Asset reconstruction companies in India at an inflection point
Indian asset reconstruction companies (ARCs) present a bizarre mix of ageing and infancy. Fourteen out of 16 operating ARCs in the country have been in the business for over a decade. This period is sufficient for the industry to mature. However, the industry still displays infantile behaviour judging from an insignificant capital of Rs5,757 crore employed by the sector and assets under management of about Rs50,000 crore, relative to banking sector's non-performing assets (NPAs) of Rs3.10 lakh crore as March 2015, and low profitability vis-à-vis the underlying business risk (see Graph-1). The NPAs have galloped to Rs5.94 lakh crore as on March 2016, and this anomaly has only worsened. 
 
 
The recent guidelines issued by the Reserve Bank of India (RBI) are set to change the ARC business forever. Recently, three new ARCs have been added, and more are about to follow. Can the ARC business, which has languished for over a decade look up now?
 
Sluggish business
Indian ARCs are the by-product of tardy and inefficient legal system characterised by clogged and inefficient Debt Recovery Tribunals (DRTs), Debt Recovery Appellate Tribunals (DRATs) and higher courts, and public sector banks' high and growing NPAs. The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interests (SARFAESI) Act, 2002 introduced ARCs as intermediaries to buy NPAs from bank on payment of a part of acquisition cost in cash with the remaining cost being deferred. The NPA acquisition and management by ARC is done through a trust, which issues security receipts (SRs) to the ARCs for the cash payment and to the seller banks for the deferred part. The SRs are redeemed out of the recovery from NPAs, and the unredeemed SRs due to recovery shortfall are written off without recourse to the ARC. The management fee of ARCs as a fixed percentage of total SRs outstanding ensures high returns to ARCs in case of low SR investment even with significant SR write off. In the initial years, low SR subscription and issue of senior SRs to ARCs led to NPA acquisition at bloated book values and gave high returns to the ARCs despite significant SR write off in the later years, which impacted the seller banks adversely. Hence, in September 2006, RBI made at least 5% SR subscription by the ARCs mandatory (5:95 structure). Having suffered due to SR write offs, banks continued to insist on all-cash or major-cash NPA sales during 2007-2013, with the result that 5:95 sales during this period remained sporadic.
 
The banks returned with 5:95 sales in FY-2014. The 5:95 structure based on management fee of 1.5% per annum could deliver to ARCs around 18-20% return over a five-year horizon even with just one-third recovery ratio (total recovery as percentage of acquisition cost). This led to highly aggressive bidding for NPA acquisition by some ARCs, which led to introduction of 15:85 structure in August 2014, mandating a minimum of 15% SR subscription by ARCs. The management fee was also linked to the NAV of SRs. The 15:85 structure with the prevalent management fee of 1.5% pa contributed 10% to the ARCs' yearly return as against 30% in 5:95 structure. Thus, for say five-year horizon and 20% return under the 15:85 structure, the ARCs not only had to achieve full SR redemption, but also earn upside income from the surplus after full SR redemption. Hence, the 15:85 structure induced efficient NPA bid pricing, which was substantially lower than in 5:95 structure, and did not enhance ARC's cash commitment with 15% SR subscription (see table below).
 
 
The banks did not accept 15:85 bid prices, which were fraction of 5:95 bid prices, and the NPA sales dried up, barring exceptions for consolidation and strategic reasons. To generate higher bid prices, the banks permitted high management fee of up to 3% per annum, and recovery incentives. However, these could not mimic 5:95 bid prices and the NPA sales remained muted as expected. (Read: RBI restores sanity
 
RBI’s September 2016 Guidelines
Banks' major incentive for sale of NPAs to ARCs was the end of further provisioning since the SRs were treated as investment, and needed to be marked down only if the net asset value (NAV) of SRs dipped below the issue price. According to the new guidelines, from FY2018, the banks holding more than 50% SRs will have to make provisions on the SRs treating these as loans, or to the extent of NAV shortfall if it exceeds normal provisioning. From FY2019, this guideline will apply even where ARCs hold 10% SRs. The new provisioning is meant to achieve true sale presumably through all-cash sales of NPAs. The moot point is when sales under 15:85 structure nose-dived due to low pricing, will the lower all-cash pricing fire the NPA sales?
 
The new guidelines permit "other banks, non-banking financial companies (NBFCs) and financial institutions (FIs) etc." also to bid for NPAs for "better price discovery" and at the same time require two external valuations of NPAs with a bank's exposure of Rs50 crore and above. For valuation, the banks are required to adopt cost of equity or average cost of funds or opportunity cost or some other relevant rate, subject to a floor of the contracted interest rate and penalty, if any as discount rate for arriving at reasonable realizable value of the NPA. The valuation principles dictate that the discount rate should relate to the cost of capital of the target asset for acquisition. For a risk proven target NPA, the discount rate should capture the risk profile of the NPA, and this is best left to the competing acquirers. The bank's cost of capital as discount rate implicit in the guideline and the seller's valuation bias will continue to overstate the asset value and the reserve price which does not leave any margin for the intermediary buyers, and perpetuate the valuation mismatch which has stunted 15:85 sales.  
 
 RBI has prescribed number of schemes for restructuring of stressed assets, and the banks invariably adopt those for financially distressed accounts, and sell only the left overs to ARCs. Hence ARCs' bid prices are at a significant discount to the loans outstanding consistent with the asset risk profile. This has also emerged from RBI statistics according to which the ARCs acquired NPAs at prices varying from 17.2% to 20.8% of loans outstanding during FY2010 to FY2013, when the acquisitions were largely cash based (see Graph-2). These deals at low percentage of loans outstanding happened as they were purely market determined. Interestingly, acquisition at these prices has not enriched the ARCs as is evident in graph-1.
 
 
The World Bank and IFC's 2014 Doing Business Report states that, "in India, resolving insolvency takes 4.3 years on average and costs 9.0% of the debtor's estate, with the most likely outcome being that the company will be sold as piecemeal sale. The average recovery rate is 25.6 cents on the dollar" (page 206). This is indicative of asset overstatement by the borrowers, which can only compound the banks' valuation bias and impede NPA sales. In the circumstances, will the new entrants fire up the market? We will examine that tomorrow.
 
(Rajendra M Ganatra, PhD is Managing Director & CEO of India SME Asset Reconstruction Co Ltd-ISARC. He had over 26 years of experience in project finance, asset reconstruction and financial restructuring. The views expressed in above article are personal)
 
Like this story? Get our top stories by email.

User

COMMENTS

Chaturvedi Vn Govind Baba

3 years ago

A VERY FAIR ANALYSIS AFTER A LONG TIME...LOOKS VERY UPTO DATE...INFO

Sunil Karunakaran

3 years ago

Superb article which brings out the present status and concerns of ARCs so lucidly and comprehensively. Really liked the views expressed regarding valuation and the fact that the increasing number of new ARCs assumes banks perennially churning out NPAs which is not good news for the banking sector. Hence the other issue raised regarding overstatement of assets needs to be appreciated and addressed urgently.

Satish Sharma

3 years ago

I think ARC 's should seriously look into the accounts which became NPA due to transient financial stress.I am at the affected end trying to request them to solve the issue but unable to do so.àll accounts should not necessarily end up with sale of assets customer needs to given a opportunity to rectify and come on to regular business especially if professionals are involved. I hope the arc understands the efforts put in to start a good venture and it is stuck due to administrative issues of the government. Looking at the above article they should support revivalbe projects and help them to come out of the NPA tag

Gopalakrishnan K B

3 years ago

Very Nice article with precise but informative description. Excellent presentation. Keep up Ganatra. Look forward to more incisive writings from you. Thanks and Regards

Baiju Mathew

3 years ago

Excellent article explains the subject, current status and issues going forward very well

Baiju Mathew

3 years ago

Excellent article explains the subject, current status and issues going forward very well

Arunava Ghosh

3 years ago

In addition to slow movements of DRTs, intervention of High Courts in debt recovery and SARFAESI matters has made the recovery process sticky and time consuming. Defaulters prefer to knock the door of High Courts against SARFAESI procedure to lengthen the legal process.

Sameer Kakar

3 years ago

Good article on present status and prospects of ARC'S. Pricing of NPA a big challenge for all stakeholders somehow the puzzle has not been solved.
On the recovery front the overburdened legal system is squeezing the blood...
Pl through some light on the New insolvency law's - whether you feel it will help ARC'S in light of the fact that u will have to approach DRT again for non corporate borrowers.

Sameer Kakar

3 years ago

Good article on present status and prospects of ARC'S. Pricing of NPA a big challenge for all stakeholders somehow the puzzle has not been solved.
On the recovery front the overburdened legal system is squeezing the blood...
Pl through some light on the New insolvency law's - whether you feel it will help ARC'S in light of the fact that u will have to approach DRT again for non corporate borrowers.

Sameer Kakar

3 years ago

Good article on present status and prospects of ARC'S. Pricing of NPA a big challenge for all stakeholders somehow the puzzle has not been solved.
On the recovery front the overburdened legal system is squeezing the blood...
Pl through some light on the New insolvency law's - whether you feel it will help ARC'S in light of the fact that u will have to approach DRT again for non corporate borrowers.

Sameer Kakar

3 years ago

Good article on present status and prospects of ARC'S. Pricing of NPA a big challenge for all stakeholders somehow the puzzle has not been solved.
On the recovery front the overburdened legal system is squeezing the blood...
Pl through some light on the New insolvency law's - whether you feel it will help ARC'S in light of the fact that u will have to approach DRT again for non corporate borrowers.

Sameer Kakar

3 years ago

Good article on present status and prospects of ARC'S. Pricing of NPA a big challenge for all stakeholders somehow the puzzle has not been solved.
On the recovery front the overburdened legal system is squeezing the blood...
Pl through some light on the New insolvency law's - whether you feel it will help ARC'S in light of the fact that u will have to approach DRT again for non corporate borrowers.

Kashif Mohammed

3 years ago

Could not agree more. Nicely put into words!

Kashif Mohammed

3 years ago

Could not agree more. Nicely put into words!

Kashif Mohammed

3 years ago

Could not agree more. Nicely put into words!

Jio says Airtel gesture welcome, but won't address call drops
Reliance Jio on Sunday welcomed Bharti Airtel's decision to provide better interconnection for its calls. But it also said the number of such points proposed remained substantially less than actual requirement -- and these won't be able to address the issue of large-scale call drops. Airtel rebutted in a counter-statement.
 
"Based on the current traffic flow between the two networks, the proposed augmentation by Airtel would still only suffice for less than one-fourth of the required interconnection capacity," a Jio statement said.
 
"More than two crore calls are failing everyday between the two networks, which is far in excess of the quality of service parameters and of alarming proportions. Urgent steps are required to be taken in the interest of customers of both operators," the statement said.
 
"It is unfortunate that the Telecom Regulatory Authority's intervention was required for Airtel to resume augmentation of points of interconnection, which it ought to have done by itself in compliance with its licence terms."
 
The statement comes a day after Airtel said it has received the payments due on interconnection from Jio and that after executing the agreed augmentation in such points, their total number will be three times that at present. It also said the capacity will be sufficient to serve over 15 million Jio customers, and added it will be much more than Jio's subscriber base.
 
"While the interconnect agreement provides for a commissioning period of 90 days from the day Reliance Jio makes the payment, Airtel will work towards releasing the points of interconnect well ahead of the contractual obligation," said Airtel.
 
But this point was refuted by Jio.
 
"The Telecom Regulatory Authority of India's regulation does not provide for 90 days to adhere to quality of service parameters. The authority, in fact, instructed the incumbent operators to urgently provide requisite interconnection capacities to maintain quality of service parameters and not to make this subject to any contingencies or restrictions."
 
Jio also found fault with the type of interconnection points Airtel was offering, and said it was a clear case of abuse of market dominance. 
 
"It appears that the quality of service will continue to suffer and Indian customers will be denied the benefits of superior and free voice services as a result of such anti-competitive behaviour."
 
But Airtel in a statement later charged Jio with dillydallying on the issue and deliberately not cooperating on interconnection. It also said such complaints may be a ploy by Jio to cover up some technical issues in their own network.
 
This was again refuted by Jio in another statement later on Sunday, while calling Airtel's rebuttal misleading and unfortunate.
 
"While there are over two crore call failures every day between the two networks (Jio to Airtel), there are no incidents of call failures within the Jio network," the Jio statement said.
 
It added that the company not only wanted subscribers to enjoy high-definition Jio-to-Jio calls, but was also invited third party, independent assesses like the resource and monitoring wing of the telecom department to confirm the veracity of its claims. 
 
Another issue of contention has been portability.
 
Jio said the rival has been blocking mobile number portability for migration of potential Airtel subscribers to Jio -- but the other side maintained that all requests were being processed as per guidelines. 
 
Disclaimer: Information, facts or opinions expressed in this news article are presented as sourced from IANS and do not reflect views of Moneylife and hence Moneylife is not responsible or liable for the same. As a source and news provider, IANS is responsible for accuracy, completeness, suitability and validity of any information in this article.

User

Reliance Jio now says operators violating portability norms
New Delhi: Reliance Jio has sought the industry watchdog's intervention over the three main telecom operators -- Airtel, Vodafone and Idea -- refusing to allow porting of their subscribers to its network, in an alleged disregard to licensing norms.
 
"Reliance Jio Infocomm, vide letters dated September 2, 2016, sent individually to Bharti Airtel, Idea and Vodafone, who are the incumbent dominant operators, informing them that Reliance Jio would be commencing its services from September 5," the company said in its letter.
 
"In spite of being under legal and contractual obligation to port the numbers after a valid request is made, the incumbent dominant operators have rejected all the requests made for porting between Sep 5 to Sep 12," said the letter to the Telecom Regulatory Authority of India (TRAI).
 
The letter said against 201 total requests made to the three operators -- to Airtel the most, followed by Idea and then Vodafone -- 161 of them have violated the contractual obligations and eight were subject to wrong coding, among other issues.
 
None were successfully completed, it said, and elaborated upon the portability regulations.
 
IANS sent queries to all the three operators. Vodafone and Idea did not respond. Airtel's spokesperson said in a one-line written response that the company was processing all porting requests as per guidelines.
 
"Please note that these rejections are in addition to the rejection of mobile number portability request of 4,919 corporate mobile numbers issued to employees and members of Reliance Industries Group by Bharti Airtel in August 2016," the Reliance Jio letter said.
 
"Reliance Jio sincerely requests that the TRAI take serious cognizance of this complaint and intervene by taking strict action against incumbent dominant operators under the relevant provisions of the mobile number portability regulations and the unified licence," it said.
 
The letter comes just as the incumbent operators and Reliance Jio appeared to be in the process of settling their differences over providing enough points of inter-connect for calls from the latter's network to go through to their own subscribers.
 
Disclaimer: Information, facts or opinions expressed in this news article are presented as sourced from IANS and do not reflect views of Moneylife and hence Moneylife is not responsible or liable for the same. As a source and news provider, IANS is responsible for accuracy, completeness, suitability and validity of any information in this article.

User

We are listening!

Solve the equation and enter in the Captcha field.
  Loading...
Close

To continue


Please
Sign Up or Sign In
with

Email
Close

To continue


Please
Sign Up or Sign In
with

Email

BUY NOW

online financial advisory
Pathbreakers
Pathbreakers 1 & Pathbreakers 2 contain deep insights, unknown facts and captivating events in the life of 51 top achievers, in their own words.
online financia advisory
The Scam
24 Year Of The Scam: The Perennial Bestseller, reads like a Thriller!
Moneylife Online Magazine
Fiercely independent and pro-consumer information on personal finance
financial magazines online
Stockletters in 3 Flavours
Outstanding research that beats mutual funds year after year
financial magazines in india
MAS: Complete Online Financial Advisory
(Includes Moneylife Online Magazine)