Banks may be hit if debt converted to equity is not sold off in 18 months
The biggest drawback of SDR is that banks are not required to carry adequate provisions on their exposure, say analysts
Mumbai: Banks could face a large mark-to-market (MTM) hit if debt that has been converted to equity is not sold off in the stipulated 18-month period, Religare Capital Markets Ltd. warned in a note on Wednesday.
Religare analysts Parag Jariwala and Vikesh Mehta said that in the last five months, banks have evoked strategic debt restructuring in seven companies carrying total outstanding debt of 42,400 crore, as per media reports.
The strategic debt restructuring (SDR) scheme allows banks to convert loans into a majority equity stake in defaulting companies. The scheme, introduced by the Reserve Bank of India (RBI) earlier this year, requires banks to sell the equity within 18 months.The conversion of shares is done at fair value, (which is lower than market price or book value), or face value, whichever is higher.
“The biggest drawback of SDR is that banks are not required to carry adequate provisions on their exposure," the note said.
The equity shares held by the banks are exempt from any MTM hit for a period of 18 months and banks are required to find new buyers or promoters for the company within the period.
The equity shares will be marked to fair value or market price after 18 months irrespective of success or failure of the SDR.
If banks are unable to find buyers, the remaining portion of loans will slip into non-performing assets. In this case, stressed asset formation as well as credit cost, including the MTM hit, will be very high for banks, mainly as the accounts involved here are chunky, Religare added in the note.
An extended economic slowdown and stalling of infrastructure projects have pushed stressed assets (which include bad loans and restructured assets) to 11.1% of total advances as of 31 March, according to Reserve Bank of India’s (RBI) financial stability report released in June. To help banks with the process of reducing their stressed assets, RBI introduced the SDR rules in June.
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