Auction-pricing NPA sale

This year the Nobel Prize in Economics went to economists who worked on auction pricing. Here in India, we are tinkering with various mechanisms to sell NPAs — 5:95, 15:85, Swiss Auction, one-time settlement through Swiss Auction and so on.

Bankers know what to do, but fear of a post facto witch-hunt is hurting the decision making process. Bankers are naturally worried about getting a fair price for the sale/settlement of a loan. This is further hampered by the lack of adequate avenues for capital to purchase/finance the NPA acquisition. Please note it is lack of avenue and not lack of capital or demand. Unless we have competitive pools of capital vying to buy NPA, no amount of tinkering will lead to fair price discovery.

Hitherto the NPAs have largely been sold to ARCs only and mostly not for cash consideration, which means that the sale price was not a “true sale” since ARCs could pay through security receipts (SR). SR is an instrument that says — “we will pay you IF we recover some money” — a sort of participatory note. And in the meanwhile, you will continue to pay us a fee for our recovery efforts. The most recent RBI data available on outstanding SR gives us some insights on how this has played out.

The assumptions

As of June 2019, ₹1.46-lakh crore of SR were issued and ₹12,906 crore redeemed. Since year-wise issuance and redemption data is not available, we will work with some assumptions.

As recovery of NPAs take time we generously assume all of the recovery in June 2019 pertains to SRs outstanding in June 2016 of ₹79,000 crore. During this period (2016-19), the ARCs would have charged ₹6,320 crore as management fees at 2 per cent on ₹79,000 crore. Assuming this came out of the total recovery, the gross recovery would be approximately ₹19,226 crore.

Of the ₹79,000 crore of SRs issued, if we again, generously assume that 15 per cent cash was paid upfront by the ARCs, the banks would have received say ₹11,850 crore upfront. Hence on the book value of assets sold (₹2.37-lakh crore as of June 2016), recovery net of fees has been ₹24,756 crore (₹12,906 crore + ₹11,850 crore) translating to just approximately 10.41 per cent recovery on book value of loans sold until June 2016. Since year wise issuance and recovery data is not available, these are approximations based on assumptions above.

In this context, if a banker were to be told to take a decision to sell loans at 15-20 per cent of book value, they will baulk at it. Asset valuers’ reports, which are of questionable quality and far removed from reality and concepts of time value of money, further hamper the decision making to sell at such prices. Banks with ₹1.46-lakh crore of SRs are sitting in their treasury and not much is known about the value of these! Once again these are valued-basis “ratings” by rating agencies on a different scale altogether.

Therefore, bankers are constantly tinkering with various price discovery modes and asking for rebids.

The best way to achieve true price discovery is to open up the buy side and enable a clear path for capital to flow for purchase of NPA. Foreign funds (FPIs) and Alternative Investment Funds (AIFS) must be permitted to purchase NPAs and compete with the ARCs. Then competitive capital flows will naturally gravitate to fair price discovery on loan sales.

The RBI had even contemplated this in a consultative paper. The sooner this is settled the better it is for the banks to “get on” with their job of cleaning up and focus on credit creation in the economy. To ensure that bankers operate without fear, a process may be defined as well for price discovery.

Finally, the government and Tax Department need to heed to the taxation of gains or such recovery, which is unclear and will depress prices of loan sales.

A co-ordinated action between the RBI, government and SEBI is the need of the hour to open up the pathway for organised institutional capital to purchase NPAs.

The writer is the Managing Director of Kotak Investment Advisory Ltd (KIAL). Views expressed are personal