Bad loans sold to ARCs: Banks may have to increase provision for security receipts

Banks may face a new dilemma. They may need to raise the provisioning not just for expected bad loans, but also for the NPAs they have sold to Asset Reconstruction Companies (ARCs).

Data compiled from the FY20 annual reports suggest that many banks have provided about 20 per cent of the book value of the security receipts (SRs) they hold against bad loans sold to ARCs. While this is line with the regulatory requirement, according to bankers, many lenders may look to increase the provisions as there are now growing concerns over the expected fall in the valuation of the distressed assets as the Covid pandemic rages.

Typically, ARCs buy banks’ bad loans by paying a portion in cash upfront (15 per cent, as mandated by the RBI) and issuingSRs for the balance (85 per cent). At the time of recovery, banks get their share of the proceeds (85 per cent) after ARCs deduct their management fees. 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. “We are currently in the process of reviewing the recovery ratings assigned on the existing SRs, which will be completed in a month or so. We do expect recovery to be impacted over the next year in some cases. Some accounts that are already under the IBC may see buyer interest waning over the coming year. Hence, the recovery could be delayed from what was expected earlier. In terms of SRs, we expect those that are maturing within one to two years (nearing the eight-year threshold) to be impacted the most, where rating downgrades could happen in the coming months,” says Abhishek Dafria, Vice-President and Group Head, Structured Finance, ICRA.

According to the SBI annual report, the book value of the SRs held by it stood at ₹8,761 crore, for which it has provided ₹1,656 crore, or about 19 per cent. Much of this pertains to the sale of bad loans between 2014 and 2016.

Of the total book value of the SRs, about ₹6,000 crore worth were issued more than five years ago (but within eight years) as disclosed in the annual report.

According to J Swaminathan, Deputy Managing Director - Finance, SBI: “Of this ₹6,000 crore, about 90 per cent will mature between 2024 and 2026, hence, the impact if any of the current pandemic on this portfolio may not be much. But as a prudent measure, we are looking to make additional provisions (over and above regulatory requirement) on these SRs.”

Varying provisions

The level of provisioning on SRs (see table) varies across banks. 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.

According to an Axis Bank spokesperson, “the provisions held on SRs represent the provision for depreciation determined based on the difference between the book value of SRs and their latest NAV provided by the ARC.”

Currently, there are 27 ARCs with the total value (cumulative) of SRs issued exceeding ₹1-lakh crore.