Sale of bad loans to ARCs hit for second year running

Sale of bad loans to Asset Reconstruction Companies (ARCs) that had gained considerable momentum four years ago has halved over the past two years. From about ₹50,000 crore in 2013-14 and 2014-15, bad loans sold by banks to ARCs have fallen to ₹20,000 crore in 2015-16 and slipped further to ₹15,000 crore in 2016-17.

The RBI demanding a higher down payment and the ARCs stretching themselves thin on capital have been the main reasons.

The primary task of the ARCs is to acquire, manage and recover bad loans. After a lacklustre beginning, banks started aggressively offloading their bad loans to these companies in 2013-14, lured by better pricing. This was thanks to deals done through the ‘security receipts’ (SR) route. Instead of taking an upfront cash payment, banks were willing to accept delayed payment in the form of SRs. ARCs made a down payment of a minimum 5 per cent of the agreed value and the balance 95 per cent was redeemed against the SR, when the amount was finally recovered.

In August 2014, the RBI tweaked the rules and increased the upfront payment to be made by ARCs from 5 per cent to 15 per cent. This has impacted the returns for ARCs, which until then were able to make an internal rate of return (IRR) of 20-22 per cent on their investment.

The issue of insufficient capital also became more pronounced after the RBI’s directive on higher down payment. Being a capital intensive business, ARCs have not been able to take on bad loans from banks at an aggressive pace.

There are about 21 ARCs currently with an aggregate capital of just around ₹4,000 crore. The bad loans in the banking system, on the other hand, are over ₹ 6.5 lakh crore.

But, one of the proposals in the 2016-17 Budget that recently came into effect seeks to ease capital raising for ARCs.

One of the main reasons for investors shying away from infusing capital into ARCs was the cap on single ownership. Earlier, no single investor could hold more than 49 per cent. Inability to have a controlling stake in the business led to tepid investor interest.

But, the recent amendments, which allow a sponsor or promoter to hold up to 100 per cent have offered some respite to the ARCs.

“Edelweiss ARC has increased its capital from about ₹200 crore to over ₹800 crore. We have also tied up with CDPQ, one of the large pension funds in Canada for investment in stressed/distressed assets in India. Aggregate funds available for investment will be about ₹12,000-14,000 crore over the next 3-4 years,” says Siby Antony, MD & CEO, Edelweiss ARC.

The Economic Survey highlighted that the ARCs have found it difficult to recover much from debtors and the issue can be resolved by creating a ‘Public Sector Asset Rehabilitation Agency’ (PARA). The new entity can eliminate most of the obstacles currently plaguing loan resolution.

But industry players disagree. “I don’t think a public sector ARC can improve the recovery process substantially. But given that the Centre does not have sufficient funds to recapitalise PSU banks, its choices are limited,” says Nirmal Gangwal, Managing Director, Brescon Corporate Advisors, a corporate debt restructuring advisory firm.

He adds that allowing banks a second time restructuring for the next two to three years may be a better option. But economic recovery will be critical for this to work.

Antony feels that things could change for the better for ARCs soon. “It is wrong to gauge the success of ARCs based on past data, when dead assets were sold to ARCs as a last resort of recovery. Besides, pricing of such assets was not given due importance. With significant skin in the business by ARCs, pricing is critical, “ he adds.

Further, with the Bankruptcy Code in place, the resolution process is expected to smoothen. “I believe SR redemption for new assets will be more than 100 per cent,” says Antony.