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Corporate credit portfolio — Baking assets on the fire of securitisation

Venkat Ramaswami

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SRFESI) was definitely a strong indication that the corridors in New Delhi were waking up to calls from Wall Street. It is time for the wake-up signal to be strengthened by full articulations that will enable the country apply securitisation techniques to solve a few riddles in the financial system.

SRFESI was placed on the statute books in the belief that public sector banks and government-owned financial institutions are saddled with non-performing assets (NPAs) because of the lack of accountability of corporate borrowers who refused to repay the loans and interest thereon. Therefore, the Act empowers only the PSBs and FIs to initiate actions to restructure the debts that have become NPAs. Therein lies the tale of a one-sided legislation, which could have become a vehicle for national resurgence.

The data on corporate borrowings from banking and financial institutions present a different picture that make a case for a two-pronged legislation, which could transform the income statements and balance-sheets at the micro level, and India Inc. at the macro level, into stable investment-grade land.

A look at the Indian corporate credit profile vis-a-vis the banking portfolio. The present loan portfolio of all banks in India is approximately $155 billion, 90 per cent of which ($135 billion) is to corporates and private enterprises (mid-cap). The declared corporate NPA of banks averages nationally at around 10 per cent, or about $13.5 billion. However, informal prudential estimates are closer to 20 per cent. The corporate credit portfolio is distributed across the credit spectrum (see Table). Even if we write-off NPAs of about 20 per cent, as unscrupulous borrowings sanctioned with extraneous motives, dishonest management, lack of fundamental competence and other industry factors, we arrive at a workable portfolio of $ 42 billion. In addition to the above, if we focus on the low investment grade credits, we have a huge $ 63 billion of "sub-par and stressed" assets. One can find "fertile clay" hidden in this pile of `earth' where better justice can be rendered for the economic benefit of all parties involved.

How do we bake the earth to earthenware? How do we transform the sub-par and stressed assets into par assets? What are the tools? Securitisation as a generic concept offers a range of means to bake these assets. However, as always, one needs to use them in the right balance and at the right instance. India needs to combine management restructuring/disciplining along with securitisation techniques to add value in the sub-par portfolio."Whole Business Securitisation", with some modifications is an apt tool in the context.

Credit quality appreciation of even a significant portion of this sub-par corporate portfolio is the key to transforming India from an "on-the-cusp" non-investment grade country to a readily acceptable investment grade haven. Banking and financial institutions, which take a leading position in this initiative, will be buying themselves a premium position in the market. Is this transformation process worth playing for global institutions? Yes. The English-speaking nation has quality human resource, solid macroeconomic fundamentals, a globally accepted democratic political system, a developing capital market, a stable legal system, a good complement of natural resources, and global competitiveness in major industries. The missing links are systemic changes to achieve the right balance in applying the "carrot and stick" approach to the financial and credit markets.

A look at the loans that became NPAs and the following key facts.

  • One, the lending institutions did not do a competent job of project evaluation and appraisal of needs. This continues on a smaller scale in some sectors, notably the bubbling home mortgage sector;

  • Two, historical political influence and abuse of directive lending policies in major nationalised financial institutions created a fictitious advance portfolio with no intentions of recovery;

  • Three, having lent the money, the bankers sat back without monitoring the real loans till they became NPAs. This clearly spells an `urgent' need for banks to implement risk management systems of global repute;

  • Four, in many cases, they were not able to help borrowers who were struggling with high interest rates in a falling interest rate environment with timely offer of debt restructuring. This speaks well of the incentive systems in PSBs and banks, in general, where the penalty of action is often more severe than inaction, a typical characteristic of the `elephant' economy;

  • Five, the lenders did not understand that globalisation could mean fatal blows for their customers compared to the overseas competition if their financing cost did not match that of competition, who could borrow at one-third the cost of Indian borrowers;

  • Six, of late, the so-called proactive banks were reaping trading and arbitrage profits by riding the treasury curve at the expense of "traditional banking business" — credit appraisal, monitoring, credit risk management and recoveries.

    Corporations, which are centre-stage in this scenario, and some of the other excluded institutions, are the best parties to take ownership of the situation. Hence, it is tragic that SRFESI has been enacted keeping only the interests of PSBs and FIs in mind. Restricting such applicability of securitisation techniques under SRFESI to the public sector financial institutions is neither fair to the Indian industry nor is it in the long-term interest of survival of Indian financial institutions. Today, armed with the SRFESI, the PSBs are offering restructuring and reducing interest rates from 15 per cent to 10 per cent when their competitors abroad can borrow at 4-5 per cent.

    Risk premiums charged by banks in India are not market-assessed and, in most cases, result in overcharging, which reflects the relative immaturity of credit market. What will such negligent overcharging of risk premiums will do for an industry on the upswing now? A look at the steel industry.

    The steel industry is recovering from global over-capacity. The EU and the US have downsized their industry. China's imports are growing by the day. Reconstruction after Iraq will increase demand. Demand within India is also catching up with capacity. Additions in capacity, even if planned now, will take three-four years to show results.

    In India, steel-manufacturing companies are mired in debt. If debt restructuring of these companies is left to public sector lenders through the popular corporate debt restructuring (CDR) mechanism, they will be barely able to service the reduced rate of 10-13 per cent interest on their loans, even as their global competitors laugh all the way to their banks with a 4 per cent interest rate on their borrowings.

    When global demand-supply balance is restored in four years, many Indian borrowers will become NPAs. If this is the fate of steel industry borrowers, one can imagine the fate of other less competitive industries.

    And the paradox deepens when there are potential openings for financial institutions to tap into the global financial pool with structured techniques that will enable them to be globally competitive in lending to at least select clients if not a broader audience. This is just one example of a negative externality not enabling a level-playing field for financial institutions and corporates. To keep things in perspective, one has to clarify that some of the industries are in their present plight partly (or as some bankers would say `mostly') due to lack of financial discipline and overtrading. Not to mention the systemic paralysis in PSBs fostering indecision, it is essential that a solution be addressed in the national interest for the following reasons:

  • Structurally, such shocks (disparity in financing costs and its impact on end operating profitability) are first felt by manufacturing and other production-oriented firms and corporations before it ripples into the financial services sector in a developing economy.

  • Therefore, banks and financial institutions have to keep their eyes and ears wide open to receive these signals from the economy and be proactive in playing the game along with the industry at least in their own selfish interest of surviving, if not in the ideal state of serving the industry.

  • For these reasons, it makes sense for SRFESI or similar legislations to provide for corporations to take the initiative on such financial techniques to tap the market for globally competitive funds, rather than wait for the banks and financial institutions to realise the same.

    The system should allow corporations and other, more nimble, banking and financial institutions to effectively tap into the securitisation techniques to link as appropriate into the global financial pool and to restructure debt. This might at least allow Indian industries to compete nationally and globally to raise finance in par with market. Further, it might kick-start the financial institutions to clean up their acts.

    Examining the Central coffers makes an even more urgent case to amend SRFESI into a broad-based Act. The Government is not in a position to finance all the infrastructure projects because of the fiscal profligacy of the past. And the private sector is not keen to step in either, not with the kind of financing offered by the public sector institutions.

    Turning the tables might be easy if the government facilitates market linkages between consumers and producers without its intermediation. It can do so by creating a level-playing field that encourages and enables private enterprise to undertake these projects.

    To catalyse private sector/efficient investment interest in infrastructure projects, funding must be made available at competitive Libor/Mibor plus rates. A common problem with India as a country and many of the entrepreneurial firms there is that they are predominantly in the non-investment grade land, which hurts them when trying to access national and global finance.

    By liberating the playing field and appreciating global technology, there is not much to be lost and a lot to be gained. The above and more can be included in a separate legislation or as an extension to SRFESI. Broadening and clarification of the scope in the above aspects will induce private sector and foreign banks to bring their expertise in structured deals and encourage corporations and private enterprise to enter the infrastructure market. Effective de-linking of the infrastructure expenditure from the national budget will place India Inc. on a steady growth path and pave way for profitability eventually.

    One cannot forget that India has a whole host of demographic, economic and political issues to deal with in addition to financial sector reforms to achieve the status of a developed country. If without deliberating on who is at fault for past actions, the corporate, legislative and financial communities can get their acts together as a nation and focus on the business of banking, one can be reasonably sure that the country is confirming its seriousness in reforming the financial services sector.

    (The author is a credit portfolio structurer with an investment bank in New York. Feedback can be sent to ramanswamy@hotmail.com)

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