NPA resolution: Banks go for all-cash sale of stressed assets

Updated: December 5, 2018 6:54 AM

In most cases, banks simply want to get out of the mess and avoid long litigation, say experts.

Prior to the central bank’s July 2014 circular, the 5:95 structure required payment of only 5% of the net value of the asset upfront.

By Mitali Salian  

Delay in litigation aside, fear of poor redemption of security receipts (SRs) have prompted banks to increasingly insist on all-cash deals on recent sales of stressed assets to asset reconstruction companies (ARCs), sometimes despite substantial haircuts.

A senior official at one of the country’s large state-owned banks said, “The decision on whether to settle for upfront cash or a mix of cash and security receipts is taken on a case-by-case basis. In most cases, banks simply want to get out of the mess and avoid long litigation. Another factor is the poor redemption record. Sometimes it makes better sense to take the money now, when there is still some value in the asset than wait to see whether there is a satisfactory resolution.”

The above remains true of several public sector banks in spite of cases such as Binani Cement, among the few so far from the Reserve Bank of India’s first list of stressed assets to have seen succesful resolution, where SR holders have reported a return of over 100%.

VG Kannan, CEO of Indian Banks’ Association and former State Bank of India official, said, “Despite the chance of better valuation of a stressed asset, there is no incentive for banks to sell under the 15:85 structure given the higher provisioning requirements. Also, the redemption record has not been very great so far. It is preferable for banks to sell NPAs, even if at a discount and take them off the books completely. This also helps bring down the NPA ratio.”
As per regulations issued in 2014, a reconstruction company purchases a stressed asset from a lender under the 15:85 structure, where 15% of the net value of the asset is paid for upfront while SRs are issued for the balance. These SRs can then be redeemed over five to eight years, depending on the pace of resolution of the bad loan.

An ex-banker from a public sector bank pointed out that, assuming there is no recovery at the end of the designated period, banks would have to write the SRs off and make full provisions for the same while in case of ARCs, even in a 15:85 structure, the loss would be limited to the 15% disbursed as cash.
According to the RBI’s 2016 guidelines, if a bank continues to hold over 10% of SRs backed by its sold assets and issued under securitisation, it is subject to provisioning norms as per extant asset classification and provisioning norms, and the book value of the instruments is to be treated as corresponding to the stressed loans, assuming these had remained, without recovery of principal, on the bank’s books.

A senior official at a large ARC said, “It would be unfair to look at redemption data in the past given that an ARC’s role was limited to being an agency of the bank holding bad assets. One look at the resolution in recent IBC cases is evidence of the excellent redemption record.”
The 15:85 norm also poses other complications, such as disagreements between bankers and reconstruction companies over valuations given that ARCs are required to make a higher initial cash payment, leading to demands for larger discounts on value of the stressed asset.
Prior to the central bank’s July 2014 circular, the 5:95 structure required payment of only 5% of the net value of the asset upfront.

Data on redemptions on a case-by-case basis is not readily available.
Absence of a secondary market for SRs has also led to poor response to the instruments. According to data available in RBI’s annual report on ‘Trend and Progress of Banking in India for 2016-17’, seller banks have had to subscribe to over 80% of the total SRs issued.

According to Vivek Iyer and Rajeev Khare of PwC, the poor performance of ARCs in resolving stressed loan situations in the past has played heavily on the minds of banks and has affected the industry in two ways — the overall deals between ARCs and banks have reduced considerably and more banks have started preferring cash sale to SRs. In view of this, the option of exit through the sale of stressed loans to ARCs has been underutilised.

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