Banks painting the NPA town green

The RBI's largesse in the form of the 5/25 scheme might lead to banks trying to evergreen dud loans

Illustration by Kishore Das

On paper, the Indian banking system is supposed to give India Inc a 90-day agni pariksha before labelling companies as non-performing assets (NPAs). But in India, the agni pariksha remains a mythological concept as banks are finding ways around this litmus test, despite the economy still being in the woods. A recent example is Bank of India, whose executive director Sankara Narayanan says the bank has written to the central bank to allow assets that have marginally delayed payments beyond the 90-day mark to be classified as standard assets.

Earlier, media reports had suggested that the bank had written to the central bank regarding strict implementation of the 90-day threshold by its auditors in classifying the bank’s Essar Steel exposure as an NPA. Analysts believe that Indian banks should start taking haircuts on some of the bad loans and provide financing for the companies. Banks, on the contrary, are rushing to refinance assets in stressed sectors via the 5/25 scheme to make sure they don’t fall into the NPA (see: On a slippery terrain) category, thereby, keeping provisioning levels low. 

On a slippery terrain

NPA slippages have shown a sharp increase for leading banks in FY15

The flexible loan restructuring scheme stipulates that loans given to infra and core industries in which the aggregate exposure of all institutional lenders exceeds ₹500 crore can now be repaid over a maximum of 25 years and the banks will refinance the loan every five years.

The repayment at the end of each refinancing period would be structured as a bullet repayment, with it being specified upfront that the loan will be refinanced and that such a bullet repayment should be considered in the asset liability management (ALM) of banks. According to Adarsh Parasrampuria, banking analyst at Nomura, over ₹1 lakh crore of loans have already been refinanced under this scheme. 

Bankers hope that the spreadout repayment burden and option of refinancing will reduce the risk of defaults, thereby easing the provisioning requirement for the banking system as a whole. Data from Ace Equity show that banks comprising the bank Nifty index provided for ₹54,482 crore worth of loans in FY15. Assuming these assets don’t slip into NPAs courtesy the leeway given under the 5/25 framework, the provisioning requirement would be down by ₹11,600 crore. 

According to media reports, GMR Infrastructure, Bhushan Steel, Adani Power, Tata Power, Essar Power, Torrent Power, Jaypee Infratech and Uttam Galva Metallics are a few companies that have sought relief under the 5/25 scheme (see: Saving grace). The scheme’s rising popularity is also because effective FY16, the regulatory forbearance allowed for cases referred to the corporate debt restructuring (CDR) cell has been discontinued. Effective from April 1, 2015, all restructured loans are to be classified as non-performing assets (NPAs), attracting a provisioning of 15% of the loan outstanding as compared with the earlier requirement of 5%.

Saving grace

Over ₹1 lakh crore worth of loans have been refinanced thus far

However, as loans under 5/25 need not be considered as restructured, banks are tapping this option to keep their provisioning requirements down. Although banks have already started refinancing assets, analysts feel the banks should instead take a haircut on the loans extended to certain stressed companies.

“The intention of the RBI behind introducing the 5/25 scheme was to allow banks to correct the ALM gaps that were created. But when you look at the names that are coming in for 5/25 restructuring, you can clearly make out that 70-80% of them are pushing the can down the road rather than correcting the repayment structure,” says Parasrampuria.

Taking the short cut

Bhushan Steel (which has a debt-to-equity ratio of 4.96X) and Adani Power (7.82X) have recently got debt of ₹35,000 crore and ₹5,000 crore, respectively, refinanced via the 5/25 scheme. Though Parasrampuria feels it would be easier for banks to take a haircut on loans, he warns that this won’t be an easy task.

“The problem is that 70-80% of corporate loans are given out by PSU banks. Their capital levels are anyway short on a Basel basis. So, do these guys have enough capital to take write-offs? Most private banks can afford it because their tier 1 levels are pretty high. But PSU banks are running low on capital. So, I think they will have to provide on the way as they go.”

As a result, credit costs for some of these banks will continue to remain elevated for an extended period of time. According to a Nomura report, on their current capital position, 50% of PSUs do not meet FY17 Basel III requirements. These banks include Canara Bank, Corporation Bank, Central Bank, Andhra Bank, Syndicate Bank, Allahabad Bank and Dena Bank, among others. The report adds that 80% of the PSU banks do not meet FY18 Basel III requirements either. Of the 21 state-owned banks surveyed by the Tokyo-based financial services firm, only five (UCO, PNB, SBI, BoB and Indian Bank) meet these requirements. 

Bharat Iyer, JP MorganRajat Bahl, director, Crisil RatingsThe RBI defines potentially stressed accounts under three special mention account categories: SMA 0 (interest payment not overdue for more than 30 days but account showing signs of incipient stress), SMA 1 (interest payment overdue between 31 and 60 days) and SMA 2 (interest payment overdue between 61 and 90 days). However, as SMA accounts are still considered standard accounts, the provisioning would be done at 5%. According to an India Ratings analysis of 30 SMA-1 and SMA-2 assets, Indian banks may need up to ₹1 lakh crore over and above their Basel III capital requirements to manage the concentration risks arising out of their exposure to highly leveraged, large stressed corporates.

The report adds that of this ₹1 lakh crore, public sector banks may need ₹93,000 crore. But given the limited fiscal leeway that the government has, this process will be far from easy. Even if these assets were to achieve their peak levels of capacity utilisation, mentions the report, they will not be able to service the current levels of debt. India Ratings adds that the amount of ₹1 lakh crore is equivalent to 1.7% of the banks’ risk-weighted assets and also represents the loan haircut banks may have to take.

This provisioning is 1.3X the profit Indian banks made in FY15. Ananda Bhoumik, managing director and chief analytical officer at India Ratings, admits that banks are in talks to refinance some of these 30 assets under the 5/25 scheme. However, not all banks agree. “Accepting these bad loans is not a solution. Within the steel and power sector, we are taking a call and restructuring under the scheme wherever possible,” says RD Takkar, executive director, Dena Bank. As of FY15, Dena Bank’s exposure to the iron and steel sector was ₹3,848 crore, while the bank’s exposure to the power sector stood at ₹9,945 crore. 

Market experts feel that 5/25 is largely being used as just another tool to postpone the pain, even though they admit that the scheme is a better way of restructuring loans compared with CDR. Analysts say that under the CDR scheme (see: The CDR Legacy), companies would only get a moratorium and nothing else would change, whereas 5/25 guidelines allow banks to increase the tenure of the loans so that they can match each project’s inflows and outflows.

The CDR legacy

Restructured assets constitute a bigger chunk of overall stressed assets


“About 35-40% of the restructured accounts have eventually defaulted, although our expected range was 30-35%. Even with 5/25, some of the larger projects will eventually end up defaulting. For example, even if part or all of the ₹75,000 crore worth of power loans that we feel are at risk are put under the 5/25 scheme, we don’t think they will turn positive. When times change in terms of profitability, the banks will have to probably take a haircut on some of these exposures,” says Rajat Bahl, director, Crisil Ratings.

“If the banks don’t let some of the loans go, it will not be possible for them to save some of these projects. This evergreening of loans has been going on for some time before the restructuring guidelines were implemented. Now, it will continue under the flexible restructuring guidelines,” he adds. Analysts say that bankers need to be more discerning.

“They need to differentiate between the plain inefficient or gold-plated assets and the economically viable ones. Some of these assets will not make it even if the business cycle improves at a reasonable level,” says Bharat Iyer, head of research at JP Morgan. According to experts, the tendency not to recognise NPAs has its roots in the working culture present in some PSU banks. “As a society, we do not look at failures charitably. Things are much worse at PSU banks. They have a vigilance mechanism, so they are always afraid that any large NPA will be considered bad from the career perspective. There are strong disincentives in the system that discourage risk-taking. Therefore, it is difficult for some banks to be upfront in some of these cases. If a system is unable to recognise risks, then it should not be in the business of taking risks,” opines Bhoumik.

Ananda Bhoumik, India Ratings & ResearchNeelkanth Mishra, Credit SuisseHe adds that there are two risks that banks need to be careful about. “One is the concentration risk. The other is if you are unable to see unviability and you continue to increase your exposure, to the extent that your concentration risk compounds because you don’t know when to stop.” According to an estimate presented by the Swiss-based financial services firm UBS, loan approvals to potentially stressed companies has gone up by 85% over the past three years. Interestingly, the report says two private banks —Yes Bank (3X) and ICICI Bank (2X) — have seen the strongest rise in loan approvals to potentially stressed companies since FY12. 

The 100-company survey conducted by Nomura comprised of companies with high debt-equity ratios and low cash interest of coverage ratio. The report mentions loan approvals to the iron and steel sector have gone up by 47% since FY12, while loans to the infrastructure sector (including power) have gone up 45% since FY12. The surge in loans was an outcome of banks lending a helping hand to stressed sectors to keep them afloat. “Most banks are running with an ROA of less than 0.3 or 0.4. If they take a call on large exposures and decide against any further lending, these assets will slip into NPA territories. The hit on their profitability will be too large.”

Documents filed with the registrar of companies show that in the month of July, an SBI-led consortium of banks raised working capital credit facilities for Essar Steel to ₹12,000 crore from ₹8,350 crore. In the same month, on two occasions, PNB revised working capital for Bhushan Steel and Axis Bank extended ₹500 crore worth of loans to Jayprakash Power Ventures against movable assets. Analysts feel that continued lending to stressed companies has put the banking system in a sticky situation. “It is typically felt that infra projects have long-term viability. At some point in time, the money will start coming back. But what we are saying is that over the past four to five years, they have got so leveraged as banks have put more good money after bad that we have now come to a tipping point,” says Abhishek Bhattacharya, associate director at India Ratings. 

Tanking the lot

Why, then, have banks lent so much to companies and not to corporates at a reasonable proportion to the promoters’ equity? “Because we are going through a downturn, people at times feel that we should be a bit more accommodative andflexible. In that attempt, as we have discovered over the past three years, we have got sucked into the mess,” he adds. Meanwhile, power and steel analysts feel that the situation in these two sectors cannot simply be ‘managed’ unless decisive steps are taken.

In dire straits

Exposure to the power and steel sectors has risen manifold since the credit crisis

For instance, Crisil estimates that consistent tariff hikes of 10% CAGR over the next three years, accompanied by an at least 200 basis points reduction in technical losses is necessary if discoms are to achieve break-even in the medium term.

In fact, certain steel companies should be allowed to go bust to deal with over-capacity problems instead of continuing to throw good money after bad. “In terms of the magnitude of the problem, this is not something that can be taken lightly. Banks can’t say we will manage something. Even the recent coal auction policy is not good, as it is postponing the problem. It seems like a long-term problem, unless there is suddenly a rise in demand or a sharp economic turnaround. However, that doesn’t look likely now and if we just wait for the economy to bounce back, it might be too late.” 

Neelkanth Mishra, India equity strategist of Credit Suisse, also feels that banks need to let certain steel companies fall to improve the situation. Even last year, many steel companies were operational because banks were lending them more money, mentions a Credit Suisse report. “Banks cannot provide capital ad infinitum, but with only 4.3% of outstanding bank loans to the steel sector, the amount of money needed to maintain the charade is not much. As long as banks continue to fund losses at companies, the over-capacity in the industry is likely to persist and make import duties ineffective,” Mishra comments in the report.

Indian banks’ exposure to the power sector stands at ₹5.8 lakh crore, which is 22% of the outstanding banking loans to industries, and the exposure to the steel sector stands at ₹2.8 lakh crore, which is 10.76% of the outstanding banking loans to industries (see: In dire straits). However, bankers remain optimistic about the steel sector. “I expect a reversal in steel’s fortunes in another year or so. It would require an intervention from the government on the duties front,” opines Ashish Khajuria, executive director at Federal Bank. It seems like India Inc and bankers are putting the onus on the government to find a way out. Unfortunately, if the expected economic recovery gets delayed for too long, not many PSU bankers will be around to take flak for their actions. Till then the game of throwing good money after bad will continue. 


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