Will new discom package mean higher provisioning for banks?

Shares of public sector banks and power generation companies have been running up in the past week on hopes that the cabinet is close to agreeing on a package to clean up the losses of State Electricity Boards (SEBs) or power discoms as they are now called. But the financial restructuring plan has a lot of copnditions for both the discoms as well as state governments. The main features of this package are:

* A total of 50% of the loans of SEBs will be taken over by the state governments through the issue of bonds
* That balance 50% will be rescheduled and underwritten by state governments
* This will allow banks to give more loans to discoms
* The Centre will provide some cash incentives to well-behaved discoms.
* State governments must agree to conditions such as paying their subsidies for instance for a free power on agriculture on time to the discoms and discoms have to adhere to conditions that fuel costs are automatically passed through in the form of higher tariffs.

Ten years ago a package was given and thereafter in 10 years those entities have slipped into huge losses. In a discussion on CNBC-TV18, Central Bank CMD MV Tanksale and CRISIL director Pawan Agarwal hope that bankers are going to be more diligent and won't allow standards to slip.

Below is the edited transcript of the discussion:

Q: I have put in the broad outlines of this package but I just want to know does this package only comprise short-term loans, you will still be exposed to the SEBs in the form of long-term loans. Is it not a part of this?

Tanksale: Essentially the short-term loans are used for the opex purposes and the long-term loans were taken for the capex purposes. Now long-term loans in any case are to be serviced over the period of time. (For example) infrastructure has a repayment period ranging between 7 and 10 years. Thus none of us probably had any issue with the long-term payment. The issue was with the short-term where things were crystallizing; if they were not serviced then it would become non-performing asset. If the short-term loans are taken up by the state governments, the issues will get addressed.

Q: Let me come to the proposal in the package itself — if 50% is taken over by the state governments, that obviously opens up some more exposure limits to these companies. But the remaining 50% will be restructured, will be made into some kind of ten-year loans with a three year moratorium underwritten by the state government. Will it not tantamount to restructured loans? In that case you have to make a 2 percent or maybe under the new rules even higher provisioning. So if the package comes you have higher provisioning?

Tanksale: It will definitely amount to restructuring and we will have to provide two percent as per the old prudential norms and if the five percent is implemented, even that will happen. That goes without saying, it will be called restructuring unless the special dispensation is sought or is considered by Reserve Bank of India (RBI).

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Q: This will also open up more – part of the package is that you have to give more loans to the state electricity board, to the discom companies, so your exposure basically could even increase to the sector?

Tanksale: No, let me tell you there is absolutely no commitment that the bonds will have to be subscribed by the bankers but supposing if these bonds are given, then every bank has got their treasury portfolio where they have to create the SLR portfolio of the government bonds. And that could be one of the choice. But unless the SLR status is available, I do not think that the bankers will find it easy to get into those kind of exposures. And other thing is once it is restructured, then the banks' exposure will get contained only to the extent of the working capital requirement of the discoms.

In any case all these discoms need a huge working capital for atleast three-four months receivables.

Q: You have an idea now as to the provisioning that the bankers will have to make and in some cases even operational losses will have to be funded for the four states that are in trouble. For example,  Tamil Nadu and Uttar Pradesh even operational losses will have to be funded for three years. Once this package goes through, will your rating on banks improve or will you see a decrease in the rating that you can give them?

Agarwal: Specifically if you look at power sector since last one year we have been talking about the expectation that reforms are critical for lender’s exposure in this sector to remain viable. What we are seeing is essentially steps being taken towards making sure that this sector remains viable in the longer-term.

We believe that the support in form of this debt restructuring package is clearly articulation of what we have always believed that central government and state government will come together. And as a result the asset quality is not something that, specifically for the SPUs, is something that we believe will slip into NPAs.

At the same time, there is obviously an impact on the profitability that is likely to happen. One on account of clearly the provisioning requirement that will be there for restructuring. So assume that there is one lakh crore of restructuring that happens, about Rs 2,000 crore would be the cumulative impact that the banks are likely to take.

The second element is also relating to – and that is also as per the prudential guidelines on restructuring, which is the NPV impact of what this restructuring is likely to be. If the 50% of the exposure is converted into state bonds as is the proposal today, it is likely that there will be an NPV loss primarily because the interest rate on state government bonds will be lower than the rate that the banks are today charging to the state power utility. Obviously that would lead to some amount of NPV loss. If that has to be provided that has to be an additional amount beyond the restructuring; unless RBI provides amount of forbearance on this specific aspect.

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Q: Given what you have said at the moment, there is no reason for a stock market investor in bank shares to rejoice. If anything there will be a little bit of trimming of profits?

Agarwal: In the near-term that is what is likely to be the impact. However, I think the larger impact is going to be the support on the asset quality front and one of the issues around whether this portfolio of banks will perform or not? I think all those issues are therefore likely to be put to rest.

Q: There are a lot of conditions that the financial restructuring plan has for both the discoms as well as state governments. For instance, the discoms will have to ensure that the higher fuel cost is automatically passed on. They will also have to file with the State Electricity Regulatory Commissions (SERCs) their cost of the previous year on April 30 so that for the following year the higher tariffs are passed by the regulatory commissions. How much can you ensure all this actually happens? We know that 10 years ago a package was given and thereafter in 10 years those entities have again slipped into huge losses. How will you ensure? You will have paid up the money upfront and if they don’t behave you really don’t have a choice, do you?

Tanksale: Regarding what Pawan has said about the restructuring and the provisioning requirement, I would like to put the things in perspective. A couple of discoms already have been restructured where the NPVs have been protected. There is no loss that banks are carrying on their books. We are only waiting for the manner in which the short-term loans will be hived off from the books of the discoms. Once the decision comes from the cabinet, how exactly the investment come into bonds will be definitely one of the questions but as I have said in the beginning, there is no quid pro quo that the banks will have to convert their short-term loans into bonds at a lesser rate of interest. Much will depend on what kind of status those bonds have.

As regards your point on how to ensure that 10 years or 5 years down the line the discoms will be in a position to manage, (I believe) enough lessons have been learnt from the past and each discoms have really created their cash flows in such a way that when they go the Tariff Commission they have to come out very clearly that this tariff is going to take care of their purchase cost as well as the opex. If at all there are any deficits then there has to be definite commitment coming from the state government to make good the deficit if at all the power is to be sold at a subsidized rate. I have seen in last six months that the state governments are honouring and given that situation, I somehow want to believe that going forward probably we will not repeat the mistake. Now every stakeholder is very, very cautious that the discoms by itself should image as the viable entities.

Q: States like Tamil Nadu, Rajasthan, Haryana and all have really a huge problem as the report itself suggests. Do you think the states have enough headroom fiscally to takeover such a responsibility? Do you think that most of the states will be on-board or will this be a piecemeal or a part implementation with some states unable to find either the political will or the financial resources to be able to participate in the package?

Agarwal: On the ground, we are seeing commitment of states towards reforms. If you look at the seven states that are most likely to be a part of this restructuring, all except one have seen tariff increases for this year already implemented. This is also important to know that out of these seven, five of them for second successive year have increased their tariffs. For the one remaining state, where we have seen tariffs not increased for a while, the tariff has already been filed with the regulator. Once the regulatory process is completed, it is expected that the tariffs will increase. So that is clearly one positive step that clearly demonstrates the intent of the government and the regulatory process to make sure that this discipline is there.