Selling stressed bank loans

Livemint reports that Stanchart's efforts to off-load $1.5 bn in stressed loans has found few takers, even with attractive haircuts. The only interested buyer, SSG Capital, is apparently offering to buy the stressed loans with a haircut of only 30%. This, as per the World Bank's latest Doing Business Survey, would be far higher than the country's average haircut of 74.3% and comparable to the OECD's average of 28.1%.

But, despite the very attractive valuation, Stanchart is apparently in no hurry to sell the asset. Livemint quotes an insider, 

The current process is aimed at arriving at a valuation. Depending on the valuation they receive, they will assess whether they can recover more internally. The bank has already taken full provisions on these loans. They are not in a hurry to get rid of these.

There have been several news reports in recent days of intense activity in the buyout market with the arrival of major global LBO firms. But there have been very few actual transactions. In 2015-16, just 15% of the total of Rs 1.1 trillion assets put for sale were actually sold. It is widely accepted that public sector banks are naturally averse to taking haircuts for fear of subsequent vigilance and other proceedings. But the apparent reluctance of the likes of Stanchart to sell their bad assets, even at very attractive valuations, may point to deeper challenges in off-loading bad assets. 

One possible reason could be that banks, public and private, are encouraged by the prevailing incentive structures to retain the loans as long as possible in the hope of recovering as much as possible or even in the belief that the asset would repair with time. Consider the pervasive practice of banks floating Asset Reconstruction Companies (ARCs) and selling their bad assets to these entities in what has been described as "right-pocket, left-pocket" transactions. Similarly, the provisioning rules too may be encouraging banks to hold out for as long as possible. 

The Government have, including in the Union Budget 2016-17, taken several steps to allow majority foreign ownership of ARCs, even 100% ownership by sponsoring entity, 100% FDI on automatic route, complete pass-through of income tax on securitization trusts to their investors, and permit non-institutional investors to invest in securitization receipts (SRs). But they may not be enough to overcome more deep-rooted structural factors. 

While the RBI has been constantly taking action to mitigate the incentive distortions from such practices, it has refrained from imposing a clean break between the bank and ARC, if at least for certain categories of loans. Unfortunately, such incrementalism is unlikely to yield the desired results. Neither do the sponsoring banks, and their subsidiary ARCs, have the competence to effectively restore the asset, nor will the ownership structure allow their respective managements to take the hard decisions necessary to achieve the objective. More disturbingly, this may also be discouraging genuine sales of assets and the emergence of a vibrant market in stressed assets. 

In fact, we may only be kicking the can down the road, with the attendant risk of having to pay a much higher cost when the sale eventually materializes, as it must in most cases. In the circumstances, a prudent strategy may be to limit such conflicts of interest and cut the umbilical cord between the asset selling banks and asset purchasing ARCs, at least for certain categories of bad assets, and allowing for structured transactions which claw back a share of windfall gains, in any, in the future.