Can the formation of bad bank earn PSU banks a re-rating?

Can the formation of bad bank earn PSU banks a re-rating?

NEW DELHI: The formation of a bad bank could play a key role in the resolution of stress assets, but analysts say it is a case of “better late than never.”

On the face of it, the move would help in releasing the management bandwidth away from the recovery of stressed assets and could expedite the process given that the single entity will be driving decision-making as a lender. Besides, it will bring transparency in decision-making if external private sector capital is allowed to participate in the recovery of stressed assets. The exact modalities and the possible haircuts need to be explored first for gauging the exact impact of it, they said.

What can a bad bank do?

In its latest financial stability report, the Reserve Bank of India had said that state-owned banks could see their gross non-performing assets (NPAs) ratio deteriorating to 16.2 per cent in the baseline scenario by September 2020, and 17.6 per cent in the worst-case scenario.

The bad bank would buy out stressed loans of state-owned banks, and the industry estimates the gross value of such bad loans at as high as Rs 4.5 lakh crore.

Elara Capital suggested that the transfer will happen at the net book value (gross value minus provisions) carried by banks. The banks are likely to transfer loans where they have already provided 85-90 per cent, it said.

“As such, the net book value of these loans of Rs 4.5 lakh crore will be Rs 45,000-50,000 crore, or 10-15 per cent of gross value. Bulky bad loans in the road, ports and thermal power sectors could be transferred. As the transfer will take place at net book value, there will be no price discovery and the role of the ARC will be to just pool assets,” it said.

Based on its channel checks, Elara suggested that banks could get full cash for their sale to the ARC. It also noted that this was the proposal made by banks and the government would announce the actual structure shortly.

Better late than never

JM Financial said that while the step is in the right direction, swift steps are required on the implementation front, given that past attempts at creating such vehicles, such as the National Investment and Infrastructure Fund-funded special purpose vehicle, have not been materially successful.

“In our view, the bad bank creation would have got more benefits to PSU banks had it been established earlier in the asset quality recognition cycle,” it said.

“Balance sheets of PSU banks will see meaningful change in optical asset quality and thus could aid them in raising external equity capital, said JM Financial.

Neelkanth Mishra of Credit Suisse also believes that it would have been much better to launch it perhaps 2-3 years back.

Material gains?

JM Financial noted that to make material gains from the transfer of these assets to the ARC/AMC, the recovery values will need to be greater than current net book value of such assets.

“Most PSU banks hold PCR >60 per cent on the stressed assets created pre-Covid19 and the transfer value is unlikely to happen at a premium to net book value in our view. It will depend on swift realisation of the assets under the new structure for PSU banks to see meaningful gains,” it said.

PCR stands for provision coverage ratio.

Mishra echoed the view. But noted that if one transfers the bad loans at book value, it would act as a recapitalisation measure. “Banks are not really the big experts in resolving bad loans and it would get them to focus back into the lending mode,” he said.

Edelweiss said that with PSUs, the move will improve bank functioning and fundraising capabilities.

“However, exact modalities, possible haircuts etc. have to be explored first for gauging exact impact,” it said.

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