "end up refinancing 30-40 ailing accounts under the scheme in the next one year, thus postponing non-performing assets [bad loans] recognition of Rs 1.5 lakh crore."

The other option before banks is to sell these loans to asset restructuring companies for a loss, and then account for that loss over a period of two years. But given that they have the option of postponing any losses through the SDR route, they are more likely to take that route.

What is also interesting is that banks need to keep the companies in which they have converted their debt into equity through the SDR route, running, until they are able to find buyers for them.

This means that the lending to these companies can't completely stop. Hence, banks will have to provide working capital finance to these companies as well as fresh loans, so that these companies can continue to pay interest on their remaining debt.

As the Religaire analysts write: "It is important for lenders to keep companies under SDR running until they find new buyers. Banks are thus likely to continue funding interest costs and working capital during the 18-month SDR window. This includes meeting guarantees invoked by state governments or developers for delayed project completion. We assume that debt levels (including interest) will rise ~20% during this period."

To conclude, as I keep saying things are not looking good for Indian banks.

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. Vivek is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. The latest book in the trilogy Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System was published in March 2015. The books were bestsellers on Amazon. His writing has also appeared in The Times of India, The Hindu, The Hindu Business Line, Business World, Business Today, India Today, Business Standard, Forbes India, Deccan Chronicle, The Asian Age, Mutual Fund Insight, Wealth Insight, Swarajya, Bangalore Mirror among others.

Disclaimer: The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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5 Responses to "In 2016, banks will continue to kick the bad loans can down the road"

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narayanasamy

Jan 7, 2016

As one who had worked for four decades, I believe I am best qualified to offer comments on the subject. The simple rule to be followed before offering a loan either a retail or big ticket you hav to examine the rule of 3Cs. That is CHARACTER, CAPACITY and CREDIBILITY. Of course this shd be examined mediculously without any affinity or loyalty to the customer. Adequate collaterals duly examined physically and valued impassioned with right documents should be obtained.it is always better to concentrate more on retail sector but don't neglect the big ticket also. You should have a judicious mix of both to prosper. Tku.

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