NARCL: Bad Bank May Not Move The Needle Much
The National Asset Reconstruction Company, which will be backed by Rs 30,600 crore in government guarantees, will help remove legacy stress from the balance sheet of banks, said brokerages after the cabinet cleared the structure of India’s version of a bad bank.
It could also help unburden public sector banks, allowing them to grow. But the immediate benefit will be limited as the assets being transferred are mostly provided for.
Here is what analysts are saying...
NARCL would act as an entity that will buy stressed assets at their net book value, thereby removing the contentious issue of price discovery.
It will aggregate the debt and will have a steadfast focus on resolutions backed by dedicated legal/operational infrastructure.
The buyer will also find it easy to deal with one unified ARC rather than dealing with multiple lenders, improving the chances of resolution. However, slower IBC resolutions remains a concern.
The planned transfer of 1.9% of systemic loans will further reduce gross non-performing assets of public sector banks (currently down to 9.5%), but the reduction in net NPA will be limited to the extent of un-provided exposure.
The net realisation/recovery rate is expected to be about 18%, of which 15% will be paid upfront in cash and the balance via security receipts backed by sovereign guarantee.
Since most of these NPAs are fully provided for, cash recovery (about Rs 5,400 crore) will boost the profitability of PSBs.
Security receipts will be typically booked at a nominal value of say Re 1 and gains/loss will be booked on redemption. However, after the extinguishment of government guarantee (after five years), banks will have to bear the loss on the un-redeemed security receipts.
The government’s guarantee of Rs 30,600 crore (15% of pool) for five years only aims to keep security receipts as capital neutral.
Key benefit is aggregation of debt and talent to speed-up resolution.
Banks generally recover 10% from written-off loans, and we see similar recoveries here.
While the Reserve Bank of India will detail the accounting treatment of the security receipts, Jefferies said banks should be conservative. The brokerage house detailed a possible accounting mechanism:
In an example of loan of Rs 1,000 of loan that was written-off by bank:
The book value of asset in bank’s balance sheet is zero.
If the bad-bank determines the value at 20% or Rs 200, then bad bank will have to pay 15% or Rs 30 (or 3% of original loan value) upfront.
This will be paid in cash by bad bank, which may source funds from banks themselves as equity.
From accounting perspective, banks will report Rs 30 as profit from recoveries of write-off of loans that gets added to net worth.
On asset side, its a cash-neutral transaction with rise in investment as equity in bad bank.
For the balance 85%, bad bank will issue securitisation receipts which will be partly guaranteed by government and partly non-guaranteed.
For the guaranteed part, banks will recognise the value as investment but that will not require any capital for five years as there is a government. For non-guaranteed part, banks might not recognise value until actual recovery is made.
Most of the assets being transferred are from the first and second lists of companies, where RBI had directed insolvency proceedings. Chances of material recovery from these assets seems bleak.
There is a case made for capital release once these assets are transferred. However, according to Basel-III guidelines, the risk weight for unsecured bad loans is adjusted for the specific provisions. For secured bad loans, it is adjusted for collateral held by the bank.
Much of this data is not publicly available but we believe capital release will likely not be meaningful.
Optically, though, the net interest margins may look better as non-performing assets will go out of the denominator.
The bad bank is fully owned by banks themselves. The idea is to first put Rs 5,000-6,000 crore capital in the NARCL which will buy bad loans from the banks.
Effectively, this means, banks can book capital infused (as they are the owners of bad bank) as profit once the sale happens (as they are also the sellers of bad loans), which we believe is egregious.
Since, these loans are being carried at zero value on the books, when they sell to NARCL, how will price discovery happen? RBI, in our view, could have objections to this model as a transparent price discovery is not happening.
Most of these assets are already part of NCLT and are in various stages of resolution. We are unable to understand how NARCL can further improve resolution of these assets.
The step is good in intent as it brings about aggregation of bad loans, management by professionals and speeds up the decision making process.
As of now it seems to us the concept initiated is a little too late and initial recovery rates are estimated to be too low.
Impact on net NPAs is likely to be low as these are highly provided for loans. Release of capital will be to the extent of net NPA reduction.
State Bank of India, Punjab National Bank, Bank of India and Union Bank could be the bigger beneficiaries.