With The Tata Steel-Bhushan Steel Deal, Is India’s Bank NPA Cycle Turning A Corner?     

In his 2017 book, a compilation of his speeches and articles, Raghuram Rajan, the ex-governor of the Reserve Bank of India (RBI) mentions the word bankruptcy 25 times. Most of these were laments on how India did not have an effective bankruptcy code provision. The Insolvency and Bankruptcy Code (IBC) 2016 got the Presidential assent in May 2016, just months before Rajan demitted office.

Rajan did not stay long enough at the RBI to see the IBC proceedings unfold. But the current bosses at the RBI and more so those at the beleaguered Indian public sector banks (PSBs) will be waiting eagerly for the week of 25 March to dawn, with the first big case under the provisions of this law close to a resolution. Tata Steel is all set to buy Bhushan Steel, with a Rs 36,000 crore offer, allowing it to take control of the five million tonne plant of Bhushan Steel in Odisha.

Bhushan Steel was in the first list of the 12 companies, which the RBI’s Internal Advisory Committee (IAC) referred for immediate reference under IBC in June 2017. These 12 accounts at that point represented almost 25 per cent of the Rs 800,000 crore outstanding non-performing assets (NPAs) of the Indian banks, chiefly PSBs. Since then more cases have reached the National Company Law Tribunal (NCLT), the dedicated body under the IBC looking into the resolution of the Himalaya of bad debt. Right now, the NCLT is looking into the bad debt of more than three dozen large companies, which collectively owe more than Rs 400,000 crore to the banks.

The Tata Steel bid for Bhushan Steel will lead to the lenders – State Bank of India (SBI) is one of them –getting back almost 60 per cent of the advances made to Bhushan Steel. This resolution – yet to be approved by the NCLT and the Competition Commission of India – will be the first-of-its-kind for a large case under IBC. There is one legal matter pending as well, where Larsen & Toubro (L&T) has petitioned to be considered as a secured creditor and not an operational one. Once resolved, this case will have several salutary effects on the Indian banking system and the ambient discourse.

Firstly, this resolution is a resounding slap to the political media which has long equated loan write-offs to loan waivers, out of either abject incompetence or malicious reporting intent. Secondly, it will be a boost to the resolution professionals working on the other NCLT cases, several of which remain mired in negotiation complexities and legalities. Thirdly, in the long run, successful NCLT resolutions should help bring down credit spreads for the corporate borrowers – one of the components of the difference between the borrowing rate and the policy rate being the risk premium banks charged as they had no recourse to an IBC like system earlier.

But most importantly, there will be the realisation in the Indian businesses to support projects which demonstrate some economic value. For many projects, mainly infrastructure ones, the firm can have positive operating cash flow, but it is not sufficient to pay back the interest on the debt. Without a bankruptcy law, such projects would find it difficult to attract incremental credit or other financing means and often languish, until they were left orphaned by the promoters. With an IBC resolution at hand, the possibility that banks taking a haircut but not letting a viable project die, will get stronger.

By corollary, the IBC mechanism also empowers the banks to stop financing projects, which have either become unviable or will become so over a period of time. Until now, the lending banks would simply kick the can down the road for such projects – they would keep evergreening the loans or pass the buck to a different set of management in the case of the PSBs. With an effective IBC mechanism at hand, lenders can take early action against such debtors once reasonable doubt of the project faltering is established.

But the IBC process did not get off to a pretty start last year. Once the Narendra Modi government notified most of the operational provisions in July and August 2017, the first IBC resolution was not the best advertisement of the system. Synergies Dooray, an automotive parts maker, was the first IBC resolution in August 2017, which led to lenders taking a 94 per cent haircut on their exposure. There also were allegations of promoters trying to game the system, buying back their assets for next to nothing through the bankruptcy process.

This case led to a burst of scepticism in the business media on the effectiveness of the IBC itself. The government came under criticism for letting the supposedly errant promoters through the back door. The reaction was swift – an ordinance was passed in November 2017, barring any entity whose accounts were non-performing for over a year would not be allowed to participate in the resolution plan. This effectively barred willful defaulters – the promoters of the firms classified as NPAs – from taking back the control of their businesses.

This step was widely considered highhanded by the economists, but ultimately the political perception and the need to demonstrate action against the old-money, entrenched promoters won the day. Raghuram Rajan had once remarked that India had only sick companies, no sick promoters. This ordinance by the government effectively tried to change that perception. The resolution process for the first 12 accounts started picking steam soon after this ordinance, going into the New Year.

As of now all the 12 initial cases have made some progress.

Of these 12 cases, Bhushal Steel and Amtek Auto are close to resolution. Alok Industries, Era Infra and Lanco Infratech have moved the slowest. The other seven cases are at different stages of resolution, subject to legal challenges. Of these Monnet Ispat and Jyoti Structures may be earliest ones to see closure.

Several other cases are currently being heard in NCLT. A summary of expected haircuts across various other NCLT cases is as below:

As the resolution process continues, several questions crop up. Should the government look into the cases where lenders are taking a steep 70 per cent + haircut? Did these promoters really invest the money in the projects they borrowed? Was there any diversion of funds? Were any or all of the capital assets overstated? Or was this the case of really poor management? Some of these companies are very old, so it cannot be that the business just went sour suddenly. Again, this will be a political decision to make.

The insolvency process itself has put forth issues which will perhaps need another ordinance by the government soon.

Firstly, each case is being met by a host of legal challenges, either at the NCLT or at the Supreme Court. Because the resolution process is more customised than what’s mandated for liquidation, these challenges are likely to continue. We have yet to see any company face liquidation via the IBC act.

Secondly, the case of Ultratech Cement bidding for Binani Cement outside the NCLT process and with a far bigger bid compared to those received by the resolution professional, needs addressing. Should a promoter be able to cut a deal outside the NCLT process? What if this deal is much better than the bids received in the process? While the external party may not have any related party transaction with the promoter, the assets going back to the promoter via a circuitous route is always a possibility in this case.

Thirdly, the clause that a bidder cannot be considered by the resolution professional if convicted in an offence, which has a prison term of two years or more is an issue to be addressed. In the case of Electrosteel Steels, Renaissance Steel has used this provision against Tata Steel and Vedanta, which have faced convictions settled through fines in United Kingdom and African countries respectively. Although the said convictions were outside India, will this provision derail the Bhushan Steel resolution as well?

Fourthly, should the deadlines mandated by the IBC hold or the resolution professional agree to late bids which maximise the value of the assets? Liberty House bid for Bhushan Power and Steel was rejected on the late submission ground, but Liberty House has challenged this. The NCLT direction in this case will set an important precedent.

Fifthly and lastly, the issue of promoters or related parties unable to bid for their assets hangs sword. While the amendment to the IBC expressly debars this, creating new entities with promoter support and know-how of the stressed assets always remains a possibility.

If all the large cases were to be resolved, the gross NPAs in the banking system should decline from an estimated 9.5 per cent to about 5 per cent (source: brokerage reports). It has taken almost two years since the IBC was promulgated to instill some confidence in its working and effectiveness. If 23 March 2018 was a big day for the Indian banking with the Bhushan Steel NPA resolution, the April to June quarter may well prove to be the most important quarter for economic growth since the Modi government took over.