Focus now on faster NPA resolution to ensure NARCL's success: Analysts

Analysts expect the 'bad bank' to improve the balance sheet of banks, and aid incremental cash flow. However, a delayed resolution may dent the asset's value over time

Finance Minister Nirmala Sitharaman has announced setting up of a National Asset Reconstruction Company Ltd (NARCL), or a ‘Bad Bank’, with an intent to resolve bad loans within a period of five years.

While the move is a 'structurally positive development' as the focus remains on faster resolution of stressed assets, analysts believe the move is a little “late in the cycle.”

Back in 2016, Chris Wood, then managing director and equity strategist at CLSA, had said that the Narendra Modi-led government should put all the bad loans into one bad bank and let investors bid for those. READ HERE 

Further, in a September 17 note, M B Mahesh, an analyst at Kotak Institutional Equities, pointed out that creation of a bad bank would have been most fruitful just after the asset quality review (AQR) or earlier when the stress was just building up.

“Today, the NPL recognition and provisions cycle is largely complete with some of the largest bad loans already resolved,” he said.

Nonetheless, the FM expects the NARCL to be operational soon. The NARCL will acquire stressed assets of about Rs 2 trillion in phases, and these soured loans would be transferred by paying 15 per cent cash to lenders and the remaining 85 per cent would be paid through security receipts. These security receipts issued by the NARCL would be backed by a government guarantee of up to Rs 30,600 crore.

Going-forward, market watchers expect the 'bad bank' to improve the balance sheet of banks, and the upfront cash payment to aid in providing incremental cash flow. However, a delayed resolution may dent the asset's value over time, they say.

Prakhar Sharma, equity analyst at Jefferies, for instance, says that of the 40 cases under National Company Law Tribunal (NCLT), the good ones in steel-sector got resolved with negligible haircuts for banks, but tough ones in power, auto, and consumer are yet to find resolution.

“Historically, banks see about 10 per cent recovery from written-off loans, and we believe that recoveries here may be broadly in line,” he adds.

Likewise, Siddharth Purohit, equity analyst at SMC Global, also shares a similar view and says that faster resolution will be the key to success.

“Resolution of NPAs is a long-drawn process in India as it is difficult to find buyers. Therefore, cash flow on full recovery from an NPA account needs to be tracked,” he says.

On the fundamental side, since most of the bad loans are fully provided for, there may not be any significant improvement in NPA ratios.

“The upfront cash received, 15 per cent of the written-down value, would be reversed while the provisions for the balance (value of security receipts) are unlikely to be reversed even if it is fully provided. As this cash is a smaller proportion and divided across public banks and a few private banks, the short-term impact is negligible,” notes Mahesh of Kotak Institutional Equities.

He further adds: The larger release of provisions, if any, would be made as and when the cash is received on sale of these receipts or redemption of security receipts. The banks are unlikely to reverse any provisions.

According to brokerages, banks will transfer nearly Rs 0.9 trillion of fully-provided NPAs in the first tranche and the balance Rs 1.1 trillion in the second tranche, taking the total NPA transfer amount to Rs 2 trillion, which is 1.9 per cent of systemic loans.

While it will reduce gross non-performing asset (GNPA) ratios of public sector banks (PSBs), the reduction in net NPA (NNPA) will be limited to the extent of un-provided exposure, says a report by Emkay Global.

Add to it, upon extinguishment of government guarantee on SRs (after five years), banks will have to bear the loss on the un-redeemed SRs, it adds.

Operationally, NARCL will have to be equipped with talented and passionate management and will require government and regulatory oversight to succeed, say analysts.

"Resolution will be key – how efficiently the professionals are resolving the stressed assets is to be monitored. One can argue that bad bank is likely to become a warehouse for stressed loans without expected recovery as it will be difficult to find buyers for legacy assets," say analysts at ICICI Securities.

If initial cash receipts are more or less equivalent to the amount invested by banks, would it then merely amount to shifting the problem from one place to another without fundamentally solving it?, they question.