_Real Estate – A Potential Bailout Catalyst for PSU Banks

Many Public-Sector Banks (PSB) in India are saddled with NPA burden and many are finding it difficult to come out of this quicksand. Given the high amount of fiscal deficit, it is difficult for the government to pump in capital on a regular basis. In such scenario, alternative models of bank recapitalisation must be explored. One of the possible options is the monetisation of their commercial real estate assets.

August 24, 2018

Background

Many public-sector banks (PSBs) have debilitated due to the protracted impact of Non-Performing Assets (NPAs). NPAs in Indian banking industry have crossed over Rs. 10 lakh crore or 12% of total loans. Some banks are finding it difficult to come out of this quicksand as the NPAs have crossed 25% of the total advances. As a consequence, they have to divert significant amount of their earnings towards provisioning and write-offs of NPAs. Several banks are now in a precarious situation as their capital reserves have come under severe pressure and are in dire need of capital infusion.

We have seen in the recent past that the government has tried to bailout banks on several occasions through various capital infusion exercises under the ‘Mission Indradhanush’ programme.

The intention of capital infusion was to kickstart the credit growth by building on capital reserves required for lending; rather, it has gone into writing-off loses incurred from non-performing assets rendering the capital infusion exercise futile. Many banks do not have capital buffer even to meet the capital adequacy norms, forget setting aside capital for lending.

Owing to such a scenario, the Reserve Bank of India (RBI) has put several banks with a weak capital reserve position under Prompt Corrective Action (PCA). PCA places several restrictions on the bank’s lending and expansion activities. The bank is not allowed to come out of PCA unless it is able to show significant improvement in its capital reserves and capital adequacy ratios.

Due to high fiscal deficit, the government is not in a position to bailout banks on a regular basis. Instead of using taxpayers’ money for bailout, the real estate assets of the bank in the form of headquarters, zonal offices, operations office and other physical assets can be used. The banks can look at the sale of assets or the sale and leaseback models or listing of assets through Real Estate Investment Trusts (REITs) to raise capital by monetisation of their assets.

Growing investor activity in office assets

If we look at the burgeoning investor interest in the Indian office market, many global Private Equity (PE) giants, pension funds, Sovereign funds and Wealth funds (like Blackstone, Brookfield, CPPIB, GIC, ADIA, etc.) are fighting out an intense battle to acquire rent-yielding mature office assets and have collectively invested Rs. 57,300 crore since 2011. The investments in office space have grown by leaps and bounds; almost 8 times since the beginning of the current decade, from Rs. 2,033 crore in 2011 to Rs. 15,448 crore in 2017. In the first half of 2018, nearly Rs. 19,100 crore has already been invested. The full year numbers would be much higher than 2017. Since 2011, 89% of the investments in office assets have been made in the ready office assets class. The investors are cautious and seek to avoid development and execution risk and prefer only mature assets.

This exuberance amongst investors has led to capitalisation (cap) rates for good quality rent-yielding office assets to contract from 10–12% in 2011 to 7.5–8.5% in 2017. There are very few mature assets remaining in the country and investors are trying hard to scout for new opportunities for investing in the office space.

While the government and the regulators have done their best to make the norms for listing of the Real Estate Investment Trust (REIT) friendly, the country has still not witnessed a single REIT listing. We might see Blackstone come out with India’s first REIT soon; however, it is too early and difficult to comment how will the investors respond. Even after the first REIT listing, it would take few more years for the REIT market to mature. Hence, given the current scenario of high investor interest and lack of available options in office space, sale and leaseback or asset sale are the best possible alternatives to REITs.

The solution

Many public-sector banks have assets in the most sought-after business districts of the country like Bandra Kurla Complex (BKC), Connaught Palace, Nariman Point, etc. Even their regional offices are in the most desired office markets of that city. The value of these properties will be negligible in their books. As prime properties, they are seriously undervalued. Banks can sell the surplus assets or do a sale and leaseback of the operational assets to raise funds, which can later be pumped in as capital.

A very recent example of asset sale was of IDBI Bank, where the bank sold its BKC office to the Securities and Exchange Board of India (SEBI) for Rs. 1,000 crore. IDBI Bank accommodated the employees working at the BKC office at its other offices in Mumbai. While IDBI Bank had space in other offices to accommodate the staff, many banks do not have that option. Hence, for them sale and leaseback would be the ideal option.

The cap rates have contracted significantly over the past few years and the investors’ appetite for office space is growing by the day. Banks can go in for a sale and leaseback of some of the assets with these funds, specially insurance and pension funds, which have a very long investment horizon (over 10-15 years) and prefer annuity income. Even domestic insurance companies looking to diversify their risk via exposure to real estate would be keen to participate in such opportunities. This would ensure that the bank would get a one-time amount on their balance sheet that can be used for meeting capital adequacy norms and they would be required to pay rent every year for that asset which would reflect in P&L. As the occupier of the asset would be the public-sector banks, which are backed by the Sovereign Government, leases would be long term and more importantly, as these assets (offices) would be indispensable from the bank’s point of view; the insurance and pension funds would jump at the opportunity to lap up such assets. On account of such a strong profile of the asset, we may witness such assets being transacted at cap rates lower than those indicated in the table. Lower cap rates will result in higher value of the asset, which benefits the seller.

This would create a win-win situation for all. The banks would get capital without having to move out of its premises. Moreover, the banks can come out of PCA and sustain themselves without the government having to use taxpayers’ money to keep them afloat.