Bad bank can wait, let’s re­cast ARCs

The Pak Banker - - OPINION - Ta­mal Bandy­opad­hyay

THE as­set re­con­struc­tion com­pa­nies or ARCs in In­dia, which are in the busi­ness of buy­ing bad loans from banks and mak­ing money by re­cov­er­ing them, had around Rs.50,000 crore worth of bad as­sets un­der man­age­ment in fis­cal year 2015. In the first three quar­ters of the cur­rent fis­cal year, banks wanted to sell around Rs.90,000 crore of bad loans, but less than one-fourth of it has ac­tu­ally been sold to ARCs, even as gross bad loans of listed banks rose to Rs.4.38 tril­lion in the De­cem­ber quar­ter, adding al­most a tril­lion ru­pees in three months. Will the pro­posed Na­tional As­set Man­age­ment Com­pany be able to do what 15 ARCs could not in over a decade?

Bank CEOs have started mak­ing an­nounce­ments on fresh pack­ages of bad loans be­ing put on sale, but the pace of sale is un­likely to gather mo­men­tum. If you ask the ARCs on why they are not ag­gres­sively buy­ing as­sets, they will blame the Re­serve Bank of In­dia (RBI) norms that have raised the min­i­mum in­vest­ment from 5% to 15% in the so­called se­cu­rity re­ceipts (SRs) or pass-through cer­tifi­cates that are is­sued against such as­sets.

The ARCs levy higher dis­counts when they buy loans of­fer­ing cash, but when they of­fer SRs for buy­ing loans, the dis­count drops. How do the ARCs make money? They get man­age­ment fees of 1.5-2%. When the in­vest­ment re­quire­ment rises three times, their re­turns drop dra­mat­i­cally. Also, the fees are now linked to the net as­set value (NAV) of the as­sets and not the out­stand­ing value of the SRs. So, any short­fall in the re­cov­ery of bad loans low­ers their fees. Six months af­ter buy­ing bad loans, the ARCs are re­quired to get the SRs rated, and based on the rat­ing­which takes into ac­count the progress in re­cov­ery-the NAV is cal­cu­lated.

From the ARCs' point of view, cash trans­ac­tions are al­ways bet­ter as they can levy rel­a­tively higher dis­counts, but they don't have the money to do so. Un­der norms, they can be 100% owned by for­eign in­vestors who can lend money mus­cle and ex­per­tise, but none of them is en­tirely for­eign-owned and, in fact, very few have for­eign stakes. They blame the 49% cap on sin­gle hold­ing for their fail­ure to at­tract for­eign in­vest­ments. It is un­likely that RBI will al­low a higher for­eign stake for a sin­gle in­vestor as it be­lieves that a widely held share­hold­ing pat­tern en­sures cor­po­rate gov­er­nance in a rel­a­tively lightly reg­u­lated sec­tor.

SSG Cap­i­tal Man­age­ment, a dis­tress and spe­cial-sit­u­a­tion pri­vate equity fund, holds a 49% stake in As­set Care and Re­con­struc­tion En­ter­prise Ltd. KKR and Co. wants to pick up a stake in In­ter­na­tional As­set Re­con­struc­tion Co. Pvt. Ltd, but the in­vest­ment is await­ing govern­ment ap­proval. About half-a-dozen ap­pli­ca­tions for new ARCs have been pend­ing with RBI. Some of them have for­eign in­vestors on board.

Cap­i­tal is the big­gest prob­lem for the ARCs. If in­deed a frag­mented own­er­ship is com­ing in the way to at­tract for­eign cap­i­tal, the ARCs should be al­lowed to tap the cap­i­tal mar­ket by sell­ing shares to the pub­lic. It's not clear whether the Se­cu­ri­ti­sa­tion and Re­con­struc­tion of Fi­nan­cial As­sets and En­force­ment of Se­cu­rity In­ter­est Act, which gov­erns ARCs, al­lows them to do so. It may not also be easy for them to raise money from pub­lic as le­gal is­sues re­main the big­gest hur- dle for the re­cov­ery of bad as­sets, lead­ing to in­or­di­nate de­lays. Till the pro­posed bank­ruptcy law is put in place, ARCs will strug­gle to re­cover and re­deem SRs. There are other is­sues as well. For in­stance, the stamp duty is not uni­form in In­dian states. This in­flu­ences the pric­ing of such as­sets.

Pric­ing al­ways re­mains a bone of con­tention for the sale of bad as­sets-while banks want a higher pric­ing, ARCs want to buy at a hefty dis­count. No­body has clar­ity on the fair value of a bad as­set put up for sale. One way of ad­dress­ing this could be a re­cov­ery rat­ing of such as­sets be­fore they are sold, in­stead of rat­ing them six months later. Re­cov­ery rat­ings re­flect a fun­da­men­tal anal­y­sis of the un­der­ly­ing re­la­tion­ship be­tween fi­nan­cial claims on an en­tity and po­ten­tial sources to meet those claims. The pric­ing can be based on such rat­ings and even if the banks are re­quired to of­fer high dis­counts, they will not be afraid of be­ing hounded by agen­cies like the Cen­tral Bureau of In­ves­ti­ga­tion and Cen­tral Vig­i­lance Com­mis­sion.

The auc­tion process must also be trans­par­ent. Cur­rently, ARC of­fi­cials are not al­lowed to visit the fac­to­ries of a com­pany of­fered as a se­cu­rity of the loans that are be­ing sold. Un­less they get a sense of the value of the se­cu­ri­ties that are back­ing such loans, how would they make a fair of­fer to buy them? We need a fair prac­tice code both for the banks as well as ARCs to make the busi­ness of as­set re­con­struc­tion a suc­cess.

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