Axis Bank's Bad Loans Battle

The country's third-largest private sector bank's aggressive growth is coming undone

There is an unmistakable sternness in the voice of Manoj Jayaswal when he realises that it’s a telephone call from the media. In a conversation that lasts no more than a minute, he is curt and hangs up saying, “I am sorry, I cannot help you. Please do not disturb me.”

This is a man who leads an incredibly opulent life in Nagpur. Every time he steps out of JP Heights, a building in the city’s toniest neighbourhood, Behramji Town, the owner of Abhijeet Group is accompanied by security guards. He moves around in a Porsche or in a BMW 7 series. City residents say he has at least another half a dozen cars and is often spotted in upmarket hotels or clubs.

It was only in 2005 that the group came into being and since then, has seen a meteoric rise. It is alleged that Jayaswal’s political connections helped him in moving swiftly from one industry into another. Starting with infrastructure and road projects, Jayaswal rapidly diversified into sectors such as power, ferro alloys, steel, cement and mining. 

In fact, his group figured prominently in the allotment of coal blocks that left many an industrial house bruised. Jayaswal was keen on setting up a 240 MW power plant, Abhijeet Mihan Nagpur Energy, to exclusively supply electricity to the Mihan-Special Economic Zone (SEZ). The project never took off after it ran into a dispute with the Maharashtra Airport Development Company, the entity in charge of developing the SEZ. 

As things turned out, in 2015 he was booked by the Central Bureau of Investigation for cheating and misrepresenting facts by inflating the net worth of his group companies to make them eligible for the lucrative coal blocks. Lenders to the power project had to take a hit when the entire loan book was sold to a group of asset reconstruction companies (ARCs) in October 2015.

As the lead bank of the consortium, Axis Bank, which had an exposure of a little over Rs.1,800 crore to the group, ended up taking a massive 65% hit. As a part of the securitisation deal, the bank initially got Rs.100 crore with the rest in the form of security receipts payable on recovery. The other banks in the consortium included the likes of State Bank of India, Bank of India and Uco Bank.

Loans to groups such as Abhijeet proved to be a costly mistake for Axis Bank, which had an ambitious growth strategy which came with its own share of risks. Putting it in context, Shikha Sharma, MD and CEO, Axis Bank, says, “There is a difference between banks which chose not to participate [in the corporate loan book growth story]. If you don’t play a game, you are neither going to win nor going to lose. But if you are in the game, you must be ready for the consequences of the game as well,”

Set the pace
It was in mid-2009 that Sharma assumed office at Axis Bank from ICICI Prudential Life. Till then, the bank’s business came from retail banking and lending to small and medium enterprises, primarily to the gems and jewellery business.

Following the 2008 global credit crisis, exports were seriously affected and, hence, sectors such as power and infrastructure were obvious temptations with the government stating its intention to boost power and infra spending.

Axis pushed the growth peddle aggressively. The power sector’s exposure shot up from a relatively modest Rs.3,029 crore in FY09 to almost Rs.27,000 crore by FY12. Similarly, during the same period, iron and steel loans moved up from Rs.5,800 crore to around Rs.11,000 crore. But the one sector that clearly stood out was real estate, where lending really took off after FY11. In FY12, the exposure to the sector was at Rs.52,730 crore and by FY16 it was close to Rs.1.12 lakh crore.

Independent banking sector analyst, Hemindra Hazari believes the bank’s strategy of giving large loans helped in expanding the balance sheet with minimal effort. “In the short term, it resulted in higher profits, higher salaries and more stock options,” says Hazari. Between June 2009, when Sharma took over, and 2012, the Axis Bank stock zoomed from Rs.833 to Rs.1,300, an increase of 56%, as also did other bank stocks.

But the good times did not last for long. The very sectors that were the bulwark of Axis corporate loan book turned out to be its biggest bane. Axis’ decision to have a large concentration of its loan book in power, real estate, iron and steel has cost it dearly. From 1.34% in FY15, its gross NPAs in FY17 rose to 5.04% of gross advances even as its net profit plummeted 55%. In Q3FY17, net profit fell 73%, while gross NPAs stood at 5.22%.

Nothing with respect to profitability taking a knock was remotely evident till the last quarter of FY16. Critically, the FY15 annual report had stated, “The NPAs and restructured assets have been kept in control, with a strong focus on guardrails.”

Just a couple of months after the FY15 annual report went out to the shareholders, the loan to Abhijeet Group was sold, coinciding with the bank’s Q2FY16 financials. Though, the topline was in sync with what analysts had anticipated, the decision to sell these loans ensured that Axis’ stock took a beating on the day of the result.

It really was the beginning of what was to follow. By then, Axis’ exposure to sectors such as power, infrastructure, iron and steel was becoming a cause of anxiety as key borrowers such as Essar, Jaypee, Bhushan and Lanco, were reeling in debt with their future looking rather grim.

Even as analysts were estimating stressed loans of the banking industry, Axis sounded confident of its asset quality during its Q3FY16 conference call with analysts in January 2016. Jairam Sridharan, CFO of Axis Bank, said:  “After going through this process of rigorous testing of our portfolio, our asset quality metrics have come out higher than before with GNPA level increasing from 1.38% in Q2 to 1.68% as on December 31, 2015 and net NPA level increasing from 0.48% to 0.75%.” However, a lot changed when a “watchlist” popped up in the following quarter. The bank, along with its Q4FY16 results, also released a list of standard loans of Rs.22,628 crore, adding a caveat that 60% of the loans ran the risk of turning into bad loans. 

Infra pangs…
As feared, a chunk of the loans on the watchlist have turned to NPAs and currently the power, iron and steel sectors continue to dominate the Rs.9,000-odd crore loans on the list (See: The pain point). 

Sharma, sitting out of her head office in Mumbai, plays down the concerns, “There was demand for infrastructure, that’s why the government pushed it and companies went out and set up those assets. Most corporate lenders, and not just Axis Bank, went into those sectors. If you look at those projects, some high quality assets have been set up. It is comparable to the best in any part of the world.”

To be fair, much before Sharma had joined Axis, the bank already had an exposure to the infra sector. In fact, in mid-2008, the bank had picked up a 2.5% stake in the ill-fated Lavasa Corporation, a subsidiary of Hindustan Construction Company, for Rs.250 crore, giving it a valuation of Rs.10,000 crore. However, according to a former Axis Bank official, while money was always lent to infra and iron and steel sectors, as they were viewed as growth engines, under Sharma’s helm, the size of the bets burgeoned. A majority (86%) of the loans in the watchlist originated between FY10 and FY14 (see: Where it all began). “It was not an error of judgement, as just like the others we also participated in the infrastructure story,” defends Srinivasan Varadarajan, deputy managing director at Axis Bank. 

In the case of Abhijeet, for instance, Varadarajan mentions that the sanction was made based on the fact that the group had a captive mine. “Suddenly the mine licence was cancelled. At that point, the allotment of land was also done and nobody anticipated the change in project dynamics,” explains Varadarajan. Sharma adds, “Delay in approvals and cancellation of coal mining blocks impacted the short-term viability of some projects. To say, we did not do well is not a fair comment. Look at our portfolio in relation to the entire banking system.”

There is little to doubt that power, among other sectors, was a huge opportunity at one point. “Banks lent money to infrastructure since that was the next big thing. It was based on assurances and announcements from the government,” maintains A Issac George, director & CFO, GVK Group. Axis’ lending to the GVK group was for two power projects in Uttarakhand and Punjab and for the Bengaluru international airport. “What was borrowed for the power projects has been completely restructured after elongating the debt schedules. The loan for the Bengaluru airport too has been refinanced,” he adds.

Many of Axis’ large borrowers blame the policy changes for the sector’s woes. According to Issac, the coal allocation scam in 2012 hit the power sector really hard. “Post the reallocation, the government, ideally, should have given alternative sources of fuel supply for companies that lost out. That did not take place and the promoters are now stuck,” he says. In October 2016, ratings agency Crisil stated that nearly Rs.1.34 lakh crore worth of debt on operational and under-construction power projects was at risk. As per Crisil, around 17,000 MW of operational power projects with a debt of Rs.70,000 crore and additional 24,000 MW under-construction projects with a debt exposure of around Rs.64,000 crore are at high risk.

In addition to power, the bank also had an exposure to the steel sector, the biggest being Bhushan Steel at Rs.1,000 crore. According to media reports, the company, which had an overall debt Rs.45,000 crore, has submitted a final proposal for debt restructuring. Reflecting on the crisis facing the industry, Seshagiri Rao, joint managing director & group CFO, JSW Steel, points out that a lot of capacity was created in the steel sector on the belief that a boom in the coming years would allow players to make money despite higher capex cost. Many new entrants spent Rs.7,000-8,000 crore per million tonne to build fresh capacity. Incidentally, most of the big-ticket investments were made at the peak of the commodity cycle. The industry’s perception was that steel could be sold at a minimum $600 per tonne when the price of iron ore was $100. “High interest rates, a very cyclical industry and the dumping of steel from China changed the equation completely,” explains Rao. 

Both steel and ore prices have dropped by at least half, placing the companies in a stressful position following an oversupply of 400 million tonne of steel globally. According to Rao, 70-80% of capex made all over the world, at any point, is usually across four sectors – oil and gas, mining and metals, infrastructure and capital goods. “No significant investments were made here post the 2008 financial crisis. The government had no money and the private sector saw no demand, which severely impacted our industry,” he says.

The case of Jaypee group is no better. Its wings were spread across sectors such as cement, real estate, hospitality, power and roads. Last April, Axis Bank took possession of Jaypee Infratech’s headquarters, Nirman Sadan, on the Noida-Greater Noida expressway. This was in lieu of Rs.700 crore that the company owed. With this Axis’ exposure to the group is learnt to be at Rs.800 crore.

In a brazen display of ambition, the group had gone ahead and built the Buddh International Circuit, for motor racing, in 2011, alongside the Yamuna Expressway. A former Jaypee group official mentions that a total of 12,500 acres was acquired in the proximity for a massive foray into real estate. “The racing project was a loss-making proposition since it required a licence fee of Rs.150 crore each time an event was held. It did not manage to bring in the crowd which, in turn, impacted the real estate business as well,” he says. By this time, the land prices crashed along with a slowdown in sectors like cement and infrastructure. 

Today, the group is in the midst of paring its assets, with parts of cement and power being sold. Even after all this, it is saddled with a debt of over Rs.40,000 crore from a peak of over Rs.90,000 crore. “A lot was linked to the promoters’ proximity to political circles in Uttar Pradesh. That changed right after the 2012 assembly elections in Uttar Pradesh,” says the official. Emails and calls to the Jaypee Group remained unanswered. 

Varadarajan points out that the borrower has agreed to sell his best assets to repay the loans. “It will take time to monetise the assets and the haircut involved is still unknown.”

…Will still linger
Given the burgeoning bad loan problem, the Reserve Bank of India (RBI) and the government are taking measures to clean up the books through various restructuring schemes and, more importantly, the NPA ordinance.

 Sharma believes that things will get better from here on, “We have seen these cycles – if the economy turns around, these assets turn around. They need some nurturing during difficult periods. The new NPA ordinance announced by the government will go a long way in nursing these assets back to health. This year will be more about resolutions.”

But on the ground, things continue to be difficult. For instance, for the power sector, the outlook for thermal plants looks very challenging and a large part of the issue lies in the quality of coal. “Thermal faces the twin challenge of renewable gaining traction and the discoms (distribution companies) not being in the best of health,” says Chintan Lakhani, associate director, India Ratings & Research. Given that thermal power costs Rs.7-8 per unit and renewable costs Rs.3 per unit, the pressure on thermal is huge. Issac of GVK Group agrees. “It is a huge challenge for thermal power to be remunerative at a time like this.”

Lanco Infratech’s managing director G Venkatesh Babu also admits the situation is grim. “The policy paralysis created a huge problem and the power sector is now being pulled up. What can we do if the government says there is no coal or gas?” he asks. The Lanco Group is currently in the midst of restructuring its debt of over Rs.40,000 crore, with Axis being one of the lenders along with ICICI Bank, State Bank of India and others. 

Power is not the only stress point. In early 2016, the government introduced a minimum import price on some steel products to protect domestic firms from cheap imports. The new National Steel Policy too has encouraged public sector projects to give preference to domestic steel. While the measures are in the right direction, it won’t completely take away the pain of an over-leveraged sector.

Bankers are making attempts to resolve large stressed accounts in the steel sector as they believe higher prices and stronger demand have improved cash flows for firms in the sector. Under the Scheme for Sustainable Structuring of Stressed Assets, banks can convert up to 50% of a company’s debt into equity. But to make the cut, at least 50% of the stressed borrower’s debt should be sustainable and serviceable from existing cash flows. But as most of it is consortium lending, each decision needs to be cleared by an overseeing committee. On how Axis Bank is approaching the issue, Sharma replies, “It will be based on the best solution for the bank.”

Loose ends
While the macro going awry did play a bigger role, the pain that banks are going through is also because promoters put in very little money on the table by way of equity. “If banks had insisted on promoters putting in a higher proportion of equity, this situation would have never arisen,” says the former Axis Bank official. 

Besides, according to Hazari, the top brass at the bank had lack of lending experience. “None from the top management had worked in a bank branch or had commercial banking experience prior to their stint at Axis Bank.” Sharma came from the insurance sector, preceded by roles in retail and investment banking. Her deputy, Varadarajan, had dabbled in treasury, investment banking and capital markets. A senior executive at a rival private sector bank points out. “Corporate banking is also about being in the recovery business.”

The ability to judge the quality of borrowers or the lack of attention to detail in some cases has also proved costly. A case in point is the bank’s loan to Deccan Chronicle Holdings (DCHL), as a part of a consortium. The Hyderabad-based company had cumulatively availed of Rs.10,000 crore through 111 loans from 16 different banks between 2004 and 2012. From being a company with a publishing business only in Andhra Pradesh, it diversified into other parts of the south, acquired Asian Age and Odyssey, a bookstore chain with the last straw being the acquisition of Deccan Chargers, an IPL team for $107 million in January 2008. The lenders including ICICI Bank and Axis Bank, who had loaned Rs.500 crore and Rs.400 crore respectively were stuck in this mess.

In early 2015, DCHL’s Chairman, T Venkattram Reddy and its Managing Director, T Vinayaka Ravi Reddy were arrested on the basis of a complaint made by Canara Bank, one of the lenders. Subsequent investigation by the Enforcement Directorate revealed that DCHL had availed loans for working capital, purchase of capital goods and short term loans by overstating receivables, under-stating liabilities by furnishing fabricated financial statements.

DCHL group companies acquired properties from the borrowed funds but did not disclose in the balance sheet to obscure the identity of such properties. And to present a rosy picture, the company declared dividends, issued bonus shares, and also bought back shares by investing Rs.230 crore.

Varadarajan points out that Deccan was a case where the balance sheet was fudged. “The promoter’s track record four to five months before things blew up was impeccable and he actually made a pre-payment of Rs.400 crore.” Though the total debt of the company was actually much higher, he explains that there was little option but to go with what the auditors had to say. “When there is a fraud, you cannot do much. It is difficult to question every balance sheet.”

Other borrowers such as Suzlon and the Chennai-based Aban Offshore are in the midst of their restructuring exercise. Loans in both cases were given to fund overseas acquisitions in the boom time. While lower oil prices played havoc with Aban, Suzlon had to grapple with a downturn and leveraged buyout. “The drop in crude oil prices was unexpected in the case of Aban. The forecast for oil is still flattish and all the banks have downgraded the account,” says Varadarajan. 

Clearly, the possibility of a slowdown in the good times was hardly anticipated and exuberance was the name of the game. Sharma though refutes that the management was lackadaisical in its lending. “In any lending business, some things will work well and some will not. In hindsight, are there projects that did not pan out the way we would have wanted to? Most certainly…but that’s always going to happen in a business,” defends Sharma.

The retail edge
Since FY10, when Shikha took charge, the bank’s income and profits have grown at CAGR of 30% and 9%, respectively. Though the bank did ramp up its corporate loan book, it has also ensured that it did not lose focus of its retail business. 

“Look at the growth of the corporate loan book pre-2009 and post that. I have not accelerated the pace of growth…if I had not made that directional change (shift to consumer), the book would have been 1.35 times bigger than what it is today. Axis was always a retail liability generator and a project finance lender. I did not change anything,” explains Sharma.

Referring to the period when Sharma took over, CFO Sridharan reveals that it was a phase when the bank shifted gears. “The plan then was to have 40% of our business coming from retail in five years. Today, at 45%, we have already managed to achieve that.” 

In FY16, when retail advances increased by just 23%, profit more than doubled for the business. According to Sridharan, “As scale takes off in retail, economies of scale start to kick in. Seven years back it was a sub-scale business at barely 1.5 million cards. Today, at three million, the size is big enough to generate profits and fee income.” 

Besides credit cards, unsecured personal loans, home loans and loans against NRI-deposits are also a part of the retail business which contributes 46% to the bank’s fee income. Internal customers continue to be the mainstay of the bank strategy for sourcing retail assets. Roughly two-third of the incremental acquisition of retail loans comes from the bank’s existing deposit customers. Around 97% of the bank’s credit card originations are from existing customers and for unsecured lending, the proportion is around 80%.

In FY17, while aggregate loan growth stood at 10% YoY, it was largely driven by retail and SME business. However, during the fiscal, retail and home loans did see slippages of around Rs.1,800 crore. But during the Q4FY17 results concall, Sridharan pointed out that the impact of demonetisation on retail and SME growth was fading. “We witnessed a strong sequential pickup in segments when things looked bleak in the third quarter. Disbursement growth has rebounded for home loans and agricultural lending which were impacted materially during the last quarter owing to demonetisation,” stated Sridharan. 

Sharma, too, believes that the bank is sitting pretty with a balanced book. “At this point in time, the [retail] book is behaving well. I cannot predict cycles. But I think our consumer lending average [growth] has been far better than the industry’s.”

However, Hazari points that in the case of retail loans, which currently account for less that 1% NPA for the banking industry, the cycle plays out quite differently. “What is not being considered is the huge slowdown. This is obvious in the IIP numbers, bank credit, two-wheeler sales or even the real estate slowdown. In the corporate NPA cycle, the pressure on revenue and profits or reducing headcount is quick and obvious. This will reflect soon in the NPAs. In the retail NPA cycle, the story is well disguised and the extent of damage is not always obvious.”

While it may appear that the worst for retail loans is yet to come, not all analysts believe that is the case. Veekesh Gandhi of Bank of America Merrill Lynch states in a report: “Axis Bank’s asset quality continues to hold up well and, with an incremental focus on retail, should limit asset quality concerns.”

While the retail business may not be a cause for worry now, the corporate loan book hangover is not going away anytime soon. The surge in Axis’ NPA levels has left many worried on how much more bad news is expected. On a cumulative basis, 84% of corporate slippages originated from the watchlist in FY17. But an equally worrying aspect is that in FY17, Rs.3,273 crore of  slippages came outside of the list with corporate loans accounting for a majority (see: Out of the blue).

Religare Capital Markets feels that the bank still has stress under various heads worth Rs.17,300 crore which, though is recognised, is yet to be accounted for. The brokerage house feels that slippages could stay elevated in FY18. Incidentally, the bank recently disclosed that Rs.1,660 crore loan to a cement company, which was part of the bank’s watchlist, was downgraded. Though the account was subsequently upgraded, the bank has made a provision of 25% against the outstanding, on this account at the end of this quarter. 

In the just concluded fiscal, total NPAs stood at Rs.21,280 crore and gross NPAs at 5.04% of advances. In the time to come, Varadarajan believes provisioning will be lower and that it is unlikely to be as large as what one has seen in FY17. “We expect to get back to the FY13-14 provisioning levels but in FY19,” he says.

Alpesh Mehta of Motilal Oswal believes the balance sheet clean-up will be over by the end of FY18 and earnings will return to normalcy in FY19. “The bank has made significant investments to ride the next growth cycle (post near term asset quality challenges) with strong capitalization (13% Tier I) and (expanding liability franchise (3200+branches),” mentions Mehta in a report..

Staying the course
It’s been close to eight years since Sharma has assumed the corner office and a lot has since transpired. Her aggression, a trait she has carried over from ICICI Bank, saw the bank decisively emerge as the country’s third largest private sector lender. 

But the 58-year-old, whose tenure is due to end in June 2018, believes too much is being made of the bank’s current state of affairs. In fact, the market was abuzz about an impending merger or takeover by Kotak Bank. Uday Kotak’s statement “that it’s time that the government encouraged hostile takeovers” were being interpreted as signs of things to come. 

Sharma though dismisses any M&A possibility. “Neither did we approach anyone nor did anyone approach us. We have built a great franchise and are playing the long-term game.” On whether she would have done anything differently, Sharma replies, “We did not make any mistakes. If I had to it again, I would have done the same thing. You have business cycles. You try to make the most out of them and that’s what we did.”