Private banks take bigger hit on loan sales to ARCs

Attempting to shore up their balance sheets, 33 private and public sector banks sold loans worth Rs 14,877 crore to Asset Reconstruction Companies (ARCs) in 2015-16. These loans were sold for Rs 11,674 crore, implying a discount of 22 per cent on the net value of the loans, according to data compiled by Kotak Institutional Equities.

A closer look at these transactions reveals that private sector banks sold loans at much steeper discount rate to ARCs than public sector banks.

The 24 public sector banks for which data is available, the net value of all accounts sold was about Rs 11,067 crore in 2015-16. These loans were sold at a discount of 16 per cent, for Rs 9,322 crore to ARCs. In the previous financial year, the discount on similar deals was 11 per cent.

At the same time, private sector banks sold loans worth Rs 3,810 crore for Rs 2,347 crore — a discount of 38 per cent. In 2014-15, the sales consideration from such deals was 24 per cent lower than their net value.

Among public sector banks, State Bank of India led the charge selling loans worth Rs 6,981 crore and Rs 1,500 crore in 2014-15 and 2015-16 respectively for Rs 4,406 crore and Rs 1,007 crore. Among private banks, Axis bank sold Rs 1,676 crore worth of loans in 2015-16 for Rs 765 crore, implying a loss of Rs 908 crore.

But the actual losses that banks, both public and private, incur in such deals are likely to be much higher.

There are several possible explanations for the sharp differences in discount rates between private and public sector banks. For one, it is possible that private sector banks are being more aggressive in getting bad loans or potential bad loans off their books in order to shore up their balance sheets.

“Private sector banks are known to cut their losses quickly,” said a bank analyst at a rating agency.

Another possible explanation could be that most of these loans are in sectors which are in deep trouble. “It is possible that in the case of private sector banks, loans that have been sold to ARCs are in sectors such as steel where haircuts of a much higher magnitude are required,” said Vibha Batra, former group head of financial sector ratings at ICRA.

Madan Sabnavis, chief economist at CARE said, “It depends on what kinds of assets are being sold off. The discount offered will depend on the stickiness of the asset. Lower the rate of recovery, greater is the discount rate.” With an uncertain future, it makes sense for banks to offload these loans and recover some amount rather than worry about the uncertainty of payback.

Another possible reason why discount rates for public sector banks are lower could stem from the fact that over the past year, PSBs have been aggressively making provisions for bad loans. This would have brought down the net value of these assets significantly, reducing the discount rates. “It is possible that in the case of public sector banks, loans have already been provided for to a much larger extent. Hence, the haircut is of a lower amount,” said Batra.

At the aggregate level, 25 public sector banks made provisions to the tune of Rs 157,475 crore in 2015-16, up from Rs 82,566 crore in the previous year. By comparison, provisions made by 13 private sector banks increased to Rs 22,468 crore in 2015-16 from Rs 10,850 crore in 2014-15.

This data has two possible implications for private sector banks. First, it is possible that private sector banks are still making inadequate provisions for bad loans. Second, private sector banks are selling off loans in the early stages of trouble. The former explanation seems unlikely as according to a banking sector analyst, “the provision coverage ratio for private sector banks is better than that of the public sector banks.”

The latter and more plausible explanation is that private and public sector banks are selling off loans at different stages. It is likely that in the case of PSBs, loans that are being sold off are already bad in which case these banks have made significant provisions against them, lowering their net value in their books. This would, in turn, reduce the discount rates.

For private banks, it is likely that loans sold off to ARCs are in the early stages of trouble and thus adequate provisioning has not been done to account for potential losses. This seems plausible as the Kotak report mentions that loans sold are a mix of standard, NPL and loans written off by the banking system.

“Loss on sale of NPA would depend upon specific provisioning against the asset and duration for which it has remained NPA. So, if an NPA is sold early on, provisioning may be low and hence may result in higher losses on sale,” said Anuj Jain, assistant general manager, CARE Ratings.