One of the leading problems that the Indian Economy is facing is the alarming volume of stressed assets with the banking system. There are various ways in which these Non-Performing assets are tackled. After the introduction of Insolvency and Bankruptcy Code (IBC), it was believed that the resolution of stressed assets would become an easier and quicker process but it has been observed that in some cases banks are turning to the old route of sale of stressed asset to Asset Reconstruction Companies. But before understanding the reason behind selling such stressed assets, we need to understand few aspects.
What are Non-Performing Assets and Stressed Assets?
A Non-Performing Asset is the loans or advances that are default or are in arrears on scheduled payments of principal or interest. Debt is considered non-performing when no payments are received for 90 days. At times, nonperforming assets are also classified under such head when the interest is paid but repayment of the principal is not done. The non-payment of such assets reduces the cash flow in the banks which disrupts the budget and creates a reduction of earnings. These appear in balance sheets which causes a reduction of the capital available to giving out loans to the current customers. When nothing can be earned from such assets, they are written off from the earnings of the institution.
Stressed assets are health indicators of the economy. The deteriorating asset quality is an alarm to the economic risks that can arise in the near future or even the long run.
Stressed Assets = NPA + Restructured loans + Written off Assets.
Restructured loans are those loans which have been given more repayment period and also reduction of interest rates. Also, at times the loans are changed to equity. Under this method, the bad loan is changed to a new loan. A restructured loan tells us the banks are having bad loans in their balance sheet.
Written off assets are those assets whose valuation is done of the amount of loan that is borrowed.
Traditional Way: Resolution of Stressed Assets Through Sale to ARC or Asset Restructuring Companies?
ARC or Asset Restructuring Companies are special financial institutions who buy poor performing assets from the banks at a low price to clean up the balance sheet of such institutions. Banks, without going behind the defaulters, can easily sell these “bad assets” to such institution which makes their work easier at a mutually agreed value.
The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest or SARFAESI Act, 2002 states that ARCs can help financial institutions with bad assets without the intervention of courts. As per amendment 2016 of SARFAESI Act, the ARCs must have a minimum net owned fund of 2 crores.
In such a scenario, where banks are forced to maintain a healthy asset quality and thus in dire need to clean up their balance sheet, ARC(s) come to the rescue by buying the stressed assets at a haircut which is decided after multiple bargaining from both the lenders and the ARC. It is notable; however, any initial or further resolution plan is required to get a 75% vote from the entire group of both secured and unsecured creditors of that said company.
For Example: If it has been reframed to a 15:85 resolution plan for a stressed loan of Rs. 1000 cr. This primarily means that the ARC needs to pay 15% (Rs. 150 cr) of the Net Asset Value of the asset upfront to the banks. Such Net Asset Value shall be decided as evaluated by a registered valuer u/s 247 of Companies Act, 2013. The rest 85% (Rs. 850 cr) of the value shall be paid to the banks as and when the assets are realized by the ARC in the course of business or by a complete sell-off. ARC also try to refinance and reconstruct the asset such that it becomes a performing asset again. This route is being used from a long time but it has failed in proper resolution in the majority of cases as re-construction of the stressed loan is not the best solution for a business that is not doing well.
Modern Way: Resolution Through Auction of Stressed Assets Through Sale to ARC or Asset Restructuring Companies?
The Insolvency and Bankruptcy Code, 2016 is one of the most important legislative reform that has helped in the growth of the economy as well as emerged as a solution to the problems relating to the NPAs. IBC is a landmark legislative reform which brings most of the bankruptcy laws under one head making it simpler and easier for the companies as well as promotes faster and effective jurisdiction.
One of the fundamental features of the Code is that it allows creditors to assess the viability of a debtor as a business decision, and agree upon a plan for its revival or a speedy liquidation. The Code creates a new institutional framework, consisting of a regulator, insolvency professionals, information utilities and adjudicatory mechanisms, that will facilitate a formal and time-bound insolvency resolution process and liquidation. IBC allows a maximum 270 days for resolution — an initial 180 days and 90 days of extra time on top of that.
The architecture of IBC has been taken from past committees which came together under one head and was adopted as law remarkably quickly on the heels of Bankruptcy Law Reforms in 2015. The judicial adjunct to IBC is the National Company Law Tribunal and the National Company Law Appellate Tribunal.
Landmark judgments have been passed clarifying important questions such as upholding the principles of natural justice by providing an opportunity of being heard, defining the coverage of moratorium and explaining repugnancy between the Code and the state laws, what constitutes a dispute, the applicability of timelines, when a debt would be considered as time-barred etc.
Why banks are turning towards sale of stressed assets to ARCs instead of going through the IBC route
Troubles Created by Competitors
In the race to win the bidding for stressed assets the companies in race for acquisition try to challenge each others bid on legal ground which causes a delay. For example: Patanjali, which has been declared as the second highest bidder with Rs 5,700 crore offer, was asked to submit a revised bid by June 16 to match or better the highest offer of Rs 6,000 crore by Adani Wilmar under the Swiss Challenge system adopted by the RP and banks. However, Patanjali wrote to the RP seeking clarifications instead of submitting fresh and revised bid.
Under the Swiss Challenge method, Adani will get another chance to make an offer if Patanjali were to match or better its offer of about Rs 6,000 crore. Yoga guru Ramdev-led Patanjali group has also questioned the appointment of Cyril Amarchand Mangaldas as the RP’s legal advisor as the law firm was already advising the Adani Group.
The Haridwar-based FMCG firm has raised the issue of conflict of interest over the appointment of the law firm due to its alleged connection with the Adani group. Ruchi Soya, which is facing the insolvency proceedings, has a total debt of about Rs 12,000 crore.
Piling Up Cases –
Initial few resolutions has been fast but as more and more cases are coming up the process is slowing down – the 270 days limit is only for namesake now.
Heavy Hair Cut –
Banks are being made to take a huge haircut in the IBC process for the assets where there are only one or two buyers.
Lenders to Essar Steel Ltd. have decided to assess bids submitted by Numetal Mauritius and ArcelorMittal India on their individual merit. The Luxembourg-based steel giant offered a 35-40 percent haircut to financial creditors in the first bid it had submitted, while Numetal, a VTB Bank-led special purpose vehicle, had offered a 65-70 percent haircut.
Essar steel owed an amount of Rs 49000 crore to its creditors.
In the Bhushan Power and Steel Ltd., the NCLAT allowed resolution applicants to revise their resolution plans, even after one year had passed since the admission of the case to IBC.
In Essar Steel, the NCLAT allowed the resolution applicants time to cure their 29A ineligibility.
Increasing NPA and Fear of Prompt Corrective Action (PCA)
Going through the IBC route always happens to be a long and tedious process. Moreover, pending litigations at the NCLT, if piled up beyond a certain extent, may lead to an overcrowding effect resulting to blockage of Bank’s capital and thereby a significant increase in Non-Profitable Assets (NPA) of the banks, which may further lead to a ripple effect on the banks in form of Prompt Corrective Action (PCA), under the new regulations of the Banking watchdog (RBI).
The Reserve Bank has specified certain regulatory trigger points, as a part of prompt corrective action (PCA) Framework, in terms of three parameters, i.e. capital to risk-weighted assets ratio (CRAR), net non-performing assets (NPA) and Return on Assets (RoA), for initiation of certain structured and discretionary actions in respect of banks hitting such trigger points. The PCA framework is applicable only to commercial banks and not extended to co-operative banks, non-banking financial companies (NBFCs) and FMIs.
Now, taking this theory to a real-life example, recently Union Bank, Indian Overseas Bank and Bank of Baroda sold their part in Bhushan Steel and Essar Steel to Edelweiss ARC, country’s largest ARC managing around Rs.45000 crore of stressed assets out of Rs.75000 crore present in the system. However, SBI opposed the plan stating that, while such resolution plan may be profitable to a bank in short term, it may affect long-term decisions given the difference in opinions among bank and ARC, in a quest to reach the coveted 75% votes for any decision. However, they also accepted the fact that sale to ARC becomes essential to avoid PCA, and thereby, a temporary freeze to further long-term credit offtake, advances and the opening of branches.
As SBI was booking losses in the previous year as well as the current year, it decided to follow the guidelines and wanted the ARC to take over the decisions. It would facilitate the bank not to book losses and eventually can come up to break even point. As the RBI had given out the guidelines that if the “dirty dozen” is not solved within March 2018, then the banks would not be able to open new branches. Thus to make the process faster SBI willingly agreed to the fact that the stressed assets would be sold off to the ARC instead of going through IBC.
Both routes have advantages and disadvantages. IBC route assures better value to banks and proper management of the stressed asset by a financially strong buyer but NCLT resolution takes time and does not help the banks as such to recycle the trash money, while ARC has a solution to that, giving short-term liquidity and long-term regular cash flow after considering for the loss due to the haircut. If the legal hassles are eased out IBC can become a great success.
Author | Shohom Pal