NPA woes: Vultures circle India Inc; shotgun marriages seen

Last week, Henry Kravis, co-founder of private equity major Kohlberg Kravis Roberts (KKR) was in India. He minced no words in saying that the corporate sector’s present misery was a blessing for funds like KKR.

“Market dislocations like the one we see here now makes me the happiest. I am more excited than ever before about the potential here,” he was quoted as saying in The Times of India.

Funds that specialise in stressed assets buy them at a deep discount, infuse capital into them, turn them around and sell them off for a profit. They either negotiate directly with the company in distress or through the banks which have loaned them money and are keen to recover it.

And, according to banking industry sources, KKR is not the only one sniffing around for bargains. Another stressed asset specialist firm based out of Singapore, with strong political backing in India, is said to be knocking at the doors of leading state-owned banks, seeking details of their loan books for potential targets that can be bought for a song. The idea in this particular case is to get banks to armtwist the promoters into a settlement that works to the advantage of the buyer.

For banks too, matters have reached a point where they can no longer push the dirt under the carpet and pretend that their books are in decent shape. For too long, banks were reluctant to own up to the true extent of non-performing assets on their books as it meant having to set aside more capital (provisions) for the bad loans. Often banks have made fresh loans to help borrowers pay interest on the old loans so as not to classify them as non-performing assets.

But that leeway may no longer be available to banks with the RBI tightening provisioning rules for restructured loans and also laying down detailed rules for identifying stress in the loan book early on.

According to a Credit Suisse report, which analysed the debt of 3,700 companies, 82 percent of the debt was with companies which had an interest cover (IC) ratio of less than 1 for at least four quarters in the last two years. Interest cover ratio, defined as operating profits divided by interest expense, is a measure of the ease with which a company can repay its loan. Lower the IC for an extended period, higher is the probability of the loan going bad.

Nearly three-fourths of all stressed loans in the banking system are estimated to be on the books of state-owned companies. Which means they will need huge doses of capital infusion to tide over the problem.

But help from the government is not forthcoming. In the Interim Budget, Finance Minister P Chidambaram allocated only Rs 11,200 crore towards recapitalisation of state-owned banks. But that is far from adequate, according to rating agency Moody’s, which estimates that the government needs to provide at least Rs 25,000-36,000 crore for recapitalisation.

In his press conference after the Budget, Chidambaram said the lower allocation for PSU bank recapitalisation was a signal to the banks that they should generate the required capital out of their own profits. But with higher provisions towards bad loans eroding profits, that is not really an option for most banks.

Offering shares to institutional investors is another way of raising capital. But as the tepid response to SBI’s recent share issue showed, foreign investors are wary of putting money in state-owned banks because of concerns over bad loans. The bank had priced its share offering in the range of Rs 1,565-1,596, and the issue went through mainly with support from LIC and other state-owned banks.

To add insult to injury, brokerage house Morgan Stanley cut its price target for SBI a few days back to Rs 1,150, saying that weak balance-sheet and low profitability indicated more equity dilution in the days ahead.

Recapitalising state-owned banks will be a big headache for any government that comes to power after the upcoming Lok Sabha polls. It is another matter that political interference is one of the main reasons for the bad loan problem to have ballooned to the current extent.

According to Saurabh Mukherjea of Ambit Capital, for a sustainable economic recovery, the mess in the banking system will have to be cleaned first.

He sees two ways in which the next government may try to address the issue.

One would be to create a “bad bank” (like the Americans did with the Toxic Assets Restructuring Programme after the sub-prime crisis) which will buy stressed assets from banks at a nominal discount to book value. The taxpayer would foot the bill for the sub-standard assets, which would then be off the balance-sheets of banks.

The second would be to allow banks to settle with owners of stressed assets for a lower repayment, which would then help speed up sale of the assets to new buyers.

Last month, the RBI put in place a framework for “early recognition of financial distress, prompt steps for resolution and fair recovery.” The rules will be effective from April this year.

Clearly, the guidelines give enough ammunition for banks to turn the screws on errant borrowers if they so choose to.

Check these out (from the RBI document):

- If the existing promoters are not in a position to bring in additional money or take any measures to regularise the account, the possibility of getting some other equity/strategic investors to the company may be explored by the joint lender forum in consultation with the borrower.

- To discourage borrowers/defaulters from being unreasonable and non-cooperative with lenders in recovery efforts, banks may classify such borrowers as non-cooperative borrowers after giving them due notice.

- More expensive future borrowing for borrowers who do not cooperate with lenders in resolution

- In case of loan restructuring, commitment from promoters for extending their personal guarantees along with their net worth statement supported by copies of legal titles to assets may be obtained.

- (In loan restructuring), possibility of transferring equity of the company by promoters to the lenders, transfer of the promoters’ holdings to a security trustee or an escrow arrangement till turnaround of company. This will enable a change in management control, should lenders favour it.

- Banks are generally not allowed to finance acquisition of promoters’ stake in Indian companies. The RBI would allow banks to extend finance to ‘specialised’ entities put together for acquisition of troubled companies.

- An NPA in the books of a bank is eligible for sale to other banks only if it has remained as NPA for at least two years in the books of the selling bank. The Reserve Bank will withdraw this minimum holding period for any initial loan sale.

Yet, all the rules cannot still lift the banking sector out of the quagmire unless it is backed by political will. After all, bank bosses owe their jobs to the finance ministry more than the RBI. And thanks to legal loopholes and absence of political outrage, it is very much possible for a promoter to default on loans and then shell out an exorbitant sum to a buy a cricketer for his T20 team.