Risky for banks if bonds replace SEB loans: Narang

The government is planning a restructuring and is likely to replace loans to State Electricity Boards (SEB) with bonds, probably with state government guarantees. Under similar circumstances in 2002, these loans were replaced with state government bonds, not SEB bonds. The bonds got Statutory Liquidity Ratio (SLR) status but, this time around, it is very clear that the RBI will not admit SLR status to these bonds. This is likely to have an impact on the banks.

In an interview with CNBC-TV18, B D Narang, former Chairman of Oriental Bank of Commerce said that the bonds are basically being used to restructure the loans granted to the SEBs or the successor subsidiaries.
According to Narang, "Bonds can be a success only if they are rated, they are listed and they are transparently marketed. There can be a great success if there is a public participation in the subscription of the bonds. Only then, we can say the default risk can be eliminated otherwise there is no recourse to a default risk."
The chances of incurring losses by banks is higher if the loans are replaced by bonds, believes Narang. He explains, "If tomorrow the principal doesn't come, it will have to be categorized as a lost asset and the entire amount will have to be provided for." Below is the edited transcript of the interview on CNBC-TV18. Also watch the accompanying video.
 
Q: What is the difference if the loans were replaced by SEB bonds with government guarantee, state government guarantee or if they were replaced with state government bonds? What will be the impact on banks?
A: Let's understand and put things in perspective. Why bonds? Essentially, it is a restructuring of the loans granted to State Electricity Boards or the successor subsidiaries. These subsidiaries have an issue per se. It means that they were carved out of the State Electricity Board. Now they are carrying a loan of about Rs 120 thousand crore plus accommodated losses, totaling to about Rs 300 thousand crore. These loans are getting bad and the banks are being asked to restructure.
Now comes the question why not restructure? Yes when they are restructured, banks with a view to protect the net present value (NPV) will lack the coupon rate (1.56) to go up. If it goes up, the cost of borrowing to the state electricity companies will go up and they are already into losses.
Is there a way to recoup those losses? That means they have to increase the prices to the consumers because coal prices, fuel prices are going up, cost of buying electricity is going up. But are they able to pass on the prices to the consumer? No.
Second part was transmission losses. There are 35% transmission losses. Have they come down? No. That means, essentially the health of the electricity companies remains the same as it was.
Now you are trying to replace them with the bonds which would be guaranteed by the state government. As it is, the loans to the Electricity Board are guaranteed by the state government. The only relief could be that they will be able to bring down the pricing on the coupon rates, bonds.
For example, if the 10 year bond is now being priced at about 8.15% guild and securities, the bond could be priced at say 9.50 or 10%. Essentially, it brings down the cost of borrowing by the SEB by 2-3%.
Will the bank like it? There are a lot of yes and no for the banks. When the loan goes bad, first it is classified as substandard where it is placed for a year or so. Then it goes to doubtful and then it goes to loss asset. That means there is a gap of 2-3 years when the banks can recoup the situation.
What happens if it becomes a bond? First it will have to be priced mark to market. It is not SLR, it will have to be a non-SLR security. Is there any exit option for the banks? Yes there is. But who is the buyer? The only buyer could be provident funds or the insurance sector. They like to invest money in a higher yield dated securities.
That means there is an exit security but the bonds can be a success only if they are rated, they are listed and they are fairly transparently marketed. There can be a great success if there is a public participation in the subscription of the bonds. Only then, we can say the default risk can be eliminated. Otherwise, there is no recourse to a default risk. Last time also when we used to subscribe to the SEB very frequently, there was a serious default there. Q: Are you therefore saying that there may not be buyers for these bonds from the banks' hands and therefore, they will have to mark to market and their losses will be more severe than it will be if they were loans?
A: Exactly. For example, if tomorrow the principal doesn't come it will have to be categorized as a lost asset and the entire amount will have to be provided for. Q: In your experience, do the state governments pay - they are supposed to come with the state government guarantee. Have the state governments in the past paid up?
A: During my entire tenure of 35-40 years with the banking sector, I could never invoke successfully state government guarantee of any state, from any part of the country.