As the non-performing assets of banks mount, there is a readymade option to lighten up this burden in the form of Asset Reconstruction Companies (ARCs). They were formed to buy out distressed assets from banks and financial institutions and sell them at a reasonable price. But they haven’t proved effective. Recently, the RBI has proposed new guidelines on early recognition of stressed assets, and fair recovery for lenders and investors. The central bank has also sought better functioning of ARCs. We spoke to P. Rudran, MD and CEO, Arcil — India’s first ARC — for an update .
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ARCs were formed under Section 3 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002, to help banks manage and recover NPAs by securitising financial assets and empowering banks and financial institutions to take possession of the securities and to sell them without the intervention of the Court. The Debt Tribunal or civil courts present earlier were not very effective and fast. So, ARCs were set up to enable faster recovery without the intervention of the court.
Arcil was the first ARC formed under the Act. Initially, assets were transferred to us against the security receipts (SRs) we issued to the banks. However, in 2006 the RBI mandated ARCs to invest at least 5 per cent in the SRs issued to enable active participation in the recovery of bad loans. Currently, the process is something like this. When we agree to acquire assets from the banks and financial institutions at a given price, there is an assignment agreement which is signed with the selling bank. One or more trusts are set up by the ARC for housing these assets. The trust issues SRs to the selling banks as well as other investors, such as qualified institutional buyers (QIBs).
So, typically, you step into the shoes of the bank?
Yes, all the rights and privileges that banks have will be applicable to us. If the case is already in Debt Recovery Tribunal (DRT), then we can substitute our name or we can ourselves file recovery suit in DRT if the bank had not already done it. However, there is one limitation. The maximum resolution period allowed by the RBI is five years, which can be extended up to eight years, if need be, with the approval of the Board. Banks can take any amount of time to recover bad loans under various routes. Under the Trust structure, if ARCs do not resolve the NPAs within the maximum period of eight years, the investment has to be written off. However, the resolution process will continue.
With increase in NPAs in the banking system, your business must have been very robust?
Not really. In the last two-three years, banks have not used this tool very effectively, though the current year is witness to the vast improvement in the offer for sale of NPAs by the banking system. In 2012-13, we acquired around Rs 740 crore of assets which we plan to increase to Rs 2,000 crore in 2013-14. Of late, banks have been coming up with more assets to sell, but conclusion of deals is still not encouraging.
What has been the main reason behind banks’ reluctance to use this tool?
The main issue has been with the pricing. We (ARCs) do our own due diligence and value the security on a time-based recovery. This will differ depending on our assessment of the recoverable value of the underlying asset. Today, the challenge is to induce banks to sell assets to us. ARCs have to demonstrate that they are able to recover the amount and redeem SRs in their favour.
So, once the amount is agreed, you make an upfront payment?
There are two ways in which this is done. One is an outright cash purchase, under which the agreed amount is paid upfront. Two, where an SR is issued, both the banks and the ARCs decide on the sharing proportion. Say, for instance, the ARC decides to invest 10 per cent and, for the balance 90 per cent, SRs are issued to the bank.
When the amount is finally recovered, the balance amount is redeemed against the SR. In the above case, if the agreed amount is Rs 20 lakh, then Rs 2 lakh is invested upfront, and for the balance Rs 18 lakh, an SR is issued to the bank or any other QIB. Once the loan is recovered, the balance Rs 18 lakh is redeemed to the bank after netting off expenses, management fees, and so on. If there is an upside, it is shared between the SR holders and the ARC on an agreed proportion.
In 2012-13, two-thirds of the assets were purchased through the cash route and the balance through SRs. This year, we are increasingly seeing more purchases through the SR route.
What happens if the recovered amount is more than Rs 18 lakh?
Then we share the additional amount in the proportion decided by us. Typically, investors in SRs get 80 per cent and ARCs retain 20 per cent. Usually, if we have invested a higher proportion initially, then we take a higher share. This share will change from case to case.
Which are the sectors that pose a challenge to recovery?
Power, and iron and steel sectors are issues. However, we do not take large infrastructure projects anyway; we take smaller SME cases.