Asset reconstruction firms expect boost in business

According to a Bill passed on Monday, these firms can convert part of their debt into shares of defaulting companies.
Dinesh Unnikrishnan 

Updated: Wed, Dec 12 2012. 12 42 AM IST

Mumbai: Asset reconstruction companies (ARCs) that purchase bad loans given to sick units from commercial banks are likely to see a revival in their business, once the Enforcement of Security Interest and Recovery of Debts Laws (Amendment) Bill 2011 comes into effect.

The Bill, passed by the Lok Sabha on Monday, allows ARCs to convert part of the debt into the shares of the defaulting companies and purchase the sticky assets of multi-state cooperative banks, among other things.

The actual implementation of the new rules may not take place immediately as the Bill is yet to be cleared by the Rajya Sabha, the upper house of Parliament, following which the Reserve Bank of India (RBI) will announce detailed guidelines.

Chiefs of leading asset reconstruction companies are optimistic that the provision to convert debt in distressed companies to equity will make such purchases more attractive as equity ownership will give more control to them in the operations of companies besides yielding higher returns once the companies turn profitable.

For companies too, conversion of debt into equity will be beneficial as their interest payment burden will come down.

“It’s indeed a big positive for ARCs,” said P. Rudran, managing director and chief executive officer of Arcil, India’s largest ARC. “This will enable us to do actual reconstruction of businesses for the eligible firms. ARCs will be able to take equity ownership in such companies and exit at a later stage by earning an upside on the equity, when the unit turns profitable.”

Another key provision of the debt recovery Bill allows banks to accept immovable property of defaulting companies to realize claims.

ARCs are currently not allowed to directly pick up stakes in stressed units whose loans they buy from commercial banks or other financial institutions. Instead, they typically facilitate the bringing in of long-term capital to these firms.

According to Rudran of Arcil, the provision to allow banks and financial institutions to file caveats and to be heard in debt recovery tribunals before any stay is granted will ensure that the process of law is not misused by unscrupulous borrowers to delay settlements and payment of dues.

“When you are reviving a running company, you are investing in a sick unit. ARCs always wanted to have equity relationships in companies which have a potential to revive but it was not allowed,” said P.H. Ravikumar, managing director and chief executive officer of Invent Assets Securitisation and Reconstruction Pvt. Ltd. “The new provisions will help ARCs to focus more on reviving the units rather than just buying out the bad assets.”

Ravikumar is optimistic that the provisions in the new law will help Indian ARCs buy more assets and enhance their ability to revive sick units in a slowing economy. Birendra Kumar, chief executive officer of International Asset Reconstruction Co. Pvt. Ltd, said more clarity will come only after the Reserve Bank announces the norms.

Slowing global exports, high inflation and high interest rates have hit the earnings of most industrial units, especially small and medium enterprises, in Asia’s third largest economy. This has impacted the ability of many companies to repay loans to commercial banks.

However, despite the rise in non-performing assets (NPAs), the business of ARCs is not swelling. Even Arcil, the largest among the ARCs, added just Rs.200 crore to its books this fiscal. For the other two ARCs, there have been hardly any deals in the current fiscal. Arcil has assets under management worth Rs.6,200 crore, Invent has bought assets worth Rs.2,500 crore, while International has principal outstanding assets of Rs.4,000-Rs.4,500 crore. Analysts said the business prospects of ARCs look bright in India, given the stress in the economy and the rise of bad loans and restructured assets. Gross NPAs of 40 listed banks rose by 47% to Rs.1.6 trillion in September from Rs.1.1 trillion in the year-ago period, with state-run banks leading the pack.

Analysts expect at least 25-30% of the restructured assets to turn bad in the absence of a major pick up in the economy, which grew at 5.3% in September quarter. Total restructured assets under the so-called corporate debt restructuring mechanism touched Rs.1.9 trillion on a cumulative basis till September. “It is boom time for ARCs, given the rise in bad loans in the banking system,” said Abhishek Kothari, research analyst at Violet Arch Securities Ltd.

“Post the new regulations, there is a likelihood of more bad loans being sold to ARCs as they will be keen to take equity relationships, which will reward them at a later stage, when valuations go up.”

http://www.livemint.com/Politics/xtLcRxhvhTqpwySmiABmYM/Asset-reconstruction-firms-expect-boost-in-business.html

Foreign investment limit in ARCs raised to 74%. The finance ministry said that 74% would be the combined investment limit for FDIs and FIIs

Asit Ranjan Mishra 

New Delhi: A day after allowing asset reconstruction companies (ARCs) to take equity stakes in bad assets of banks through amendment of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act in Parliament, the government on Friday raised foreign investment limit in ARCs to 74% from 49% at present.

The proposal is considered critical to boost the asset reconstruction business in India at a time when bad loans in the banking system have been on the rise in a slowing economy. Gross non-performing assets (NPAs) in the banking system were around 3.5% of the total assets at the end of the first half of this fiscal, according to government estimates. Cumulatively, banks restructured Rs.1.9 trillion of loans till September.

In a press statement, the finance ministry said 74% would be the combined limit for foreign direct investors (FDIs) and foreign institutional investors (FIIs), removing the prohibition on FIIs investing in ARCs. “The total shareholding of an individual FII shall not exceed 10% of the total paid-up capital,” it added.

A single sponsor will not be allowed to hold more than 50% of the shareholding in an ARC either by way of FDI or FII. “The foreign investment in ARCs would need to comply with the FDI policy in terms of entry route conditionality and sectoral caps,” the statement said.

S.C. Bhatia, chief executive officer of Phoenix ARC, said the move is is more of an enabler and it will take time to produce results. “Unless banks are incentivised to sell (bad loans) to ARCs, I don’t see a flood of equity coming into ARCs,” he said.

There are several regulatory restrictions imposed by the Reserve Bank of India on the source of funding that ARCs can tap. Out of the available sources, banks, notified financial institutions and non-banking financial companies do not lend much to ARCs. Another source of liquidity for ARCs could have been domestic funds, but there are a very few in India focused on distressed assets. Since foreign investors are minority shareholders at present, they don’t take an active part in the revival of assets.

Typically, ARCs set up separate trusts to acquire individual assets. These trusts issue security receipts (SRs) against the bad assets bought. The SRs are bought by banks themselves as qualified institutional buyers, or QIBs, as well as other investors. Under the current laws, banks can undertake corporate debt restructuring and convert some of the debt into equity according to prescribed guidelines. But no such option was available for asset reconstruction companies (ARCs). They acquire bad debts from banks and other lenders at a discount and then try to recover them, earning a fee.

Through the amendment of the SARFAESI Act by passing the Enforcement of Security Interest and Recovery of Debts Laws (Amendment) Bill, 2011 in Parliament, the government allowed ARCs to take equity interest in such bad debts.

The finance ministry also increased the limit of FII investment in SRs from 49% to 74%. It has also done away with the individual limit of 10% for investment of a single FII in each tranche of SRs issued by ARCs. “Such investment should be within the FII limit on corporate bonds prescribed from time to time, and sectoral caps under the extant FDI regulations should be complied with,” it added.

http://www.livemint.com/Politics/xZNSZVtOkqUHUAyHuklgwO/Foreign-investment-limit-in-ARCs-raised-to-74.html

Save the rod ... and create a Frankenstein

Like all morals and most hazards, moral hazard is man-made. Only man can reduce it.
Dipankar Choudhury - LiveMint

A close friend, who works for an asset reconstruction company, recently told me after a few drinks: “I suggest that you do a project report and take a Rs.100-200 crore loan. The bank, RBI, government –will all treat you like a king if you default. Don’t borrow just 5 or 10 crore, then you will be in trouble.”

He went on: “If my son wants me to find a match for him, I will look for the daughter of a defaulter. Then his life will be made”. Yes, some entrepreneurs regularly dream of graduating from facing a problem to becoming a problem for the system.

Nearly 20 years ago, Michael Fay, an American student in Singapore, was sentenced to six cane lashes for vandalism, which due to hectic American lobbying was reduced to four and he was let off with that. His partners in crime got more severe punishment. Four years later, Fay was held in the US for possessing drugs.

Wikipedia defines moral hazard as a tendency to take undue risks because the costs are not borne by the party taking the risk. The bothersome part is that it is rife even in developed and developing countries which hold the rule of law in high esteem. Just the perspective differs: in the West, public discourse sees moral hazard largely as excessive risk-taking by overpaid bankers, in India it is repeated defaults encouraged by mollycoddling lenders.

Where genuine accommodation ends and mollycoddling begins is extremely tough to ascertain ex-ante. There have been cases of remarkable borrower resuscitation after one lifeline, and even two. And then there are the perpetual delusions. Most banks do not have this data, or choose not to compile it.

But one thumb rule will always work. Indulgence by a lender makes sense only if the underlying fundamentals of the borrower’s business are sound and he happens to be facing a cyclical problem (this of course is a judgment call but not too difficult to make, e.g. it takes some imagination to contend that airlines are facing a temporary problem and their fundamentals are sound). Else it is mala fide and a potential source of moral hazard.

It is a difficult and unpleasant subject as a result of which not much literature is available. However, in a noteworthy paper titled “Financial Intermediation in India: A Case of Aggravated Moral Hazard?” dated July 2002, Saugata Bhattacharya and Urjit Patel made an attempt to look at this issue very early in the lending growth cycle in India. Many points presented there are still relevant.

The authors identify three reasons for the malaise: large and increasing government role in the financial sector, high regulatory forbearance and absence of efficient bankruptcy procedures. They premise that the resultant moral hazard inhibits effective co-financing and capital formation in the economy.

On the first point, it is important to note that the authors identify government participation in the financial sector and not just government ownership that leads to increasing moral hazard. It includes provision of government guarantees to projects, priority sector lending, mandating write-offs of loans, and so on. In good times, there is little incentive for the government to change the status quo, and in bad times, it feels the need to increase its involvement, at which point prudence takes a back seat.

Regulatory forbearance ensures lenders, especially banks, do not close down. At least for banks there is this argument, though shallow, that faith in them should not erode. Why wholesale lenders like IFCI have to remain in perpetual life support is less understandable. If a lender will most likely never be allowed to fail, depositors will not care to monitor lender performance, managers will be less vigilant and the borrower incentivized to take advantage of the system.

Developments on the bankruptcy procedures front have however been encouraging. The SARFAESI Act (which is India’s foreclosure law) has been quite effective but there is still a long way to go.

Ironically, bankers suggest that it has been used largely as a stick to beat the borrowers with and bring them to the negotiating table, and not for seizing and selling off security, the ostensible purpose for which the law was enacted. Thus the effectiveness is at best sub-optimal. Judicial and quasi-judicial proceedings for debt recovery are still tortuous.

To conclude, I particularly like one sentence which the authors use: “This process of increasingly aggravated moral hazard driving…riskiness of the asset portfolios…is analogous to riding a bicycle without brakes – once on it, if you stop pedaling, you will fall off.” Very similar to what Ramalinga Raju remarked along with his confession of having cooked the books of Satyam for years. Let’s not carry on the comparison further; it looks scary.