Future provisions: The skeletons in banks’ closet

The good, the bad and the ugly….the banking sector has had its fair share of all, over the past year. Banking stocks have zoomed 40-50 per cent in one single day, euphoric over the Centre’s ₹88,000-odd crore capital infusion into public sector banks; only to fall like dominoes, as one of the biggest scams unravelled in the second largest state-owned bank.

But it has not been these big daddy events alone that have stirred up the sector. The ‘good cop, bad cop’ routine of the RBI has only left markets more confused than ever.

The RBI’s new framework for stressed assets released in February nudges banks to act quickly by setting a time line for resolution and withdrawal of the old restructuring schemes. This will lead to around ₹2 lakh crore of loans coming under the framework. For banks, this would imply moving out of benevolent provisioning requirements.

But that wasn’t all. In a surprise move over the last week, the RBI sought to soothe ruffled feathers, relaxing the provisioning norms for large accounts under IBC. Banks choosing to make use of the dispensation can optically report far better earnings than anticipated earlier. But investors should not get carried away by stellar ‘bottom-lines’ and sharp earnings recovery in the March quarter.

Whatever the crisis-mitigating steps, eventually, banks will have to provide for large haircuts on accounts under the National Company Law Tribunal (NCLT). While a few cases are seeing good recovery, it is still early days to gauge the success of the IBC. Aside from the steel accounts, finding bidders for some of the other accounts referred to the NCLT is proving to be a challenge. All of this is likely to keep provisions elevated for banks in the current fiscal.

Our analysis of bank-wise data (information taken from company presentations/post-result transcripts) on IBC cases and loans under restructuring reveals that provisioning is set to rise sharply for banks in 2018-19. The RBI’s recent dispensation is nothing more than an optical treat.

IBC: Provisioning, haircuts and recovery

Empowered by the new NPA ordinance, the RBI, in June last year, went into fire-fighting mode, identifying 12 big accounts for insolvency under the IBC. Constituting a fourth of the system’s bad loans or around ₹2.8 lakh crore, these big-ticket loans have been under focus over the past several months. For most of these accounts (barring Era Infra Engineering), the time line for resolution under the IBC is fast running out (deadline for resolution falls in April-May). The RBI also came out with the second list of defaulters — 25 accounts amounting to around ₹1.5 lakh crore — to be referred to the IBC. For most of these cases admitted under NCLT in December-January, the time line for resolution would be up in September-October this year.

While outside of the RBI’s lists too, there have been over 600 cases filed for resolution under NCLT, the first two lists take care of ₹4.5 lakh crore of bad loans out of the ₹9-odd lakh crore in the system. Hence, for banks, the successful resolution of these accounts is critical. Until then, banks have to adequately provide for these loans.

The RBI had stipulated elevated provisioning requirement for cases referred to the NCLT — 50 per cent provisions for secured and 100 per cent for unsecured exposure when cases are admitted under NCLT and a further 100 per cent for those cases that fail to get resolved under the stipulated time — 180 days with 90 days extension.

This is where the RBI has offered some respite to banks. Provisioning for the secured portion of the large accounts (from the RBI’s first and second list) up to March 31, 2018, has been brought down from 50 per cent to 40 per cent. So what does this imply for banks?

A look at the bank-wise data reveals that most banks appear to have met their provisioning requirements (50 per cent or over) on the first list of NCLT cases referred by the RBI.

Banks, thus wanting to cushion the blow, can make use of the RBI’s dispensation and write-back the excess provisioning to pad up their earnings. Data suggests that some banks could write-back ₹1,000-3,000 crore of provisioning on both lists in the March quarter.

Hence, investors will need to be cautious of robust earnings and read the fine print after the March quarter results.

Remember, provisioning on the NCLT cases on the RBI’s first and second list will go back to 50 per cent in the June quarter. So what happens in 2018-19?

A lot hinges on the success of recovery of these cases, as this will determine the possible write-backs (the real ones!) and additional provisioning that banks need to make. Steel accounts that constitute a little over half of the first list are seeing ample interest from bidders (see table). But there are still a few hurdles to cross in most of these cases. Also, the other cases in the infrastructure, textile and ship building space are finding few bidders, with haircuts to lenders at a steep 60-70 per cent.

On the second list, our discussion with a number of bankers, asset reconstruction companies and resolution professionals reveals that there may be even fewer bidders, and steeper haircuts of 70-80 per cent. Bankers feel that an additional 10-20 per cent provisioning may be required on such accounts in 2018-19 (over and above the current levels). On a conservative basis, this amounts to close to ₹14,000-16,000 crore of additional provisioning in 2018-19, for such NCLT cases alone. If the haircuts are steeper, then the provisioning requirement could only inch up further.

Restructuring schemes: The end

There is yet another sword of Damocles hanging over banks’ heads. Fondly referred to by bankers as ‘The February circular’, the RBI’s revised framework on resolving stressed accounts is expected to result in steep rise in provisioning in the coming quarters. Essentially, the RBI has done away with all the old restructuring schemes — Corporate Debt Restructuring Scheme (CDR), Flexible Structuring under 5:25 scheme, Strategic Debt Restructuring Scheme (SDR), change in ownership outside SDR, and Scheme for Sustainable Structuring of Stressed Assets (S4A).

All roads lead to IBC

With the scrapping of all old restructuring schemes, the IBC appears to be the endgame for banks' bad loan saga. A look at the status of some of the big accounts reveals that the resolution process is still riddled with multiple challenges. Tackling the accounts down the pecking order can be a challenge.

Banks will have to begin resolution process on an account as soon as it is classified as an SMA-0 account — where payments are overdue by 1-30 days — by any one bank within a consortium. In respect of accounts with aggregate exposure of ₹2,000 crore and above, lenders will have to draw up a resolution plan within 180 days from March 1, 2018, (or default date as the case may be), failing which banks will have to file for insolvency under IBC.

On the provisioning front, what this implies is that accounts restructured under the new framework will attract provisioning as per the NPA norms. Under RBI’s norms, a substandard asset that has remained an NPA (interest/principal remains overdue for a period of more than 90 days) for less than or equal to 12 months carries 15 per cent provisioning. This inches up to 25 per cent the following year; 40 per cent for the next two years and finally 100 per cent after four years.

Based on the bank-wise data on existing restructured accounts, we believe that there could be a steep rise in provisioning in the next few quarters.

For one, the ₹1.7 lakh crore addition to NPAs in the first nine months of the current fiscal has mainly been from banks’ restructured accounts. For instance, of the ₹19,394 crore of corporate slippages for SBI in the December quarter, the management stated that about ₹10,000 crore each had come from standard restructured accounts, and SDR/S4A respectively. For Bank of Baroda, ₹3,000-odd crore of accounts had slipped from restructured to NPA in the December quarter. Thus, we believe a large portion of the existing schemes will attract higher provisioning.

Two, given that banks have been unable to arrive at a resolution in most of these accounts, it is likely that they will get referred to the IBC process, after the 180-day time line expires. While for now, the RBI has not specified accelerated provisioning (50-100 per cent as in the case of the first and second list of NCLT), bankers feel that the RBI may choose to bring in stringent provisioning norms for these accounts as well. Also, given the low chances of recovery, banks may have to take far higher haircuts in these accounts.

Three, much of these accounts and other stressed accounts are in the power sector, where resolution is proving to be a challenge. Of the ₹21,823 crore corporate slippages for SBI in the December quarter, ₹14,422 crore was from the power sector. Of its watchlist accounts of ₹10,300 crore, a little over a third still pertains to the power sector. For ICICI Bank (34 per cent of ₹19,062 crore of watchlist) and Axis Bank (67 per cent of ₹5,300 crore watchlist) too, a substantial portion of watchlist accounts pertain to the power sector.

While it may be difficult to put an accurate number to it, a back-of-the-envelope calculation — assuming a conservative ₹1.5 lakh crore of restructured loans falling under the new revised framework — would entail over ₹20,000 crore of provisioning initially based on NPA provisioning of 15 per cent. Given the large quantum of cases that will be referred to IBC eventually and large haircuts, for some banks there could be a huge erosion in their networth/book value over 2018-19.

SBI, PNB, Bank of India, Union Bank, Bank of Baroda, IDBI Bank are some of the PSU banks that have a significant portion of loans under various restructuring schemes. Among private sector banks, ICICI Bank and Axis Bank have a higher proportion of stressed assets, though they have a stronger capital base to weather losses.

The sharp rise in provisioning over the last three quarters has seen earnings of many banks slip back into the red. From about ₹40,000 crore in the June 2017 quarter, provisions for NPAs have risen to around ₹70,000 crore in the December 2017 quarter.

Going ahead, as the overall credit growth in the sector sputters back to life, it is the significant rise in provisioning that can erode earnings sharply. Investors need to brace themselves for yet another bumpy ride ahead.

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