Banks may have to increase provisions on security receipts held against NPAs sold to ARCs

With the pandemic crisis expected to increase delinquencies in the months ahead, many banks have set aside sizeable provisions to tide over the stress. But aside from providing for bad loans, banks may also have to set aside additional provisions for their investments in security receipts (SRs), held against bad loans sold to ARCs (asset reconstruction companies).

Data compiled from the FY20 annual reports of banks suggest that many banks currently carry provisions at about 20 per cent of the book value of SRs held by them. While this is in line with the existing regulatory requirements, according to bankers, many lenders may look to increase these provisionsto provide additional cushion amid the Covid-led crisis. This is because there are now growing concerns over the expected fall in the valuation of distressed assets.

According to SBI’s annual report, the book value of SRs held by it stood at ₹8,761 crore, against which the bank has made provisions to the tune of ₹1,656 croreor about 19 per cent. Much of these pertain to the sale of bad loans made between 2014 and 2016. Of the total book value of SRs, about ₹6,000 crore are SRs issued more than 5 years ago (but within 8 years) as disclosed in the annual report.

According to J Swaminathan, DMD-Finance, SBI: “Of this ₹6,000 crore, about 90 per cent will mature between 2024 and 2026, hence, 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.”

Typically, asset reconstruction companies (ARCs) buy banks’ bad loans by paying a portion as cash upfront (15 per cent as mandated by the RBI), and issue security receipts (SRs) 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 in their books and make provisions based on the SR’s 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 underlying realisable value of the assets and the expected cash flows.

Recovery rate

The level of provisioning on SRs (see table) varies across banks – from 19 to 69 per cent. For instance, Bank of India holds about ₹1,593 crore of provisions against ₹2,300 crore of SRs (book value), while PNB holds just ₹144 crore provisions against SRs (book value) amounting to ₹1,400 crore. Axis Bank and ICICI Bank hold about 19 per cent provisions against their SRs.

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

Weak track record of recovery rate (30 to 40 per cent) in the past, coupled with expectations of sharp downgrades by rating agencies owing to fall in the value of underlying assets amid the pandemic crisis, may require banks to beef up existing provisions on SRs.

Currently there are 28 ARCs with the total value (cumulative) of SRs issued amounting to over ₹1-lakh crore.