On September 16, the Union Cabinet approved a government guarantee of up to Rs 30,600 crore for security receipts (SRs) issued by the National Asset Reconstruction Company Ltd (NARCL). The government wants to transfer around Rs 2 lakh crore non-performing assets (NPAs) to the new bad bank, of which Rs 90,000 crore will be transferred in the first phase. According to the details shared by the finance minister at the presser, banks will get 15 percent cash payments of the value of assets being transferred upfront (not the Rs 2 lakh crore) and 85 percent will be given as security receipts (SRs).
What does this mean for banks? Do they really get any money? Let’s try to find out.
To begin with, most of these bad assets are already fully provided, written down accounts on the books of banks. They no longer nurture hopes of any meaningful recovery from these assets.
Coming to the bad bank deal, the most critical part will be how banks arrive at a valuation for the transfer of these assets to NARCL. Even if some mechanism for price discovery is worked out, the value of the assets is unlikely to exceed 10 percent to 20 percent of the assets at the time of transfer.
Take for example the scenario of 20 percent valuation. Banks will get Rs 40,000 crore for Rs 2 lakh crore worth NPAs, of which Rs 6,000 crore (15 percent) will be the upfront cash payment. The remaining Rs 34,000 crore will be given as SRs. Any write back from this portion will solely depend on the recovery in a period of five years, which is the time given by the government for resolution. If the debt resolution doesn’t happen within that five-year period, the government will have to pay banks against the SRs if the guarantee is invoked.
Now, these are really bad assets. Most of these assets are stuck with banks for so long and despite the best efforts of bankers, the resolution hasn’t been achieved. During the presser, Sitharaman said professionals will manage the resolution part. How efficient will be these professionals is something one needs to wait and watch. Only time will tell. Banks, for years, have tried hard for the resolution of a big chunk of corporate bad debt but hasn’t been successful. There are no takers for such assets.
For now, going by the above calculation, banks are getting Rs 6,000 crore in hand upfront. In fact, this is almost equal to the money they are investing in the new NARCL. So, in some sense, banks aren’t really gaining or losing anything as far as the cash component is concerned.
But, of course, one good thing is banks can get rid of these bad assets by transferring to the new bad bank and clean up the book.
NARCL, being a government-supported, banks-backed industry body can negotiate better with banks. Till now, banks have been bargaining hard with asset reconstruction companies individually and needed to get approval from all consortium members. In most cases, the deals fell through because of valuation differences. Banks always asked for a higher price than what ARCs offered. Also, ARCs didn’t have the cash strength to make upfront payments in large deals. This is one reason why gross NPAs remained high in the Indian banking system. Now, with an industry-level ARC in place, the process of transferring the assets has become easier.
The real challenge will be on resolution. Even if the government lines up the best professionals to manage bad assets, the big question will be where are the buyers for these assets? There is very little appetite for the SRs in the market. As Anil Gupta, Vice President & Sector Head - Financial Sector Ratings, ICRA said in a note, the upfront cash payment by NARCL to banks will immediately be accretive for the profitability and capital of the banks. “However, the ability of the NARCL to resolve these assets in a time-bound manner will be critical for future provision writeback by banks. We need to see how NARCL raises this cash of ~40-50 billion to be paid upfront to the banks.”
Banks can attempt to sell down the SRs in the market but again market appetite for such chronic bad assets will be a question. “In a worst-case scenario of low recoveries against the SRs and invocation of GoI guarantee on these SR in the fifth year, the present value of the SRs is unlikely to exceed Rs 150 billion today,” said Gupta.
To cut a long story short, as far as the immediate cash component is concerned, banks aren’t really gaining anything. Yes, they can clean up books but the real gain will hugely depend on the resolution. That is always the trickiest part.
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