A reconstruction boom?

For the first time, that there exists a legislative framework that allows ARCs to focus on revival and reconstruction.
Haseeb A. Drabu .

By allowing asset reconstruction companies (ARCs) to convert a company’s debt into equity, the framework of management of non-performing assets is likely to undergo a fundamental change.

Amendments to the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI) that allow these changes can potentially alter the landscape of asset reconstruction.

Till now, banks and lenders in general had access and recourse only to the assets of the borrowers. The debt of a company was directly linked to the physical assets created by it. Equity was kept out of these arrangements unless it was specifically earmarked or borrowed against. It was not available for recovery of overdue debts.

With the new amendment passed by both Houses of Parliament, debt and equity have been made fungible as far as recovery from defaulting companies is concerned. ARCs have been given complete and unbridled access to the equity of a defaulting company. With no restrictions on it, either in terms of size or type, this amounts to powers of changing the ownership and, with that, the management and leveraging not just of financial equity but also the business, brand and other types of equity of a company. This has enormous implications not only for lenders and borrowers but the entire financial architecture of the economy.

The biggest problem for ARCs was their ability to extract value from assets. Apart from all the litigation, procedural problems and unreal pricing of impaired assets by banks, ARCs often face a situation where the value of the asset is lower than that of the debt of the defaulting company. In such a case, the enterprise value of a company is less than its asset value. As such, ARCs can’t make much from the assets that they buy.

Despite a situation where the rate of growth of non-performing assets (NPAs) has been higher than the rate of growth of credit and the consequent high levels of NPAs, ARCs have been asset-starved for the past two years. No wonder then that despite permitting the formation of securitization companies and asset reconstruction companies in 2003, the market for impaired assets in India is far from developed.

Even though a number of ARCs have been set up that have been purchasing NPAs from banks, they haven’t been able to develop a robust stressed asset market or an active distress and restructured debt paper market in India. At best, ARCs have functioned as asset-recovery centres that are primarily into asset stripping rather than asset reconstruction and business revival.

This amendment which gives them recourse to equity has the potential to trigger the development of a healthy market for non-performing and impaired assets. The move seems to have been timed well. It comes at a point when the gross non-performing assets of the banking system are at a decadal high and are likely to be around 4% of the gross advances at the end of this fiscal. If one adds restructured assets, one-time exemptions and evergreen ones, the level is almost twice as much. Seen from a stressed asset market perspective, it is a business worth Rs 5 trillion.

If private equity participants—globally there are specialist distressed asset private equity firms—can team up with local ARCs, this can be a great business opportunity. Not only that, it will also be a systemic gain as their ability to turn around companies will be much higher as India seems to be nearing the end of the downturn. This is an ideal time for investments in distressed assets. From next year, interest rates will start declining and as and when growth picks up, the pricing of these assets will improve faster than their prospects of revival.

At the transactional level, the ability to convert debt into equity will be especially useful as it will reduce interest costs for companies. This is a frequent reason for firms getting into default. In addition to this, reconstruction and revival becomes easier with innovative and quick structuring of the debt component.

These possibilities, including those of changing owners, promoters or managements, will enable ARCs to offer better packages to banks for bad loans.

Now, for the first time there exists a legislative framework that allows ARCs to focus on revival and reconstruction. The efforts will be, or rather should now be, on buying an impaired asset based on business viability, using specialized skills and tools to turn it around and then reselling the stake the moment the company recovers. Apart from making profits for themselves, ARCs will have contributed to the national economy by preventing capital waste.

Haseeb A. Drabu is an economist, and writes on monetary and macroeconomic matters from the perspective of policy and practice. Comments are welcome at haseeb@livemint.com. To read Haseeb A. Drabu’s earlier columns,go towww.livemint.com/methodandmanner-

http://www.livemint.com/Opinion/bsS1xllKPFzCj95WqqoSxN/A-reconstruction-boom.html

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

Attention . Attention, Attention please.......

Dear Borrower / Co Borrowers.

ARCIL intends to return the surplus amount available on borrowers loan account. All are requested to please spare two minutes and go through the names of the borrowers / Co borrowers and if you know any of them, please  inform them  to go to the address given in the advertisement and claim their surplus immediately.

Published in THE FREE PRESS JOURNAL, Mumbai, Wednesday, March 14, 2012, PAGE 13

Asset Reconstruction Companies - Missing the Good In Bad Loans

Business for ARCs picks up when bad loans mount with banks.  Not in India, where they remain hobbled by fear among banks and policy paralysis,
report Rishi Shah & Dheeraj Tiwari 

 

    The business of asset reconstruction companies, which specialise in settling bad loans of the financial sector, should pick up when an economy feels pain. Yet, even as the Indian economy decelerates to its slowest in three years and bad loans of banks hit an all-time high, ARCs remain in a state of drift, subdued by fear among banks and a loose policy framework. The pace of new bad loans with banks has always exceeded the loans transferred by them to ARCs for disposal. For example, between March 2009 and March 2010, even as bad loans with banks increased by Rs 15,774 crore, transfers to ARCs trailed at Rs 10,675 crore, according to data from the Reserve Bank of India (RBI). This differential is likely to increase as, between March 2010 and September 2011, bad loans of banks are up 40%. While exact numbers are not available, anecdotal evidence suggests flows to ARCs is not keeping pace. “There is no business coming our way,” says a senior official with a leading reconstruction company. According to the latest financial report of State Bank of India (SBI), India’s largest bank, it has Rs 40,000 crore of bad loans. Yet, in 2009-10 and 2010-11, it passed on just six bad loans with a combined book value of Rs 40 crore to ARCs. “In a continually rising NPA scenario, even large banks such as SBI and IDBI Bank sell three and two NPAs, respectively, in a year, that too year after year,” adds Rajiv Ranjan, president & CEO of Reliance ARC. “What can you guess about business coming the way of ARCs?” Business is not picking up for two reasons: fear among bank officials and a weak policy framework. 

FEAR OF ACTION

Bank officials are hesitant to sell bad loans. “Banking is dominated by the public sector, which is reluctant to pawn off assets to other management firms as they fear a loss of face,” says the head of a PSU bank, not wanting to be identified. When a loan is transferred, it goes off the bank’s books. But rather than see it as a way to clean the balance sheet, along with a possibility of recovering something from it, many bank officials fear this might be perceived as an admittance of failure to recover the loan. They also fear vigilance inquiries. “The problem in India is that everybody wants to complain,” says MS Verma, chairman of International Asset Reconstruction Company (IARC), an ARC promoted by HDFC Bank and Tata Capital. “Bankers are afraid that even in a fair process, questions might be asked as to why the NPAs had to be sold when recovery was possible.” Typically, every bank has a chief vigilance officer (CVO) looking into such complaints. Beyond the bank’s CVO, if required, even the Chief Vigilance Commissioner (CVC) and the Central Bureau of Investigation (CBI) can take up such inquiries. In fact, when an ED is to be promoted to CMD, CVC clearance is needed, and inquiries over transfers of bad loan to ARCs can lead to delays in appointments. Given all this, not doing anything is seen as a safer option. “In the public sector, usually, there is accountability only for doing, but none for not doing,” says a senior advocate who declined to be named as he represents banks in courts. “For existing bad loans, all he has to do is create a record that he tried to recover it in every possible way.” The numbers of Arcil, India’s largest ARC, bear that out. Arcil has acquired bad loans with a principal value of Rs 24,000 crore. Of this, Rs 9,000 crore came from ICICI Bank, a private bank, which is 50% more than what SBI gave. Both banks, along with PNB and IDBI Bank, are copromoters of Arcil.

WEAK POLICY FRAMEWORK

According to the RBI, as of June 2011, India had 13 operational ARCs, holding assets with a combined book value of about Rs 74,000 crore. But they are not endowed with capital. In developed markets, well-capitalised ARCs buy loans outright. In India, however, ARCs, pay a bank about 5% of the price of the loan agreed on. For the rest, ARCs issue security receipts (SRs), which is a promise to pay the bank a certain share of the sale value at the time of selling the bad loan. When bad loans have been transferred, both banks and ARCs have bickered over the pricediscovery mechanism and the auction process. Indian banks, typically, offer those loans to ARCs they have been unable to realise for five years or more, and so are often mired in legalities. Banks sell bad loans through an auction, for which they fix a base price. Neeta Mukerji of Arcil says the base price fixed by banks is random and has no relation to the asset’s residual value. “An ARC’s estimate of recovery expected, time frame, cost and funding cost is quite different from that of banks,” says Mukerji, officiating CEO of Arcil. Officials of four ARCs that ET spoke to say the process favours banks, with one even labelling the auction “a sham”. “They only want to sell the worthless, age-old NPAs, where they have almost exhausted recovery possibilities," says an official of one of those ARCs, not wanting to be named. "And they want us to pay a substantial price.” Verma of IARC says some banks conduct auctions only to find the “right price” for themselves to further use as a bargaining tool with defaulters. “Then, they go to the borrower and scare him by saying that ARCs will use tougher means and try to settle it for a higher price,” he adds. Another head of a smaller ARC, speaking on the condition of anonymity, says that during due diligence, one bank refuses to show any papers or even the asset to ARC officials, even though some might have legal claims on them. A government panel, with representation from industry, is currently looking at regulatory, legal and accounting issues plaguing ARCs in India. These include a standard format for documentation, ARCs going public to raise more capital and reduction in bottlenecks in the functioning of debt recovery tribunals (DRTs), which is the stage preceding ARCs. A quick resolution will benefit all stakeholders, says a finance ministry official who is part of the panel but did not want to be identified. “Experience suggests that NPAs, like a cube of ice, lose value over time. And rather fast,” he says.


http://epaper.timesofindia.com/Default/Scripting/ArticleWin.asp?From=Archive&Source=Page&Skin=ETNEW&BaseHref=ETM%2F2012%2F03%2F13&ViewMode=GIF&PageLabel=15&EntityId=Ar01501&AppName=1 

   

Managing NPAs, maintaining NIMs, are immediate priorities: Sri B A Prabhakar,

Interview with CMD, Andhra Bank , Parnika Sokhi / Mumbai Feb 14, 2012, 00:39 IST

B A Prabhakar, who took over as chairman and managing director of Andhra Bank last month, has drawn up his to-do list. He shares his priorities in an interview withParnika Sokhi. Edited Excerpts:

Have you listed the areas needing immediate attention?
My immediate priorities are to concentrate on management of non-performing assets (NPAs) and net interest margins (NIMs). Slippages have gone up because of a few accounts but recoveries have been good. As a result, we have been able to show a net reduction in NPAs this quarter. We recovered about Rs 500 crore in the third quarter. We aim to show better results in the next quarter. Our NIM of 3.8 per cent is in line with our public sector peers. We aim to maintain this level. We want to also focus on branch expansion policy outside Andhra Pradesh.

You said the bank doesn’t aim to lend to micro finance institutions (MFIs) as   of now. Is it on fears that the exposure to the industry could turn bad? 
No, we have a negligible amount of bad loans from that sector, but we have restructured three accounts there. The reason for not going aggressive in that sector is that we would like to have more clarity on the regulation and legal structure there. We can look at expansion in a big way only after we have clarity on those issues. All the accounts restructured from the sector are from Andhra Pradesh. About half the total exposure of Rs 300 crore in MFIs is from that state. So, incremental lending will take place selectively, and preferable outside Andhra.

Which are the target sectors to increase exposure?
We would like to have an even growth in small and medium enterprises, and the retail category. We have not fixed any targets, as such, but these will be two focus areas that will enable us to meet our priority sector commitments. Loans to large corporate bodies form about 50 per cent of our portfolio and whatever credit growth we are targeting has to also come from that segment.

What are your plans to boost fee income?
That is one area we’ll have to work on. We are planning to take up third-party product distribution in a big way. That is where the focus on retail comes in. But we will also focus on increasing the retail liabilities and assets.

Your growth targets for advances and deposits?
We are planning to achieve credit growth of about 16 per cent and deposit growth of about 18 per cent by the end of this financial year.

We will wait for guidance on monetary aggregates from the Reserve Bank of India (RBI) before drawing up plans for the next financial year. That will give us some idea on the potential growth in the coming year.

Any thoughts on revising the interest rates on loans and deposits?
We’d like to wait for RBI’s next policy announcement.

Your hiring plans for the next financial year?
We are planning to hire about 1,450 clerks and 800 officers to take care of next year’s branch expansion and also to take care of the attrition in the bank. We plan to add at least 150 branches next year.

Banking on staff for recovery

Lenders are dedicating full-fledged teams to curtail the threat of rising defaults. Parnika Sokhi & Abhijit Lele / Mumbai Feb 15, 2012, 00:02 IST

Every day, between 7.30 pm and 11 pm, a top official of a public sector bank gets text messages from 46 zonal managers. The messages contain details on recovery figures of respective zones, with additional information on ranking of centres, based on recoveries.

The zonal managers have to send these numbers daily. Failure to do so will see an email from the chairman’s office seeking the details. The official says he has been doing this chore daily for the last one year. This helps keep a tab on the accounts which have slipped into the non-performing asset (NPA) category.

This is not a one-off incident. Banks reeling under asset quality pressure have beefed up recovery efforts. And, it has percolated to the ground level. Branch level staff are also being deployed for collection of dues.

“We have a recovery team of about 200 employees. Of this, a majority were redeployed from other departments in the third quarter,” said B A Prabhakar, chairman and managing director of Andhra Bank. The bank is targeting a recovery of at least Rs 500 crore this quarter through its in-house team.

The last two quarters of a financial year have always seen a flurry of activity for credit deployment. However, the situation is different this year. With the slackening of credit demand due to high interest rates, hectic activity is being seen on meeting recovery targets.

Lenders are also resorting to referring bad accounts backed with securities to Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interests (SARFAESI) processes.

Nupur Mitra, chairperson and managing director at Dena Bank, said the bank was using SARFAESI and one-time settlements in a big way. “We are also holding massive lok adalats for small accounts,” said Mitra. The bank has deployed clerical staff and nodal officers to do the task.

In rural areas, some banks are asking customers, while extending fresh loans, to at least pay the minimum interest to avoid the loan slipping into the non-performing category.

Bankers say since asset quality pressure is more in the agriculture and small and medium enterprises (SME) segments, maximum recovery efforts are given in these two categories.

State Bank of India (SBI), the country’s largest lender, which had gross NPAs of Rs 40,000 crore at the end of December, has seen 19 per cent of its bad loans in the farm sector and 28.7 per cent in the SME sector. SBI’s cash recovery and upgradation in the December quarter was about Rs 2,000 crore, compared to Rs 1,430 crore in the year-ago period.

The thrust on recovery also comes at a time when not much activity is seen in the stressed asset sale market, after RBI issued guidelines in October 2007, stating banks while selling NPAs, have to work out the net present value of the estimated cash flow associated with the realisable value of the available securities net of the cost of realisation. The sale price, generally, should not be lower than the net present value.

“We were able to recover 100 per cent of principle in accounts, where the offer from asset reconstruction companies was at 30 per cent,” said Sounadra Kumar, deputy managing director, SBI. “Given this experience, the preference is for in-house effort than sale of bad loans,” she added.

Panel suggests broad changes on asset reconstruction

Livemint Jan 17, 2012

Mumbai: A finance ministry-constituted advisory group on the workings of asset reconstruction companies (ARCs) has recommended sweeping changes to develop the industry and help banks reduce bad assets even as the Indian banking sector is seeing a record rise in bad loans.

ARCs are in the business of buying bad loans from banks at a discount and recovering them. They buy loans by paying cash or offering security receipts (SRs) that get redeemed after a few years.

Introduction of a standard process for the sale of bad loans to ARCs and allowing banks to write off bad loans gradually rather than taking a one-time hit are essential to revive the industry, said the 41-page report submitted to the ministry on 30 December.
Mint has reviewed the report.

The advisory group has made 18 recommendations, including allowing ARCs to trade debt among themselves, letting non-banking financial companies sell bad loans to ARCs, increasing foreign participation and allowing bad debts to be converted into equity.

Reconstructing asset reconstruction firms

Asset reconstruction companies can buy the bad assets from banks by paying cash or offering security receipts that get redeemed a few years later

Banker’s Trust | Tamal Bandyopadhyay


My last week’s column, “What ails asset reconstruction firms?” evoked strong reactions from various quarters. While some bankers feel I was unnecessarily harsh on banks and did not understand the “spirit” of securitization (whatever that means), a few others are not surprised with my ‘findings’ as the practice of financial incest has been rampant since the inception of the industry. The column was the first of a two-part series on the subject that I had planned. Before writing the concluding part, I have discussed the issues with four senior professionals of the Indian asset reconstruction industry, including S. Khasnobis, former managing director and chief executive of Asset Reconstruction Co. (India) Ltd (Arcil), the country’s oldest and biggest asset reconstruction firm.

In the first quarter of fiscal 2012 ended June, the non-performing assets, or NPAs, of 11 banks with maximum stressed loans rose by Rs15,425 crore. Since fiscal 2010, these banks have added almost Rs83,000 crore worth of bad assets. With interest rates rising and the economy slowing, more and more corporations will default on bank loans. But not too many banks are selling their bad assets to asset reconstruction companies, or ARCs. Why? Many of them are restructuring stressed assets by giving borrowers more time to repay, while a few are disbursing fresh funds to the stressed accounts to pay up the bad loans.

ARCs can buy the bad assets from banks by paying cash or offering security receipts (SRs) that get redeemed a few years later. Typically, banks look for higher valuations while accepting SRs against bad assets, and discounts are steeper for cash deals. Overall, banks are not too willing to sell bad assets to ARCs and there are many reasons behind that. When a bank parts with an asset to an ARC, it has to set aside money or make full provision between the book value of the loan and the value at which it is sold to an ARC. This impacts the bank’s profitability. Typically, banks make full provision for a bad asset over three to four years. This means they can postpone the impact on their profits by carrying the bad assets on their books for a few years and sell them to ARCs as a last resort of recovery when no more fresh provisions are required.


Besides, banks enjoy the same powers that an ARC enjoys even though, operationally, they may lack the expertise to recover bad loans. So most banks attempt to recover a bad loan or rehabilitate the stressed borrower on their own and when they fail to do so, sell the bad assets to ARCs.

Finally, there is always a gap between the value that banks expect from bad assets and the price ARCs are willing to offer. The driving factor here is the cost of funds. While banks discount the future expected realizations from recovery at about 10% a year, ARCs insist on at least 20% discount. This means over three years, while bank wants to recover Rs70 from an asset worth Rs100, ARCs quote a price of around Rs40. Besides, banks need to pay them a management fee that varies between 1% and 2% of the size of the asset in case of sale through SRs. Most banks find such a hefty discount unacceptable; they also do not realize that the longer they delay the transfer of assets to ARCs, the faster is the fall in the final realizable value.

Banks auction bad assets to ARCs, but do not offer any floor price for such auctions. Often, after receiving price quotes from ARCs, they withdraw the assets from auction and start negotiating with the borrower for a settlement, using the highest bid as a floor. The auction of bad loans for many banks is not a part of the process of selling such loans, but a price discovery method to bargain hard with the defaulter for recovery.

While banks are allowed to take profit from the sale of bad assets (if the sale price consideration is higher than book value), in case of a settlement with the defaulter borrower, such profit from the sale of assets to ARCs cannot be booked even if it is paid in cash. They money thus generated needs to be kept as a cushion against future provisions. This is also a disincentive for banks to sell NPAs to ARCs.

Regulatory aspects

Let’s look at the regulatory aspects of the industry. The Reserve Bank of India (RBI) issued the final guidelines for ARCs in April 2003 after the Parliament passed the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, and subsequently several changes were made. The norms allow the acquisition of financial assets both on the books of ARCs as well as under a trust structure outlined in the Act. There are 14 ARCs in India and about 98% of the assets that they have acquired are through the trust structure. This means ARCs do not own the assets but they manage the assets of the trust. In that sense, they cannot have NPAs on their books; but RBI norms insist that when they are not able to recover the bad assets in accordance with the plan envisaged, they need to classify them as NPAs and this means they cannot earn their management fee on such assets.

Incidentally, SRs are subject to declaration of net asset value (NAV) every six months, based on ratings by ratings agencies; and SR investors (including ARCs for their own investments) are required to book losses in case of a drop in NAV.

The capital requirement for ARCs is also an issue on which the industry is divided. Going by RBI norms, an ARC needs to follow 15% capital adequacy till it has Rs100 crore capital. This means that for every Rs100 worth of bad loan bought, they need to have Rs15 capital. This norm is relaxed once an ARC has Rs100 crore capital, but all ARCs must pick up at least a 5% stake in the SRs that they sell against the bad assets.

Many say that ARCs should have more capital and invest more in SRs as they will be more aggressive and diligent in recovery when they have more skin in the game. Often when they buy bad assets and offer SRs, the valuation is too high and ARCs strike deals knowing fully well the SRs will not fetch such a high price at redemption and seller banks will lose. They will not do so if they hold a larger part of the SRs. But there is a strong opposite view too: since ARCs are managing the trusts, why do they need to have hefty capital? Also, why do they need to invest in SRs? After all, they are playing the role of asset management companies (managing bad assets); and the mutual funds that follow the same principle do not require a big capital base and they do not need to make own investments.

ARCs are being created to clean up the banking system and prevent capital infusion in banks (as banks need to set aside money for bad assets, they need more capital when bad assets grow), and if ARCs themselves need hefty capital, the purpose of their creation is not well served.

Instead, RBI needs to broaden the investor base in SRs. Currently, qualified institutional buyers, or QIBs, such as banks and insurance firms, are allowed to subscribe to SRs which are rated instruments. Foreign investment in such instruments is capped at 49% and no individual foreign institutional investor, or FII, can hold more than 10%. Perhaps, the regulator feels that a larger role for foreign investors will encourage them to take over sick Indian firms through the back door. But such apprehensions have no basis as most defaulters are in bad shape and they cannot attract serious investors. Foreign investors should be allowed to play a larger role in investing in SRs floated by the trust and encouraged to get actively involved in the recovery process, the way a private equity fund handholds the promoters of a firm in which it invests. Foreign distressed-debt investors are specialized institutions who like to have a significant stake in a trust or scheme with some control.

Recovery models

Typically, ARCs follow three models of recovery. The first is the asset stripping or the vulture model. In this case, they shut the unit’s functioning and strip the assets to recover money.

The second model is the arbitrage model. In this case, ARCs add very little value; they acquire an asset from a bank at a price and go back to the same borrower and settle at a higher price, creating a spread by virtue of their superior negotiating skills with the borrower. This also explains why banks use ARCs as a price discovery platform and then go back to settle with the borrower themselves using the ARC-quoted price as a floor.

The last model is the revival model that involves the restructuring of financials, processes and the infusion of long-term funds. The mere acquisition of an asset doesn’t revive an account. Apart from arranging funds, ARCs should also be allowed to take equity exposure in a sick company by converting a part of the debt for speedy recovery. While dealing with a listed entity, any such exposure will attract the so-called takeover code of the market regulator that makes an open offer mandatory for any acquisition of a 25% stake or more in a company; for unlisted entities, it can be a contract between the company and ARC.

The Securitisation Act allowed ARCs to change or take over the management and sale, or lease, of the business of the defaulting borrowers; but RBI took seven years to actually empower them, that too in a truncated manner. They can take over the management, but cannot lease the business as yet.

There have been very few cases where the business has been taken over, but the powers to do so act as a threat and make the recovery process relatively easier.

The rogue borrowers always want to oppose any recovery move; there have been thousands of cases in which they have dragged ARCs to court to delay the process.

Technically, the borrowers are required to offer one-fourth of the dues to legally challenge any recovery move, but this norm is not always followed. Besides, ARCs are allowed to acquire only secured NPAs from the Indian banking system, leaving the other debt-holders to proceed under civil court procedure.

There are many other issues that RBI should look into to make the asset reconstruction industry work well, such as allowing the transfer of assets among ARCs and permitting them to offer working capital support to industrial units under revival; but no model will work unless the banks themselves appreciate the importance of selling bad assets and stay away from financial incest.

The concept of securitization has not taken off as banks that sell their bad assets to ARCs often insist that these cannot be mixed to create a pool.

This means ARCs need to hold bad assets of individual banks as separate pools under a trust, and the banks are subscribing to SRs of their own assets. In other words, the banks are simply removing the bad assets from their loan books and bringing them back as good assets through their investment books (that hold SRs). Arcil, I am told, has set up at least 350 trusts, and many of them are seller-specific trusts. This practice might prove to be the proverbial last nail in the coffin of India’s asset reconstruction industry if it dies a premature death.

There is a clear conflict of interest as the banks are holding the dual role of owners as well as beneficiaries—sellers as well as investors in SRs. They are also the major shareholders in some ARCs. One way of reconstructing ARCs could be by capping sponsor banks’ exposures at 10% and keeping the nominees of the sponsors out of the acquisition and resolutions committees of the firms.

The representation of banks as a class of shareholder in the board of ARCs should also be capped. This is not a unique idea as in credit information bureaux, too, no bank is allowed to hold more than a 10% stake. This, along with an expansion in the investor base in SRs will help ARCs securitise bad loans in the true sense of the term. Let the banks focus on their main business of lending, and ARCs on recovery.

And till such time the industry fully understands the nuances of bad asset buys and recovery, no new ARC should be allowed to set shop.

Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as Mint’s deputy managing editor in Mumbai. Your comments are welcome at bankerstrust@livemint.com