Even as banks grapple with the uncertainty over loan moratorium, the interest charged on such loans, and the NPA recognition cycle, they have yet another issue to tackle. Aside from providing for the likely rise in bad loans, the banks would also have to increase provisions for their investments in security receipts (SRs), held against bad loans sold to ARCs (asset reconstruction companies).
Data released by ICRA reveals that there has been a higher share of rating downgrades on SRs in its latest surveillance as on June 2020, compared to December 2019. Of the ICRA-rated SRs, 37 per cent have been downgraded (from the rated portfolio) as on June 2020, significantly up from 21 per cent of downgrades as on December 2019.
According to ICRA, the Covid-19 pandemic has affected operations of ARCs, as they are facing disruptions in their recovery from the NPAs procured from banks. The recovery efforts are getting affected due to deferment or failure of auctions due to unsatisfactory bids or absence of any bidders, default or delay in payment as per the agreed settlement plan or agreed restructuring terms.
Resolution under IBC proceedings has also seen a sharp slowdown in Q1 FY21, with only 16 corporate insolvency resolution processes (CIRPs) ending in resolution, compared to 35 in the previous quarter.
Typically, ARCs buy banks’ bad loans by paying a portion in cash upfront (15 per cent) and issuing SRs for the balance (85 per cent). At the time of recovery, banks get their share of the proceeds (85 per cent). Until then, banks record the SR portion as investments and make provisions based on the SRs’ net asset value (NAV) arrived at by the ARCs. The NAV is, in turn, determined by the ratings assigned to the SRs by rating agencies, based on the realisable value of the underlying assets and the expected cash flows.
ICRA evaluates the possible recovery and assigns ratings on a scale of RR1+ to RR5------RR1+ indicates the present value of anticipated recoveries is more than 150 per cent of the face value outstanding of the SRs and RR5 indicates a recovery range of 0-25 per cent.
Due to an expected increase in the recovery timeline as well as a decline in recovery value on the SRs, there has been a higher proportion of downgrades in ratings of SRs.
Abhishek Dafria, Vice President & Group Head – Structured Finance, ICRA, says, “Recovery for ARCs depends on the value realisation from the underlying securities, so willingness and fund availability with prospective acquirers is of utmost importance. As currently, the primary focus of the businesses is to set their own house in order first and preserve liquidity, acquirers are less keen to invest in further assets even when the same is available at attractive valuation.”
As of June, only 63 per cent of the SR ratings were re-affirmed, as against 76 per cent in December 2019 and there were no upgrades (3 per cent in December 2019), according to ICRA. The rating agency expects recovery ratings to remain under pressure in the near term until the economy improves and this could result in further provisioning by ARCs and banks that are investors of the SRs.
Lower buffer
Data compiled from banks’ FY20 annual reports suggest that the level of provisioning on SRs varies across banks, with a few banks holding a lower percentage of provisions than others. While these provisions may meet the regulatory requirement, further downgrades of SRs would require many banks to beef up their provisioning levels.
For instance, PNB holds just ₹195 crore provisions against SRs (book value) amounting to ₹1,500 crore. Axis Bank and ICICI Bank hold about 19 per cent provisions against their SRs. The book value of SBI’s SRs as of FY20, stood at ₹8,761 crore, for which it has provided ₹1,656 crore, or about 19 per cent.