Saturday, February 20, 2016

Resolving bad loans and reconstructing assets

I had blogged earlier that addressing India's banking crisis would require both resolving bad loans and reconstructing assets. And both would have to be complemented with devolving complete operational autonomy and massive recapitalization. 

The first step would be to classify stressed assets into completed infrastructure projects, ongoing projects, and all remaining retail, credit card, and commercial loans. In the case of the last category, equity holders should be stripped and assets auctioned off to private Asset Reconstruction Companies (ARCs). 

As regards completed infrastructure projects, where it is possible to monetize the revenue stream, the current Strategic Debt Restructuring (SDR) may be the best course of action. But banks ability to dispose-off these assets remains questionable. An alternative, therefore, may be to auction them off to ARCs, stripping equity holders and with haircuts on banks, with a cascaded and backend clawback of some share of future revenues to the banks and equity holders. This could avoid the political backlash likely in case the asset generates windfall revenues once the economy recovers. 

Finally, ongoing projects would need financial reconstruction. A vast majority of them are likely to be commercially viable once completed, but may require further equity infusion. Further, the construction risks associated with them make them less attractive for long-term investors like infrastructure debt and equity funds. And, in any case, such risks are best borne by the government. In the circumstances, a preferable strategy would be to value them and sell off to a public entity like the IIFCL. The IIFCL, by itself or through the newly created National Infrastructure and Investment Fund (NIIF), can raise three or four dedicated infrastructure debt funds, leveraging long-term foreign patient capital, to finance these purchases. These funds, with professional project management units, should manage the completion of these projects. The financing patterns can even be restructured once the construction is completed. A distinction may have to be made between public good assets like roads and private assets like power and steel plants, in terms of the extent of public financing. 

All this would have to be done quickly and simultaneously. The entire process may be concurrently audited and all requisite clearances taken to pre-empt post-facto audit and vigilance objections. As aforementioned, it would have to go with clearly defined operational autonomy as well as an equally clear recapitalization schedule. The operational autonomy would have to include eschewing the urge to saddle banks with various social obligations without sufficiently compensating them. 

The biggest uncertainty with this approach rests on the supply side. Does India's credit and capital markets have the capacity to absorb such scale of transactions? Will there be enough buyers for these assets? The gross NPAs are estimated to reach Rs 5.5 trillion by end-March 2016, and maybe double that by including all the other badly stressed assets. To put that in context, the total incremental non-food bank credit in 2014-15 was Rs 5.46 trillion, new bond and equity issuances Rs 0.17 trillion, new PSU bond issuance Rs 0.38 trillion, net CP issuance Rs 0.87 trillion, and all disbursements by public financial institutions Rs 1.03 trillion.

Update 1 (22.02.2016)

Links to articles that explain how an ARC works, problems faced by ARCs, more on problems, high ARC asset acquisition costs and banks' risk aversionsystemic problems, and disturbing relationships between bankers, promoters and ARCs.

Update 2 (26.02.2016)

Corruption is never far away with such deals. Livemint reports of a circular by the RBI on,
... fears that promoters of companies acquired by banks after they failed to repay loans may be using shell entities, in India and elsewhere, to buy back these assets at much lower prices... If that is the case, it would also allow unaccounted-for or black money stashed by Indian businessmen overseas to come back into India.
And on the progress with the Strategic Debt Restructuring (SDR) scheme,
Since June 2015, when SDR rules were introduced, lenders have converted debt to equity in a number of firms including Electrosteel Steels Ltd, Ankit Metal and Power Ltd, Rohit Ferro-Tech Ltd, IVRCL Ltd, Gammon India Ltd, Monnet Ispat and Energy Ltd, VISA Steel Ltd, Lanco Teesta Hydro Power Pvt. Ltd, Jyoti Structures Ltd and Alok Industries Ltd. Of these, the only known case where lenders are closing in on a sale is Electrosteel Steels.

1 comment:

Unknown said...

Economist Nitin Desai had a different classification where he said action should be taken based on the sector since external economy is also a reason for inviability of the some projects. In those sectors where unviability of projects is due to external environment, appropriate policy intervention by centre is needed.In other cases involving bad biz decisions and malfeasance appropriate actions is needed. I think if the delayed projects are found to involve some irregularities due to collusion of promoters of project and bankers, they must be punished.