NPAs of PSBs could rise on tighter asset sale norms

Restructured assets of SBI, Canara Bank, BoI could rise as they have been aggressive in selling bad loans

For three quarters, public sector banks (PSBs) have reported a sharp drop in accretion of impaired assets (non-performing loans and restructured assets), as fewer loans are being recast. According to Kotak Institutional Equities, impaired loans have declined to 10.3 per cent during the quarter from 11 per cent in the second quarter of FY14, as restructured loans declined 50 basis points from a peak of 6.5 per cent of loans. While banks are claiming a sharp drop in new referrals, analysts believe aggressive asset sales are responsible for the asset quality improvement seen over the last two quarters. According to analysts, CRISIL data show a fourfold increase in security receipts outstanding of banks in June to Rs 42,000 crore against Rs 8,800 crore last year.

Thanks to lax norms on asset sales, banks have resorted to aggressively selling bad assets to asset reconstruction companies (ARCs) by paying up five per cent of the total value of security receipts issued by the ARC. By paying a small amount, banks were aggressively transferring bad debts to ARCs, which in turn were issuing security receipts against the loans they acquired. As a result, the risk was shifting to the bank's investment book from the loan book. The sharp sell-off in impaired assets has helped lower the accretion of bad debt, but has not removed the risk. With the Reserve Bank of India (RBI) tightening the norms on asset sales and increasing the minimum capital contribution to 15 per cent of the security receipts, PSBs are expected to see a spike in the loan recast.

After interacting with asset reconstruction companies, Centrum Broking's Aalok Shah says aggressive asset sales by banks might have to take a hit, as pricing and asset sales volume could be on the lower side than current levels. However, this will also depend on the age of assets sold and recoverability, he adds.

While redemption ratio of security receipts has improved from 2010 levels, asset recovery companies will go easy on buying impaired assets for two reasons. First, the management fees ARCs charge has been changed from a percentage of security receipts outstanding to a percentage of net asset value. The asset recovery companies will also have higher accountability as far as realisations are concerned.

Tightening of norms will have a direct impact on the asset quality of banks that have aggressively sold impaired assets over the last six months. Three banks are expected to be hit hard by this. In the June quarter of FY15, Bank of India sold 15 per cent of its opening gross NPAs to ARCs, while SBI has sold 10 per cent of opening GNPA and Canara Bank has sold 12 per cent. Centrum's Shah believes that banks, which have resorted to huge sell-downs, could be impacted in coming months.