Rs 40,000 cr question: Why banks were so eager to overlook the mess at Bhushan Steel

Bhushan steel, now facing a Central Bureau of Investigation (CBI) probe in connection with the Syndicate Bank bribery case, owes about Rs 40,000 crore to 51 banks, majority of which are public sector lenders. As a point of comparison, this is more than the aggregate capital the government infused in state-run banks in last three consecutive fiscal years through budgetary allocation.

Syndicate Bank Chairman S K Jain and Bhushan Steel vice-chairman and managing director Neeraj Singhal were arrested after Jain was caught accepting a Rs 50 lakh bribe from Singhal in exchange of extending a Rs 100 crore credit from Syndicate, which allegedly helped Bhushan service some of its overdue amount and this prevents a substantial chunk of its loans from slipping to the non-performing asset (NPA) category.

Under norms, a loan becomes a NPA when interest payments are overdue for a period of 90 days. As per the recent changes the RBI made in the norms, even before a loan account turns into an NPA, banks are required to identify incipient stress in the account by creating three sub-categories under the Special Mention Account (SMA),for overdue ranging between 30 and 90 days.

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Hence, according to bankers, Singhal chose to give Rs 50 lakh to Jain to get Rs 100 crore additional loan, so as to service some over due payments, to keep substantially larger chunk of loans, say a few thousands crores, standard (performing). This is because if a loan becomes NPA, then the whole game changes for the company. A declared defaulter will not get even a rupee more from banks.

According to bankers, who spoke on condition of anonymity, Bhushan was on the verge of defaulting some of its loans, with payment overdues stretching to the deadline.

Typically, if the repayments are delayed and the company’s financial health isn’t indeed in a good shape, banks do not extend further loans to the stressed borrower. Hence, to get a life saver for Bhushan Steel, Singhal had to bribe Jain through a hawala transaction. That’s about the bribe part.

But here is the other side of the story. The net debt on the books of Bhushan Steel, as of end-March 2014 stood at Rs 35,142 crore, implying that in just one quarter, the debt level saw an addition of Rs 5,000 crore, which came from leading state-run banks. Questionably, Bhushan Steel did not opt for a loan restructuring; instead it sought fresh loans to avoid a recast, for which the banks agreed.

Here are a few questions that state-run banks and rating agencies need to answer:

First, how did Bhushan Steel, which had significant repayment issues and faltering finance lines, manage to get large loans repeatedly from banks, including an estimated Rs 5,000 crore-Rs 6,000 crore loans in the June quarter?

Bhushan Steel was in poor financial health. For the quarter ended March, the company posted a net loss of Rs 19.57 crore as against net profit of Rs 280.21 crore in the corresponding period of last year. Sales declined 10.93 percent to Rs 2,399.73 crore in the quarter as against Rs 2,694.18 crore in the year-ago period.

For the full year, Bhushan Steel’s net profit declined 93.18 percent to Rs 61.96 crore from Rs 908.89 crore in the previous year and sales declined 10.05 percent to Rs 9247.82 crore. The company has not reported its June quarter earnings yet.

What is important here is that the reasons for Bhushan Steel’s financial ill-health were not necessarily attributable to genuine industry issues. The company reportedly operated without necessary permissions. It had faced a mining ban in Odisha and was facing several other operational issues.

In November last year, following an explosion occurred in the slag pit during the trial run of a blast furnace in Odisha, which killed three workers, Bhushan Steel was directed by the state pollution control board to not t start operations of the furnace until further directions.

The company allegedly flouted several safety and labour laws. According to a 7 August report in the Financial Express, Bhushan Steel had 96 cases against it for violating labour laws under the Minimum Wages Act, Payment of Wages Act and other relevant laws. Bhushan plant didn’t have the ‘Consent To Operate’ certificate from the Odisha State Pollution Control Board.

Some of the bankers do not rule out the possibility of massive fund diversions by the company from the stated end use of the loan. “There needs to be investigations into the fund diversion aspect, as to where exactly such substantial amount of money was used,” said a senior banker, who didn’t want to be named.

How could banks overlook such gross violations and continue funding the company, despite the fact that its cash flows were in stress? Were the risk-management units at these banks sleeping throughout? What were the inspection units of banks doing?

Notably, in another case involving the now-defunct Kingfisher, the CBI last week registered against IDBI Bank charging the lender from extending a Rs 950 crore loan to Vijay Mallya. CBI’s version on finding fault with the lender is important.

“There was no need for the bank to take the exposure outside the bank consortium when already other loans were getting stressed,’ Times of India quoted a CBI official in a 10 August report.

Secondly, how did rating agencies miss the deterioration in the financial health of Bhushan Steel, which has substantial exposure to banks, and didn’t flag caution until the last moment?

By definition, rating agencies are the assessors of financial system. The deterioration in the financial health of Bhushan Steel happened over a period of time.

Ratings assigned to the financial instruments issued by the firm enjoyed top ratings by various agencies. One of the rating agencies, Care Ratings, put the firm under credit watch after the arrest of Singhal.

To be sure, the loans of Bhushan Steel aren’t bad yet, but are indeed not in a good shape for several banks.

A timely warning by rate assessors could have, perhaps, helped some banks from further increasing their fund/non-fund exposure to the company.

In a way, one must thank Jain for taking the Rs 50 lakh bribe and CBI for digging out the dirt, thus bringing the whole issue to public.

Else, this could have gone on forever.

After all, it is the tax payers’ money.