'Bad loans pricing and scope of recovery to determine NPAs sale'

Mumbai: The quantum of recoveries from bad loans is going to determine the appetite of asset restructuring companies' (ARCs) to buy such stressed assets, says a report.

"ARCs' role in acquiring non-performing assets (NPAs) from banks is likely to be guided by the quantum of recoveries from distressed assets," India Ratings has said in a report.

The agency's experience of rating security receipts (SRs) backed by large corporate NPAs indicates that a pricing that overlooks the level of sustainable debt and potential recovery is unlikely to result in a positive yield for investors.

The report said in closed trusts, ARCs have recovered only 30 per cent of the acquired principal in SME assets and nearly half of the acquired principal in large corporate assets.

"Despite the low recovery in SME assets, the investments generated positive yields for the investors as SRs were priced below 30 per cent of the acquired principal and average time of recovery was in the range of two to three years.

"While large corporate cases generated higher recoveries, the investments did not generate positive yields because of the disproportionately higher pricing of nearly 90 per cent and much higher average lives of nearly 5.5 years of investments," it said.

It further said banks have largely ignored the recovery potential of these assets as demonstrated in the past and have sold them at much higher prices, with average acquisition price of SME assets in 2014 reaching over four times of the past prices.

"Aggressive reserve pricing on the part of banks allows them to convert their loans to investments in SRs at par or close to par with the expectation that such SRs will not be downgraded. We believe that the risk of a downgrade in net asset value is accentuated for such acquisitions, bringing them at par with a disposal strategy that builds in a suitable haircut at the time of sale," the report said.

The agency believes that lack of a prudent pricing for SRs also effectively does not take the benefit of the dispensation provided by the Reserve Bank which allows banks to spread the loss on sale of distressed assets over a two-year period.

It further said the nature of distressed assets that are put up for auction by banks has shifted from SME loans of closed businesses, which required liquidation, to large corporate loans concentrated in sectors such as infrastructure, iron and steel, power and construction.

"Aggressive reserve prices of these assets will make ARCs wary on three counts-a higher value of investments that they have to make in the form of 15 per cent of the issued SRs, potential downgrade in the valuation of SRs on account of lack of progress or slow progress on such accounts, and its resultant impact on the management fee that ARCs can charge which has been revised to the lower side of the valuation range.

"This is one of the key reasons for the lack of successful auctions by banks," the report said.