The newly minted Insolvency and Bankruptcy Code, 2016 (IBC) has put banks in a spot. The bankruptcy process is forcing them to book massive losses. Take a look. Promoters of Mumbai-based Shirdi Industries, a manufacturer of decorative laminates for the furniture industry, left just 26 cents for a dollar on the table for bankers as part of the IBC resolution. In the bankruptcy proceedings against Noida-based oil producing company JEKPL, bankers managed to negotiate just a cent higher than what Shirdi Industries offered them. Worse, in the case involving Hyderabad-based Synergies Dooray Automotive, bankers didn't even get the liquidation value. They accepted a paltry 6 cents for a dollar.
This is the state of affairs of most mid-sized companies under the bankruptcy code and bankers are taking huge haircuts on their loans. The situation is no better for the dozen large cases referred by the Reserve Bank of India (RBI) for bankruptcy in June last year. Kolkata-based Electrosteels Steel is the first company to emerge from the bankruptcy proceedings - here, the successful bidder Anil Agarwal's Vedanta has offered around 50 cents for a dollar to bankers. Barring the examples of steel giants Essar Steel and Bhushan Steel, where there is interest from strategic players or rival steel majors for consolidating their market share, the rest of the large bankrupt companies are not fetching good value. Interestingly, there are three large cases - Lanco Infratech, ABG Shipyard and Alok Industries - where bidders are offering close to the liquidation value, generally 10 per cent of the total value of the company.
Clearly, bankers are at the receiving end in the bankruptcy proceedings with conservative bidding by strategic and financial players. At last count, there were Rs14 lakh crore of stressed loans in the system - it includes Rs8 lakh crore of non-performing assets (NPAs). A seasoned executive of a public sector bank (PSB) gives an inside view of the "realisable value" of the bad loans in the system. He says that almost 60 per cent of the loans classified as NPAs by banks - Rs4.8 lakh crore - are good assets. Of these NPAs, banks will manage to realise a little over 50 per cent of the loan value. "The losses for banks will be around Rs2.40 lakh crore in these good assets," he says. The quality of 30 per cent of the bad loans, with a value of about Rs2.40 lakh crore, is not so good, according to the executive. It would be difficult for strategic or financial players to put more money into these assets and banks are likely to recover only 30-35 cent for a dollar, i.e. Rs72,000 crore. The remaining 10 per cent of the bad loans, adding up to Rs80,000 crore, have little value and these assets are a fit case for liquidation. "So Rs80,000 crore will be the loss for banks," he says. The losses for banks, then, comes to around Rs4.8 lakh crore.
Business Today made another estimate of the "IBC loss" by talking to consultants and insolvency professionals based on the cases referred to the bankruptcy code since its inception. The losses work out to Rs4.4 lakh crore. The provisions and contingencies of PSBs, according to the Indian Banks' Association, had been rising even before the code came into effect in December 2016, indicating the gravity of the problem - they have jumped from Rs1 lakh crore in 2014/15 to Rs1.53 lakh crore in 2015/16 and Rs1.70 lakh crore in 2016/17. In the same period, the profitability of banks has gone down drastically -from a combined profit of Rs37,540 crore in 2014/15, PSBs slipped into losses of Rs12,992 crore in 2015/16 and Rs11,388 crore in 2016/17.
The bankruptcy code is mostly used by operational creditors to put pressure on promoters of stressed companies for extracting their dues. But bankers were a bit reluctant to actually take defaulters to bankruptcy, worried about getting a lower realisation or company liquidation. It was only in June last year that the RBI began forcing banks to invoke bankruptcy proceedings against defaulters. Its latest diktat says the resolution process would get triggered within 180 days in cases where there is a default even for a day. Ashesh Shah, Managing Director, Trans Continental Capital Advisors, says the banks are totally unprepared to handle a bankruptcy situation. "They lack necessary skills and expertise to make the most of it," believes Shah. In the current challenging economic environment, time-bound bankruptcy proceedings of 180 to 270 days have increased the risk of liquidation of stressed companies. Out of the dozen large cases, Alok Industries (debt of Rs22,000 crore plus), Lanco Infratech (Rs43,000 crore) and ABG Shipyard (Rs8,700 crore) are on the verge of getting liquidated. In less than two years of the bankruptcy code, there are already over 40 companies awaiting liquidation - it means a loss of assets, production, employment and also loans going down the drain. "It's a loss to the economy," says a consultant. Many suggest banks, especially PSBs, are getting pushed to a corner in the haste to clean up the banking system (See The IBC Experience).
With operational creditors invoking the code very aggressively, bankers have no option but to sit together and devise a resolution plan. Such a situation also creates panic among bankers and they start cutting fresh credit exposure to the company, especially working capital. Also, bids coming from strategic and financial players are far lower than their expectations or the principal amount of the loan. Currently, banks are getting close to or slightly more than the book value (principal minus the 50 per cent provisioning). "The prices in the large cases are driven by franchise value to gain market share. The value would moderate in the balance cases," says Abizer Diwanji, Partner and National Leader (Financial Services) at consulting firm EY India. A PSB banker aptly sums up the bankruptcy experience. "IBC is not a value maximiser for us," he says. "It gives me a safe exit. The options outside IBC are open to questioning tomorrow."
Meanwhile, participation from global players is almost absent in the IBC proceedings so far. One of the reasons is frequent amendments to the code and challenges by defaulting promoters. "Let the code stabilise first. We don't want to get stuck in litigation before or after taking over the assets," says a global fund manager.
The Last Resort
Plenty of work is required by banks even before a company becomes a fit case for bankruptcy. Rajkiran Rai G., MD & CEO, Union Bank of India, says that banks need to evolve a mechanism to deal with stress. Amit Kumar, Partner and Managing Director, BCG, says there is a need for continuous monitoring of vulnerable accounts and pre-planning restructuring options, giving due consideration to the size, industry, indebtedness and business model of borrowers.
Abizer Diwanji says that most banks are worried about conserving cash. "Unless the banks actually try and turnaround the operation and create some enterprise value, these businesses will not attract anybody," feels Diwanji.
"We all are working towards it," says Rai, adding that banks have been working with corporates as a partner for decades. "There is too much focus on the 15 per cent stressed cases. The fact is that the rest 85 per cent are good despite a difficult operating environment. We always work very closely with promoters in resolving their issues," says Rai.
With early identification of stress, there is a possibility of accepting one time settlement (OTS) of loans with promoters. Similarly, there is an option of selling loans to asset reconstruction companies (ARCs). Some of the ARCs have acquired scale in the last decade and there is now healthy competition among them to grab good assets. For example, Edelweiss has a separate team for the operational turnaround of stressed companies. There may be cases where banks can hire the services of turnaround agents to effect an operational turnaround.
Shah of Trans Continental Capital believes that many businesses can be sensibly restructured rather than sending them to IBC. "IBC process won't result in good value unless banks approach it with a proper strategy," believes Shah.
Similarly, banks can also insist that promoters hive off some non core business or a part of the business to make the whole entity viable. Expert suggest that the IBC should be the last resort to restructure or recover the money. Shah says that the banks can achieve a better outcome by arming themselves with necessary information such as details of outstanding dues, collateral, legal agreements, stock of assets, etc. "This will give the insolvency professional a headstart and save valuable time. They can also work towards identifying potential buyers for the assets," says Shah. In the US and UK, banks prepare a pre-packaged plan where the deal is struck much in advance for the sale of business. The actual sale is executed on the commencement of the bankruptcy proceedings. It could help banks manage stressed cases in India as well - once a case lands up at IBC, the bankers have little control over the process.
"The erstwhile joint lenders forum (JLF) of banks needs to transform into the committee of creditors (CoC) under IBC. That is not happening in terms of the mindset. The whole approach of bankers in CoC has to change," suggests Diwanji.
Amit Kumar of BCG says that banks need to allocate substantial skilled resources to achieve recovery in a short time. "Banks may need assistance of external advisors to bolster internal resources and to fully utilise the IBC process," advises Kumar.
Many analysts feel that banks could aggressively take equity in businesses and use the operational turnaround agent to create more value in the business. The ARCs are experimenting with this model in India. "Banks have traditionally utilised equity instruments only to improve negotiating leverage with the promoters rather than long-term value creation tool," says Shah of Trans Continental Capital. Indeed, at some stage in future, the banks will treat their stressed assets division as a separate profit centre.
The new modern bankruptcy code aims to solve the banks' NPA problems faster than the earlier, defunct laws. Studies in India reveal that banks used to recover, on average, 25 cents to a dollar over a four-year period. Rashesh Shah, Chairman & CEO, Edelweiss Group, says that the recovery rate under IBC is going to be higher than 25 per cent. "Banks will also recover money faster," says Shah. The recovery rate will also improve gradually as the code evolves.
Globally, laws similar to the IBC have proved to be extremely effective in resolving stress. For example, recovery rate in the US is as high as 80 per cent. Banks get their money back in a year's time. In neighbouring China, the recovery rate is 40 per cent spread over a period of two years. The Indian bankruptcy code is also acting as a deterrent. Today, promoters are really scared of losing their business - Ruias of Essar Steel, Singal brothers of Bhushan Steel and Gaurs of the Jaypee Group are among those in the firing line. Many promoters are coming to the negotiating table. The bankers, who for long were scared of coming under scrutiny by taking substantial haircuts, are accepting whatever they are getting in terms of the pricing. The stringent provisioning requirement for NPAs and consequent lower profitability or losses is also cleaning up the years of bad assets in banks' books. "They actually have a good opportunity to make a fresh start. The legacy assets or exposure is getting cleaned up in the IBC process," says a consultant.
The government can do its bit by relaxing the bidders eligibility criterion to include existing promoters if they are not wilful defaulters - their absence is resulting in lower realisation for banks. For example, in the US the debtor retains the management control of the company and also has right to propose a restructuring plan. In India, Section 29A of the IBC disqualifies defaulting promoters from submitting a resolution plan. "If Section 29A of the code goes away, the recovery will be better," says Abizer Diwanji of EY India. Rai of Union Bank of India suggests promoters should be allowed after proper scrutiny, forensic audit and other checks and balances. "Value maximisation will happen if there is fair competition," he says.
The code has also been criticised for declaring a liquidation value, which is actually becoming a benchmark for bidders to put a price on the asset. The bankers are lobbying hard for not making the liquidation value public. "The correct way forward is the enterprise value," says Rai. Enterprise value refers to total value of the business instead of its market capitalisation or equity value. If banks can push the government and the RBI for an enterprise value, there are some chances of getting a good value for the bad assets. And that will surely make the IBC a win-win for all.