Bad Bank SR to be govt guaranteed

Bad Bank SR: Government Guaranteed

Recent News: Union Government has approved setting up of a sovereign guarantee (SG), limit not exceeding Rs.30,600 cr., for National Asset Reconstruction Co. Ltd.(NARCL) to acquire stressed loans from public sector banks (PSBs). In this regard, NARCL will acquire the stressed assets at an agreed valuation, modalities yet to be spelt out, through upfront cash payment and issue of security receipts (SRs).  The SRs, which will be subscribed by investors including selling banks, will be backed by the SG and can be invoked by NARCL to meet shortfall, if any, between the face value of SR and actual realisation of the relevant stressed assets assigned in its favour. Salient features include (i) the guarantee is valid for five years (ii) resolution or liquidation of the stressed asset concerned will be a ‘condition precedent’ for invocation of the SG and (iii) the guarantee fee should be paid by NARCL periodically to keep the SG in force. 

Background: Hon'ble FM Smt. Nirmala Seetharaman announced in her budget speech that a new Asset Reconstruction Company (NARCL) and Asset Management Company (IDRCL) will acquire and manage existing stressed assets of Public Sector Banks (PSBs), aggregating up to RS. 2 lac cr. NPAs with aggregate outstanding in excess of RS.500 cr. to the banking system, where at least 85-90% provision is already made in the banks’ books, will be identified for take-over by  NARCL. As per newspaper reports, 22 stressed assets totalling Rs. 82500 cr. have been identified, so far. While NARCL will acquire the stressed assets, management and sale thereof through resolution will be entrusted to IDRCL.  Canara Bank is likely to have an equity participation of 12% and all PSBs put together will hold 51% of the infused capital. The new ARC is expected to have a capital fund of Rs.6000 cr., initially.

Implications of SG from the government: 

Present position: When stressed assets are sold to ARCs, the successful bidder gets the stressed assets assigned in his favour through cash payment and SRs.  Cash payment is accounted as recovery, which is adjusted to reduce the loan outstanding and the remaining taken to P&L a/c, depending on the net outstanding in the bank's books. However SRs carried on as investments, in the books of the selling bank to the extent of subscription by the latter, are treated as recovery, when it is realised into cash. At that point of time only, the lender is permitted to reverse the excess provision held in respect of this asset. RBI also introduced progressive provisioning, as applicable to the underlying stressed asset, on the SR if the investment in the SR is in excess of 10% all SRs backed by its sold assets. 

Change in present position: With the SG now available on SRs, the above position is likely to change to the advantage of the banks, which sell the assets.

1. Since government guarantee is available on the SR to be issued, NARCL will be able to rope in other eligible investors, instead of the selling bank subscribing to it fully.  To the extent of subscription by other investors in the SR, the selling bank can treat it as a cash recovery and reverse excess provisions as well. Hence cash recovery may go up beyond 15% of the bid amount in the year of sale to NARCL.

2. Even if NARCL is unable to get new investors when the asset is sold, since the SR is tradable, it can be sold at a premium or discount (depending on the recovery prospects and value of the underlying asset) later on. The selling bank will be able to account the cash received, on its 'SR investment',  as recovery and also reverse the excess provisions to P&L a/c much earlier than is the case now.

3. In the worst case scenario, where the SR continues in the books of the selling bank, there may not be any need to make any provisions on the SR, as SG is available for the full amount.

Shortfall Risks:

·        Market has already discounted the realisation percentage: If the newspaper articles about the proposed SG are any indication, the market has already discounted the recovery amount on the stressed assets to be transferred to NARCL to the total value of cash payment and SG available on SRs. Their assumptions are based as under: 

i. Total stressed assets to be taken over :Rs. 2 lac cr. 

ii. SG available for SRs to be issued: Rs.30600 cr.

iii. Assuming that SR to be issued will be backed by 100% SG and will be at 85% of agreed value, the cash component works out to Rs.5400 cr. (30600/85*15=5400)

iv. Based on (3) above, NARCL is expected to take over RS. 2 lac cr. assets at Rs.36000 cr. (30600+5400=36000)

v. The bid amount of NARCL to acquire the stressed assets works out to 18% and is treated as recovery amount.

·        Major ARCs/Big Venture Funds (VFs) may bid aggressively: Unless the assigned stressed asset has explicit (opposite to intrinsic)value, major ARCs or VFs or big corporate houses may bid aggressively to take over the stressed assets in and around the value of SRs and the benefit of lower realisation will not be to the advantage of NARCL

·        Selling banks may be keen to exit, if they invest in the SR of the asset concerned:  If the selling banks had to invest in the SRs at the time of sale to NARCL, they may evince interest to exit the investments at the earliest, as SG is available to cover the shortfall in realisation. They may not play a major role in maximising recovery as their hands are otherwise tied with stressed assets still in their books. So, if the economy has to discover a better price for the assets involved, it will be better if NARCL could get other QIBs for investing in SRs.  

·        Guarantee Fee and validity period: NARCL had to pay guarantee fee to keep the SG in force and SR is valid for five years only. Unless the resolution/liquidation takes place within the first three years, there will be cost factor and pressure from SR holders to sell the stressed assets at a discount. The government may be forced to meet the shortfall in order to honour the invocation of SG. In this regard, it is possible that a sizeable number of loans may be relating to incomplete infrastructure projects and the issues requiring resolution may not be finance alone but requisite legal/environment approvals. In such cases, to obtain maximum value, the period of resolution may be longer than five years. So, the government should be flexible to extend the SG on exceptional cases like the ones mentioned above.

Lingering Doubts: When the Bad Bank proposal was announced in the budget, it was welcomed by many, as stressed assets lying in the books of PSBs will move out and the government owned NARCL (Bad Bank) will be able to find better value for the same through resolution/liquidation. Equity Participation by the PSBs at 51% is also a good move, as they being ex-owner/SR holder of the said assets, may be able to help out NARCL in the bid/recovery process. The government announcement that the SRs to be issued by NARCL will have its guarantee, has also gone down well in the market. But there are lingering doubts that whether the move will ultimately end up in making NARCL a parking space for transferring bad loans from PSBs as

Ø  The said banks could not find successful bids for which they have provided more than 85% in their books for so many years.

Ø  Even after six months after the bill is passed, the banks are yet to identify eligible assets in full, giving an impression that the other loans to be transferred might have issues other than finance, which impede transfer.

Ø  Creation of SG for Rs.30,600 cr. for aggregate loan exposures at Rs.2 lac cr. is an implicit admission that the realisable/distress value of assets created out of the bank loans might be less than 25% of total outstanding.

 

Conclusion: Though the above doubts are valid, the intent of the government is good and I would like to remain an optimist. The move will benefit the economy,  if at least 50% of the stressed assets transferred to NARCL are realised through resolution, (and not liquidation), even at the cost of the government guarantee getting invoked to meet the shortfall in realisation.

 

V.Viswanathan                                                                

25^th September 2021.