With the Finance Minister’s announcement in her Budget speech about incorporation of an Asset Reconstruction Company and Asset Management Company to transfer the bad loans of banks to enable them focus on fresh lending, the discussion has moved on towards how to capitalise them and what would be the fair value of such transfer of bad assets.
Even before such transfer to so called bad banks, price discovery of loans at each stage is to be ensured which is possible through introduction of a secondary market for bank loans. Downselling of loans is followed in Indian market by very few banks, but it cannot be a substitute for a secondary market.
The Indian context
In India, banks typically tend to hold loans till maturity or till they go bad with minimal recovery while enforcing the security. Neither the bank nor the corporate debt have the feasibility of changing hands during the life cycle of a loan. A refinancing market which allows for such change of hands, is also at a nascent stage and not as vibrant as in developed markets. Under these circumstances there is an urgent need for a secondary market for bank loans to enable price discovery at every stage of a loan. Even in the developed markets, a secondary market for bank debt is on ‘Over-the-Counter’ platform (OTC) and it is not as deep as equity or bond markets, but it enables price discovery. The secondary market in US can be divided into three segments — par (standard loans), sub-par (impaired loans) and distressed.
Coupon on the loan, cost of funds, remaining tenor, industry, sector, rating, government policies, risk appetite of the buying institution and available liquidity in the market are primary factors for arriving at the price in par market; seniority of the loan in a corporate’s debt profile, chances of turn around, available security distribution and its realisable value reflect the price for sub-par and distressed markets. While entering into a deal, the seller and buyer institutions declare the loan either par or sub-par, impaired as declared by the Regulator. If it is a par loan, it is explicitly recorded that the transaction has taken place on ‘Par Docs’ basis.
Interestingly, with introduction of a secondary market, a few loans might even attract a good price, based on the perception of the market, despite the loan being declared as impaired by the Regulator. So, the decision of the Regulator/Auditors would not dictate the price or its intrinsic value and cash flows.
Price discovery might take place in three stages. For par loans, the price generally varies from 95 per cent to premium of 101 per cent of loan and it mainly depends upon the available coupon. In India as the average interest rate is around 10 per cent which is higher than developed markets, it may fetch higher premium than usual 101 levels. Akin to equity markets, any news either negative or positive will reflect on the secondary price.
For sub-par loans, the price generally varies from 80-90 per cent of book price. For declared distressed loans, the price may go as low as 40-60 per cent. But the important take-away here is that there is a market at every stage of the loan. A secondary market also enables banks to churn their portfolio frequently and optimise fund deployment. Banks in the US offload loan books frequently for effective balance sheet management including reducing capital costs. Effective use of the available technology platforms can make implementation easier in the Indian market.
In effect, a secondary market would bring in the required liquidity to bank loans, enable price discovery at every stage elongating the underlying asset value before being subjected to liquidation and long drawn process of litigation. It is now up to the Indian markets to encash the huge potential available.
The writer is AGM, SBI, Industrial Finance Branch, Hyderabad