MARCH 25, 2016

By Naresh Minocha, Our Consulting Editor

"THERE is a ten-year history behind these loans and the repayments have not yet begun and the interest, also is not being paid. Therefore, the Government is considering steps to see how best to get back these amounts."

That was Late N. Sanjiva Reddy , Minister of Steel and Mines, replying to questions put by Atal Bihari Vajpayee on the overdue loans taken by TISCO (now Tata Steel) and IISCO (later merged with SAIL) in Parliament.This happened on 17th September 1964 when the deceptive term - non-performing asset (NPA) – did not exist in the banking jargon.

To Mr. Vajpayee's query as to whether "the Government is being pressurised by these companies and that they want that these loans should not be recovered fully from them, "Mr. Reddy answered: "I can assure the hon. Member that the Government would not surrender, whatever may be the amount of pressure put on them."

Another veteran MP Bhupesh Gupta interjected: "We have heard that earlier also."

An Aam Aadmi would today react in an identical manner to Finance Minister Arun Jaitley's recent pep talk on NPAs especially on Vijay Mallaya-promoted Kingfisher Airlines (KFA) loans.

The other day Mr. Jaitley claimed that the banks are going to recover "every penny"of money lent to Mr. Mallya. This goal is impossible to attain as I elaborate in this column.

Like late Bhupesh Gupta, three generations of Indians have been taken for a ride by successive Governments on corporate lending against inadequate securities and resulting NPAs & tax arrears.

Gross NPAs of public sector banks (PSBs) stood at Rs 3.6 lakh crore in December 2015. Of this, Rs 64334.59 crore constitutes the willful default. The direct taxes primarily income tax arrears aggregated to Rs 2.4 lakh crore in March 2015. Out of these tax arrears, more than 96 per cent is difficult to recover as admitted by Income Tax Department (ITD) to CAG in a report submitted to Parliament on 11th March 2016. The complete picture of doubtful recovery of public money would become very frightening, if indirect taxes and non-tax revenue arrears are factored in.

Thousands of crores of have been lent, classified as NPAs (formerly sticky advances) and written off since the Nehru era. Loan default shave now emerged as a symbol of good corporate living. And this is typified by Mr. Mallya who was allowed by Modi Government to slip away to London to avoid imminent arrest.

Secrecy in sanction of bank loans, their rescheduling coupled with interest rate cuts, often followed with fresh loans, debt recovery at snail's pace, interest subvention (read subsidized loans for selected sectors) collectively constitute the hallmark of crony capitalism.

This has grown much faster than the country's GDP growth rate under different regimes. Successive regimes have flaunted banking secrecy laws such as Public Financial Institutions (Obligations as to Fidelity and Secrecy) Act, 1983 to protect loan defaulters.

It is here pertinent to drive home this shameful Nehru legacy by quoting parliamentary debates on The Industrial Finance Corporation (Amendment) Bill, 1952 in which MPs condemned nepotism, loan defaults and secrecy.

As put by C. G. K. Reddy in December 1952, "unless you put them up to the examination of the entire people of India, the way you have secured these loans. Here is a statement of those who have defaulted, defaulted time and again, not once, but, time and again and you have security. Well, by the time you try to foreclose, that security would have disappeared and your secrecy also might have disappeared by that time."

See how pertinent is this observation in relation to Mallyagate. Had Nehru Government paid heed to concern voiced by visionary and conscientious MPs like Reddy, many scams of Mallyagate type would not have happened over the decades.

UPA practiced crony capitalism unashamedly to promote and protect KFA's interests. It skirted probing questions on KFA in Parliament. It had the audacity to publicly pitch for 3rd bail-out for KFA!

Mallyagate today constitutes perhaps the most apt subject of case study on crony capitalism. The study is needed to pinpoint the role of PSBs, Reserve Bank of India (RBI), UPA regime, Modi Government and the legal system in contributing to scam. To be fair to Mr. Mallya, we should not rule out the possibility of his entering into one-time settlement with PSBs and followed by his return home.

Lending-linked crony capitalism works at the expense of hapless depositor, whose paltry insurance cover the Government has kept unchanged since 1993! Thus, the maximum amount of refund a depositor can get in the event of a bank failure is Rs. one lakh only. Any additional saving deposited with collapsed bank would go down the drain if it fails under the weight of NPAs.

The Government has prevented banks' collapse by pumping thousands of crores of potential development expenditure into them under the garb of recapitalization.

This issue was succinctly put by Mr. T.N Chaturvedi in Rajya Sabha in April 1994. He stated : "Rs. 5,600 crores were provided to increase the capital adequacy of the banks last year. A similar provision has been made this year also. The Finance Minister talks of the banks going to the public and the farmers being taken care of; is it not possible for the Finance Minister to postpone this Rs. 5,600 crores as provision towards capital adequacy of the banks and transfer this amount to the farming community?"

The size of recapitalization has grown in direct proportion to the magnitude of NPAs. Modi Government has thus already decided to pump in Rs 70,000 crore in PSBs over four years ending 2018-19. The logic for diversion of this potential development expenditure is same as was advanced by Dr. Manmohan Singh in April 1994: Recapitalization is required to strengthen PSBs to comply with global banking norms. India's saving community has thus become hapless spectator to this cycle of NPAs growth following recapitalization.

Reverting to Mr. Mallya, recollect how brazenly UPA tried to organize 3rd bail-out for KFA in November 2011 as was reported extensively by media.

A news dated 11 November 2011 stated: "the Minister for Civil Aviation, Mr.Vyalar Ravi, met the Finance Minister, Mr.Pranab Mukherjee today, on the issue of a corporate debt restructuring plan. The meeting comes in the wake of the private sector airline seeking Government help for keeping its regular operations going smoothly. In the past few days, Kingfisher has had to cancel more than 70 flights. Travel agents are also advising passengers to fly other carriers."

The story continued: "Sources indicated that the Kingfisher promoter, Mr. Vijay Mallya, had met the Finance and Civil Aviation Ministers, seeking funds at lower rates of interest as well as the same treatment that was being provided to the state-owned Air India."

Two days later, a news report filed on Board PM's Aircraft stated: " With Kingfisher Airlines gripped by an acute financial crisis, Prime Minister Manmohan Singh today said that he would speak to Civil Aviation Minister Vayalar Ravi to see how to get the Vijay Mallya-owned airline, which has cancelled at least 210 flights in the past week, out of trouble."

UPA, however, did not proceed with this misadventure following strong protests from bank employees, the opposition parties, SpiceJet & opinion leaders. Industrialist Rahul Bajaj's statement "those who die must die", questioning KFA bailout rattled UPA regime.

Consider now a few facts on UPA's attempt to shield Mr.Mallya even after KFA grounded its entire fleet in October 2012. In reply to a question on KFA overdue loans and steps taken to recover them, Minister of State for Finance, Namo Narain Meena, told Lok Sabha in November 2012: "In accordance with the practices and usages customary amongst the banks and in conformity with provisions of statutes governing the financial institutions as also the provisions of the Public Financial Institutions (Obligations as to Fidelity and Secrecy) Act, 1983, information relating to the details of the individual borrower of the banks is not divulged."

Earlier in March 2012, Mr. Meena had ducked in Rajya Sabha a query which reads: "whether an investigation by CBI/CVC/JPC would be conducted into the conversion of bank debt into equity shares of Kingfisher Airlines at a far higher price than its market value; and (d) if not, the reasons therefor?"

Both UPA & NDA avoided ordering a full-fledged special probe into the working of KFA and related UB/Mallya group companies.

Serious Frauds Investigation Office (SFIO) belatedly launched its probe in 2015 only, a fact that emerged from disclosure made by Diageo-controlled United Spirits Limited (USL) to the BSE on 15th September 2015. It stated: "We wish to state that United Spirits Limited received a letter from the Serious Fraud Investigation Office in connection with its investigation into Kingfisher Airlines Limited."

Immediately after coming to power in May 2014, Modi Government should have asked banks, tax and other statutory authorities to get cracking on KFA scam and fix accountability. It instead helped Mr. Mallya distance himself from KFA. The Government did this by rejecting KFA's application for approval for his re-appointment as Managing Director for a period of 5 years without remuneration!

Mr. Mallya's intent for willful default became crystal clear when he sued consortium of banks and sought relief in a petition filed by his holding company, United Breweries (Holdings) Limited (UBHL) in Bombay High Court in 2013.

UBHL's annual report for 2014-15 says: "The Company is defending recovery proceedings by the consortium of banks of KFA based on corporate guarantees, the validity of which is being contested. As stated herein above, the company has filed in Bombay High Court, a suit seeking to declare the (UBHL's) corporate guarantee null, void ab initio and non-est. The suit is still pending adjudication."

The term 'void ab initio' means the relevant agreement has had no legal validity. And 'Non est factum' means the agreement is invalid because the petitioner mistakenly signed it.

The annual report has also mentioned other suits filed by UBHL and UB group companies against the lenders. The message is clear that intransigent Mallya would fight the loan repayment battles as a victim and the lenders as the culprits!

KFA's intent to avoid payments through litigation is demonstrated by his dubious legal battle against ITD that culminated in special leave petition before the Supreme Court. In April 2015, the apex court dismissed the petition and directed KFA to pay Rs 372 crore dues (inclusive of interest) to Income Tax Department (ITD). This amount is what KFA collected as tax deducted at source (TDS) from its employees in three years ending 2012-13.

Tax arrears are difficult to recover due to multiple claims over woefully inadequate KFA assets. The Government should not have allowed build-up of tax dues as it knew about KFA's inclination towards tax evasion and defaults.

UPA Government admitted in Parliament during December 2011 that KFA had not adhered to TDS provisions. The amount of liabilities (read evasion) quantified on preliminary examination of KFA accounts aggregated to Rs 153.82 crore for 2010-11 & 2011-12. Of this, ITD collected only Rs 21.04 crore as KFA had filed a commitment letter to pay the balance TDS liabilities by the end of 2011-12.

The auditors in KFA annual report for 2009-10 gave detailed account of delay in payment of TDS, fringe benefit tax, with holding tax, professional tax and service tax to the authorities. Why did tax authorities not take this as wake-up call? The Government must fix responsibility for laxity on this count.

Similarly, the Banks also owe an explanation for overlooking auditors' observation in KFA report for 2007-08 about defaults in repayment of loans and interest.

The Banks, on other hand, bailed out KFA on 8th February 2008 by renewing the loans and by giving additional credit. Auditors meticulously kept reporting KFA defaults on various counts in the subsequent annual reports. The consortium of banks declared loans to KFA as NPA in April 2009.

Overlooking this, RBI granted special relaxation in its corporate debt recast (CDR) guidelines in November 2010 to enable banks to organize 2nd bail-out for KFA. Who in UPA prodded RBI to take this decision to favour Mr. Mallya?

The master Debt Recast Agreement (MDRA) signed by consortium of banks with KFA on 21 December 2010 was too generous for King of Good Times. It reduced interest rate on loans by 3%, apart from providing additional loans and converting working capital loan into term loan.

MDRA resulted in conversion of Rs.750.1 crore bank loan into 7.5% Compulsorily Convertible Preference Shares(CCPS). The 7.5% Compulsorily Convertible Preference Shares of Rs. 10/- each were converted into equity shares at a conversion price of Rs. 64.48 per Equity Share.

Even before the conversion took place in March 2011, KFA share price had declined by 36.49%, leaving banks poorer by Rs 165 crore. The market value of KFA scrip declined very fast subsequently and reduced to Rs 14.92 in 2012. KFA Rs 10-share last traded at the BSE at average price of Rs 1.36 on 22 nd June 2015. The scrip once traded at a price of Rs 307 in 2008.

MDRA facilitated conversion of Rs. 553.1-crore loan into 8% Cumulative Redeemable Preference Shares redeemable at par after 12 years. The prospect of KFA redeeming these shares is as good as nil as it is not an operating company and is facing 25 winding up petitions in Karnataka High Court alone. KFA is destined for liquidation like Mallya's greenfield telecom equipment venture Unitel.

This analysis shows that banks' total investment of Rs 1303.20 crore in KFA's share capital (equity plus CCPS) is simply not recoverable. The conversion of debt into equity in a defaulting company itself implies its inability to repay debt. In such basket cases like KFA, conversion serves as fig leaf for deemed loan write-off.

KFA is today nobody's baby as promoters have reduced their stake in phases to insignificant level. CDR enabled Mallya group to reduce its equity stake from 49% in June 2008 to 29.64% in March-end 2011. The promoters' stake was further reduced in phases to 8.54% by September-end 2014.

The conversion of debt into equity, on the other, saddled banks with 18% stake in KFA in March 2011. The banks later sold shares at loss and reduced their stake in KFA to 5.89% by September-end 2014.

Let us understand further how ridiculous is Mr. Jaitley's claim that banks would recovery every penny from Mr. Mallya. According to Finance Minister, banks have to recover Rs 9091.40 crore (inclusive of interest compounded) as on 30th November 2015. The recovery can be made only by invoking and assets sale of primary security (PS) aggregating to Rs 5238.59 crore and two guarantees totaling Rs 1850 crore.

Of the total PS, the lion's share of Rs 4111 crore (78.47%of PS) was taken by banks as pooled collateral security. This comprises seven trademarks that banks accepted at fancy price of Rs 4111 crore by relying on Valuation dated 23 April 2010 done by a global consultancy firm, Grant Thornton (GT). In 2014, SBICAP Trustee Company, an arm of State Bank of India, failed to attract buyers for seven trademarks.

This shows how outrageous is GT's subsequent contention on valuation as mentioned in KFA is annual report (latest available) for 2012-13. It says: "a recent brand valuation conducted by Grant Thornton put the brand value at 0M once the airline business becomes operational."

Would Mr. Mallya buy back his useless KFA brands from banks at this depreciated price of USD 550 million (about Rs 3678.4 crore at exchange rate of $ 1 equals Rs 66.88) as part of one-time settlement with banks?

CBI would hopefully investigate what special relationship KFA had with GT. The latter had also done valuation for charter business of Deccan Aviation Limited (DAL) in 2007-08 prior to its demerger. This transaction formed part of the move to merge unlisted KFA into stock market-listed DAL and rename the combined company as KFA.

The key question that CBI should ask is: whether it is banks or KFA that assigned trademarks valuation job to GT? And why the valuation was not assigned two separate entities as is normal practice for valuation of shares in merger deals?

What is most bizzare is that the hypothecated brands include obscure names such as Flying Models, Funliner, Flying Bird Device.

With Kingfisher beer brand excluded from the deal, the brand extension to aviation sector lack the crucial brand affiliation. With so much negativity attached to Kingfisher as airliner brand, it is moot point whether brand would be an asset or a liability for a prospective airliner. Recent reports show that the brand has been valued at Rs 100 crore and Rs 200 crore separately by two consultancy firms.

This brings us to the inherent danger of valuing a brand of company that didn't earn even one paisa profit and which was patently unviable.

As once put by Dr Jeremy Phillips , Research Director, Intellectual Property Institute, London, "A trade mark has no one objective value. Assessment of the value of a trade mark depends upon which of a number of conflicting methodologies is used in order to achieve that objective. Problems are increased by the need to attribute value to a trade mark for one of several different purposes [examples: to inflate its value in order to ward off a prospective purchaser; to fix a transfer pricing value for an intra-company transaction; to find whether it is cheaper to create a new brand or buy an existing one; to calculate the damage caused by third party trade mark dilution."

Which valuation methods GT utilized to value Kingfisher and its allied trademarks? Why did banks not do any due diligence on use of trademarks as collateral? Had even a bank clerk done half an hour Google search on this subject, he would have given thumbs-down to the absurd idea of hypothecating brands as security for loans. Would the management of banks have dared to commit such unprecedented blunder or mischief if lending was transparent business?

In the US, the listed companies use their trademarks and other intangible assets such as patents as collateral to raise loans. They, however, do it totally transparent manner. They make public the entire text of Trademark Collateral Assignment and Security Agreement in compliance with stock market regulations.

KFA for the first time disclosed in its annual report for 2009-10 that security offered to banks for term loans as on 31March 2010 included "Kingfisher Brand". In the annual report for next year, the company mentioned "all trade marks"as one of the securities offered to banks.

The inference that can be drawn from these disclosures is that these intangibles were offered as security for loans under debt restructuring of 2008 and 2010. Acceptance of intangible assets, is, however, not permitted under RBI's guidelines.

According to Prudential Guidelines on Restructuring of Advance by Banks dated 27th August 2008, "While assessing the realisable value of security, primary as well as collateral securities would be reckoned, provided such securities are tangible securities and are not in intangible form like guarantee etc., of the promoter / others."

Consider now the other intangibles -two guarantees totaling Rs 1850 crore. Of this, Rs 248 crore is the personal Guarantee given by Mr.Mallyaand the balance Rs 1601.43 crore is UBHL's Corporate Guarantee.

If we exclude all intangible assets, we find that the banks had taken woefully inadequate security from KFA for providing loans. This calls for full-fledged probe against the consortium of banks.

The web of issues underlying Mallyagate can be untangled and responsibility fixed only by an independent probe. Will anyone file a PIL in Supreme Court for a court-monitored investigation into Mallyagate in particular and NPAs in general? Can the apex court take call on dispensing with secrecy cover provided to borrowers?

The resolution of primary causes of bleeding of exchequer through NPAs and tax arrears is the key to putting India in sustainable high-growth trajectory.