Bad assets: The role of whistleblowers

HDFC Bank is believed to have sold 80% of its Rs.550 crore exposure to a stressed asset to an ARC but other banks that lent to this account haven’t done so. Photo: Bloomberg

HDFC Bank Ltd’s gross non-performing assets or NPAs in the March quarter dropped marginally from 1% to 0.93%. They would have remained at the same level had the bank not sold a bad asset to an asset reconstruction company (ARC).

HDFC Bank is believed to have sold 80% of its Rs.550 crore exposure to a stressed asset to an ARC. Such assets are sold at a discount and at least 15% of the price is paid upfront in cash, while the rest is settled through the so-called security receipts over a period of time. So, a bank which sells bad assets to ARCs needs to book losses partially. HDFC Bank’s total provisions in the March quarter more than doubled to Rs.576.7 crore from the year-ago quarter. This is probably the new private bank’s largest exposure to a bad asset. Despite this, both gross NPAs as well as net NPAs of HDFC Bank are low by industry standards and it remains one of the most valued banks by virtue of profitability, quality of assets and adequate capital.

Since HDFC Bank was part of a consortium of banks that had lent to the particular company, why haven’t other banks declared this account as an NPA and provided for it? Is HDFC Bank being over-cautious and, in the process, unfair to the borrower? Or, are other banks doing something that is not prudent? If indeed other banks are sweeping the dirt under the carpet, HDFC Bank has played the role of a whistleblower in this case.

In his conference call with analysts on the fourth quarter earnings, the bank’s deputy managing director, Paresh Sukthankar, explained that this was a “single corporate NPA, which had been an overdue account in an SMA-2 (special mention account)” category and that the bank’s exposure was “somewhere between 1.5% and 2%” of the company’s borrowing. “…Since we were not completely convinced with the bankability of increasing exposure… we felt that it was prudent to sell the non-performing asset to an asset reconstruction company.”

He also said that it was an isolated instance and that the bank did not have similar exposures. “We might have exposures in that industry, but they are certainly not of the credit concern or of the credit rating that this particular account had,” Sukthankar told analysts, without naming the particular company or the industry to which it belongs. A banker is not supposed to talk about individual loan accounts.

There has been speculation about the identity of the company and many believe that the accounts belong to a large over-leveraged and diversified industrial group, based in western India. A recent report of Credit Suisse which mentions that bad assets of Indian banks are likely to rise, driven by the stress in the steel sector, talks about two large accounts that have been classified as NPAs by private banks while other lenders continue to treat it as a standard asset. One of them is Essar Steel Ltd.

The so-called special mention account or SMA-2 category refers to those accounts where principal or interest payment is overdue for 61-90 days. This is the third stage in an account’s progress to becoming an NPA after SMA-0 (where the principal or interest payment is not overdue for more than 30 days but the account is showing signs of incipient stress) and SMA-1 (where principal or interest payment is overdue between 31-60 days). Once a borrower is not able to service the account for 90 days, it becomes an NPA and the lenders need to set aside money for such an account.

Once a loan account worth Rs.5 crore or more is classified as SMA, banks are expected to report all relevant data to the Central Repository of Information on Large Credits, set up by the Reserve Bank of India (RBI). In accordance with RBI norms, when a loan account starts showing signs of stress, bankers are required to create a Joint Lenders’ Forum (JLF) to chalk out an action plan. The creation of the JLF is mandatory when a relatively large account—with an exposure of at least Rs.100 crore—is categorized as SMA-2 even as the lenders always have the option of setting up the forum for smaller accounts.

If the existing promoters are not in a position to bring in additional money or take any measures to regularize the account, the JLF can explore the possibility of getting new investors in the company in consultation with the borrower. The account can be restructured if it is prima facie viable and the borrower is not a wilful defaulter, who has resorted to fund diversion. If these two options are not feasible, the JLF can initiate a recovery process. All decisions of the JLF need to be endorsed by a minimum of 75% of lenders by value and 60% of creditors by number.

In this particular case, I understand the borrower bargained for more money but HDFC Bank was not convinced by its projections of business volume, cash flow and profitability and decided to walk out from the consortium. By doing this, has it denied the company a chance for resurrection?

The total exposure of the banking system to this particular account could be around Rs.40,000 crore and since some of the banks have large exposure to this account, it is not easy for them to classify this as NPA as they would need to take a bigger hit on their balance sheets than HDFC Bank. Is this a reason for taking a lenient view and not classifying the account as NPA or do they really believe this company stands a genuine chance of doing well after getting fresh money? Probably, there is an element of subjectivity in the entire process. However, classifying an account as NPA is not really a bank’s “decision”; it is an accounting requirement if there are overdues of 90 days. Since banks deal with public money, they need to remain as sensitive to a borrower’s requirement as in protecting depositors’ interests.

Tamal Bandyopadhyay, consulting editor of Mint, is adviser to Bandhan Financial Services Pvt. Ltd, India’s newest bank in the making. He is also the author of Sahara: The Untold Story and A Bank for the Buck. The writer’s Twitter handle is @tamalbandyo