Tag: asset reconstruction companies

RBI Committee, BFSI News, ET BFSI

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Multiple factors have led to sub-optimal performance of the asset reconstruction companies (ARCs) in the country, said the Reserve Bank Of India (RBI) Committee.

The ARC framework was designed to allow originators to focus on their core function of lending, by removing sticky stressed financial assets from their books.

It was also designed to help borrowers revive their businesses, which protects the viable and productive assets of the economy and often ensures a better return to banks and financial institutions (FIs).

Accordingly, the Committee constituted to “Review the working of ARCs said multiple factors behind the sub-optimal performance of the sector such as vintage NPAs being passed on to ARCs, lack of debt aggregation, non-availability of additional funding for stressed borrowers, difficulty in raising of funds by the ARCs on their balance sheet, among others.”

“Also, ARCs have lacked focus on both recovery and acquiring necessary skill sets for holistic resolution of distressed borrowers.”

The RBI Committee cited data which showed that the performance of the ARCs has been lacklustre, both in terms of ensuring recovery and revival of businesses.

“Banks and other investors could recover only about 14.29 per cent of the amount owed by borrowers in respect of stressed assets sold to ARCs during the FY 2004-2013 period.”

“Similarly, data shows that approximately 80 per cent of the recovery made by ARCs has come through deployment of measures of reconstruction that do not necessarily lead to revival of businesses.”

Considering the challenges impacting the performance of the ARC sector, the Committee recommended sale of stressed assets by lenders at an earlier stage to allow for optimal recovery by ARCs.

“In this respect, the Committee highlights the need for regulatory clarification on sale of all categories of special mention accounts (SMAs) to ARCs.”

“Further, as a measure to incentivise lenders to sell their financial assets to ARCs at an early stage of stress, the committee recommends a dispensation to lenders, on an ongoing basis, to amortise the loss on sale, if any, over a period of two years.”

Besides, it called for a higher threshold of investment in SRs by lenders below which provisioning on SRs held by them may be done on the basis of Net Asset Value (NAV) declared by the ARC instead of the IRACP norms.

In addition, the Committee among other measures, recommended the creation of an online platform for sale of stressed assets.

“Infrastructure created by the Secondary Loan Market Association (SLMA) may be utilised for this purpose.”

–IANS

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As India’s bad bank knocks, ARCs seek relaxations from RBI, BFSI News, ET BFSI

Banking & Finance

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With the bad bank on the anvil, asset reconstruction companies have sought relaxation of the pricing structure for the purchase of bad loans, funding from banks, and clarity on participating in insolvency cases as a resolution applicant. These are among the suggestions made by ARCs to the committee formed by the Reserve Bank of India in April.

Usually, sales take place either on a full-cash basis or under the 15:85 structure, where 15% is paid as upfront cash and the remaining in the form of security receipts.

ARCs have sought a reduction in the minimum investment requirement to 2.5% from 15% in cases where cash is fully paid upfront.

The cash proportion of 15% has pushed the ARCs to raise their returns through securitisation and asset reconstruction.

Unless the ARC recovers 130% of the acquisition value, it will not make its return. Even at 100%, an ARC will make a loss because the management fee of 1-2% doesn’t make any ARR for ARC. Recovery should be over 130% so that 100% of security rights will be redeemed.

Also read: What are NARCL and IDRCL? How do they work and what is the plan?

Also, in September 2016, the Reserve Bank of India introduced new regulatory guidelines regarding provisioning. From April 2018 banks have to sell at 90% cash and 10% SRs. If a bank holds more than 10% SR, it had to continue provisioning for the loan which is not even on their books. So there is no incentive for them to transfer to ARCs. Now no banks transfer on 15:85 and all deals are in cash.

Bank funding

Asset reconstruction companies have asked RBI to allow bank funding for them on the lines of provided to non-banking finance companies. They have also sought doing away with dual-provisioning norms, a move which will benefit banks the most.

ARCs have suggested that bank provisioning needs to be solely based on the rating agency-determined net asset value of the security receipts.

From April 2018, banks have had to make provisions for stressed assets that are sold, assuming they remain on the books. This is applicable in cases where security receipts make up for more than 10% in the sale of non-performing assets.

Banks also have to make mark-to-market provisions in cases where the rating of security receipts is downgraded. Security receipts are valued on net asset values, linked to recovery ratings, which is an assessment of probable recovery from an underlying non-performing asset by rating agencies.

With banks not having to go for dual provisioning, they sell NPAs on a 15:85 structure, making more NPAs available for ARCs.

Currently, outstanding security receipts are estimated to be around Rs 1.1 lakh crore.

The RBI committee

In April this year, the RBI has formed a six-member panel under the chairmanship of Sudarshan Sen, former RBI executive director, to examine the role of asset reconstruction companies (ARCs) in stressed debt resolution, including under the Insolvency & Bankruptcy Code (IBC), 2016 and review their business model.

The committee is reviewing the legal and regulatory framework of ARCs and recommend measures to improve their efficacy. It will submit its report within three months from the date of its first meeting. As of January, the number of ARCs registered with the RBI stood at 28.



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RBI allows banks to sell ‘fraud loans’ to ARCs

Banking & Finance

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The Reserve Bank of India on Friday allowed loan exposures classified as fraud to be transferred to Asset Reconstruction Companies (ARCs). This comes in the wake of banks reporting frauds aggregating ₹3.95-lakh crore between FY19 and FY21.

Stressed loans, which are in default for more than 60 days or classified as non-performing assets (NPA), can be transferred to ARCs. This shall include loan exposures classified as fraud as on the date of transfer.

Issuing the guidelines for transfer of loan exposure, including stressed loans, the central bank said the transfer of such loans to an ARC, however, does not absolve the transferor from fixing the staff accountability as required under the extant instructions on frauds.

Until now, when an account is declared fraud, banks had to set aside 100 per cent of the outstanding loan as provision. Under the new rules, banks can hope to recover a part of the loan. For ARCs, this will allow them to buy debt cheaper than regular loan accounts.

Swiss Challenge method

The RBI also said the transfer of stressed loans above ₹100 crore negotiated on a bilateral basis between lenders and permitted acquirers, including ARCs, must necessarily be followed by an auction through the Swiss Challenge method. Under the Swiss Challenge auction, the price bilaterally negotiated for the sale of a stressed asset becomes the floor price for inviting counter-proposals from other interested buyers.

Loan transfers are usually resorted to by lending institutions for multiple reasons ranging from liquidity management, rebalancing of exposure or strategic sales. “A robust secondary market in loans can be an important mechanism for management of credit exposures by lending institutions and also create additional avenues for raising liquidity,” the RBI said in a circular to lenders.

New guidelines

Under the new guidelines, loans can be transferred only after a minimum holding period (MHP) of three months in case of loans with tenor up to 2 years, and six months fior those with tenor of more than 2 years. In case of loans where the security does not exist or cannot be registered, the MHP shall be calculated from the date of first repayment of the loan.

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RBI allows banks to sell fraud NPAs to ARCs, BFSI News, ET BFSI

Banking & Finance

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In a move that will help banks unload a major chunk of their non-performing assets (NPAs) to the bad bank, RBI has allowed the sale of loan accounts classified as fraud to asset reconstruction companies (ARCs). Earlier, banks were barred from selling NPAs classified as fraud, which had left them saddled with a resolution of several large accounts.

Banks are targeting to sell Rs 2 lakh crore worth of NPAs to the bad bank or the National Asset Reconstruction Company (NARCL) for recovery. However, they have hit a roadblock in respect of accounts that have been classified as fraud, as they were not allowed to sell them. RBI has now allowed banks to sell fraud accounts, provided the transferee is not connected to the borrower.

RBI has also said that responsibilities of the transferor with respect to continuous reporting, monitoring, filing of complaints with law enforcement agencies and proceedings related to such complaints shall also be transferred to the ARC. “The transfer of such loan exposures to an ARC, however, does not absolve the transferor from fixing the staff accountability as required under the extant instructions on frauds,” RBI said.

“Due to forensic audit in all big NPAs, in last three years, advances amounting Rs 3.83 lakh crore were declared as fraud accounts. This chunk of NPAs will be available for sale to ARCs,” Hari Hara Mishra, director, UV ARC, said.



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Understanding future of revamped ARCs in India’s future trillion dollar economy, BFSI News, ET BFSI

Banking & Finance

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Asset Reconstruction Companies were established with the role of providing specialized expertise in management and recovery of non-performing assets (NPA). Ideally, this would allow financial institutions to focus more on optimizing lending instead of difficult recoveries. The high number of NPAs on the balance sheet of Indian banks in the last three years is not fresh news. ARCs are important interventionists and crisis managers who can play a major role in the insolvency and turnaround framework of India. But they are presently like the unetched character of a Bollywood potboiler without the proper chance to shine because the script fails them.

A committee has been set up by RBI to undertake a comprehensive review of and recommend the working of ARCs to meet the growing requirements of the financial sector on April 19, 2021, under the chairmanship of Shri Sudarshan Sen, former Executive Director, RBI. The role of ARCs in relation to NPAs needs to be re-thought allowing legroom for a disruptive role. Just like the Insolvency and Bankruptcy Code led to behavioural change in loan repayments, it is necessary that the market behaviour of banks and ARCs is compulsorily modified for them to think out of the box and allow risk diversification. Some of our recommendations are discussed below.

Objective Valuation of Financial Assets: The price bid by ARCs for NPAs does not reflect the true recoverable value of financial assets generally. Acquisition of assets is known to happen at acutely discounted rates which may not be aligned with the bank’s recoverable value let alone the market value of the financial asset had it not been distressed. There is a need for objective guidelines for the valuation of financial assets and prohibition on acquisitions and sales at overtly discounted values.

Concentration limit on retention of security receipts by banks: After acquiring an NPA, the ARC issues security receipts (SR) redeemable on the resolution of NPA. This mechanism is supposed to create risk spread, allow a diverse class of investors and make NPA a tradeable asset. But 80-90% of the SR are held again by financial institutions. Effectually, NPAs never leave the balance sheet of financial institutions but just re-enter through the backdoor. Financial institutions continue to heavily invest in SR despite substantial disincentives in holding SRs above 50%. It is important to create concentration limits on SR holding of financial institutions creating a compulsion to market SR to a more diverse category of investors.

Separate Regulatory Department and Class of Professionals: Some of the least supervised and audited (regulatory) classes of regulated entities in India include ARCs and credit rating agencies. Although the function of ARCs is distinctly different from banks and NBFCs, they presently come under the same regulatory and supervisory department of RBI which is already understaffed and overworked. It is important to acknowledge ARCs and even NBFC-Factors as a separate class of regulated entities from banks, cooperative banks and NBFCs. The ARC sector also needs specialized professionals to provide thought leadership and out of box thinking on NPA management, asset turnaround, investment banking, and valuation just like insolvency professionals.

Third-party funding of dispute resolution and securitization process: Most of the times banks have to take up litigation or arbitration for enforcement of security interest. Such dispute resolution is part of the NPA resolution process and maybe a high cost for the bank. To allow banks to increase their liquidity when required, ARCs should be allowed to act as third-party funders of the cost of litigation or arbitration in lieu of part or whole of a financial asset as a success fee. This form of funding is already well established in other financially mature jurisdictions like United Kingdom, Singapore, Hong Kong, and the USA.

While revitalizing the ARC industry it is important that enough thought is given to creating mechanisms and processes that allow proper shifting and allocation of risks and responsibilities. Unless the risk of NPA actually does not move out of the balance sheet of banks and there is enough regulatory freedom for ARCs for resolution of stressed assets through innovative and out of box structures, the mechanism for NPA resolution is fraught to be dependent on government rescue which is not feasible in the long run for the economy and the industry.

The blog has been authored by Ajaya Kumar Sahoo, COO, Find friends & Independent Director at PC Financial
Services and Kritika Krishnamurthy, Partner BFSI at AK and Partners

DISCLAIMER: The views expressed are solely of the author and ETBFSI.com does not necessarily subscribe to it. ETBFSI.com shall not be responsible for any damage caused to any person/organisation directly or indirectly.



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Monitor ARCs for ‘circuitous movement of funds’ with banks, says RBI paper, BFSI News, ET BFSI

Banking & Finance

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The Reserve Bank of India has flagged risks of excessive reliance on banks by the ARC industry.

An RBI paper, published in the central bank’s monthly bulletin for April, said banks supply non performing assets (NPAs) to the ARCs, hold shareholding in these entities and also lend to them, which makes it necessary to monitor if there is a “circuitous movement of funds between banks and these institutions (ARCs)”.

“Considering that banks are not just the major shareholders of and lenders to ARCs but also sellers of NPAs to ARCs, it may be necessary to monitor if there is a circuitous movement of funds between banks and these institutions. A movement of this kind can have implications for the genuine sale of NPAs and the overall growth of the ARC industry,” the article titled ‘ARCs in India: A Study of their Business Operations and Role in NPA Resolution’ said.

ARC versus IBC

It advocated for a strong a strong asset reconstruction sector, which complements the Insolvency & Bankruptcy Code mechanism, to better deal with non-performing assets and ensure higher recovery and resolution. Asset reconstruction companies recovered 29.7% of dues in 2019-20, while for IBC, this number was much higher at 45.5%, it said. Highlighting that there has been a declining trend in recovery over the years, the article said that even post IBC, their recovery amounts to 25-35% of dues, and they also account for 30% of total amount recovered through all channels.

Bad bank

The RBI article sees a greater role for asset reconstruction companies, including the bad bank announced in the budget.

“Going forward, the introduction of a new asset reconstruction company for addressing the NPAs of public sector banks may also shape the operations of the existing ARCs,” the RBI paper said. It added that there is a definite scope for the entry of a “well-capitalised and well-designed entity” in the Indian ARC industry and such a body will strengthen the asset resolution mechanism further.

It cited global experiences to lay down the necessary features of the new ARC announced by the government.

The paper advocated that the new ARC or the bad bank should have a narrow mandate such as resolving NPAs with clearly defined goals, a sunset clause defining their lifespan, supportive legal infrastructure involving bankruptcy and private property laws, backing of a strong political will to recognise problem loans, and a commercial focus including in governance, transparency, and disclosure requirements.

Capital constraints

The paper highlights the capital constraints of the ARC indsutry saying it has had an impact on the ability of their to ensure resolution and recovery. In terms of capital base of the industry, 62% was held by the top three asset recast companies and 67% for top five, which the authors argue shows how the business remains highly concentrated. As per the article, of the total assets under management, about 62% and 76% were held by the top three and top five asset reconstruction companies in March 2020, respectively.

Security receipts

About 42 per cent of the outstanding SRs (security receipts) as on March 2020 were more than five years of age and would have to be redeemed over the next four years to avoid write-offs,” the paper said, pointing out at the difficulties being faced by the current set of ARCs in resolving the stress.

While resolving a case, ARCs pay a minor portion in cash to the selling bank while the rest is SRs to be paid over a time.

Security receipts are issued as an instrument to enable offloading of stressed assets, and to encourage recovery and resolution of dues.

It said due to capital constraints, there was a high dependence on bank funding for such asset reconstruction companies, with banks selling bad loans continuing to hold security receipts, despite regulatory disincentives. In March 2020, just two asset reconstruction companies held about 62% of the total security receipts issued. The paper said that banks holding such a large volume of security receipts limits secondary trading and effectively market-based price discovery.



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Banks line up ARC sales as 2020 draws to close

Banking & Finance

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While the overall lending rates have declined when we look at the headline rates, the transmission is probably slower when we look at various products or risk segments.

The distressed asset market, which had gone into a deep freeze after the outbreak of Covid-19, has started to recover in Q3. Large banks have lined up a string of legacy non-performing assets (NPAs) for sale to asset reconstruction companies (ARCs). The deterioration of household incomes has also led banks to consider the ARC route for retail assets and the activity in this segment is now 30-40% higher than pre-pandemic levels.

On Monday, State Bank of India (SBI) and ICICI Bank put out notices for the sale of their exposures to Action Ispat & Power (Rs 540 crore) and Gammon India, respectively. A consortium of lenders to Jindal India Thermal Power (JITPL), led by Punjab National Bank (PNB), has also sought bids for the project. Earlier, Bank of Baroda (BoB), Axis Bank and IDBI Bank have also run processes for NPA sales, according to sources.

Some of the sales happening now would have been closed in the initial months of FY21, had the pandemic not halted due-diligence processes. For instance, a foreign bank with a significant interest in the stressed asset space had earlier bid for three power projects — Coastal Energen, GVK Goindwal Sahib and JITPL. After the pandemic outbreak, it withdrew the bids.

In fact, latency is one of the key factors driving the series of deals right now. Aswini Sahoo, executive vice-president and chief investment officer at Asset Reconstruction Company (India) (Arcil), said, “There are deals that should have happened in the early part of this year which have now got bundled together in the last few months. We will see some more large names in the power sector, which could get closed in the next quarter.” The deal closures in the next quarter can be put into two buckets, Sahoo added. One bucket is that of the corporate cases and the other is that of small and medium enterprises (SME) and retail. Deals up to Rs 5,000 crore could be seen in the next quarter, with Rs 2,000 crore in the retail and SME segment and the rest in the corporate segment.

Another feature of some of the asset sales happening now is the presence of a promoter willing to settle the account. The JITPL auction is being held under a Swiss challenge process after the consortium received a binding proposal of settlement from the company. Action Ispat is understood to have attracted bids from an ARC and there too, a Swiss challenge is being run.

A top executive with another ARC said that bigger deals are likely to pick up from here on and there are mainly three categories of deals being made. “The deals by stressed asset funds through ARCs had also frozen up because investors were not able to take a view amid the pandemic. The second type is where you have a small amount which is being settled by the promoter through the ARC route,” he said, adding, “The third type of deal, which we expect will now pick up, is in the retail space.” These portfolios being offered by banks range between `300-2,000 crore and there is a mix of secured and unsecured loans.

The end of the moratorium and the restructuring window could also open up space for NPA sales in 2021, said Sanjay Tibrewala, chief executive officer, Phoenix ARC. He observed that earlier, retail sales were more sporadic and in the last few months, there has been a 30-40% increase in action on retail sales by banks. “We could see a lot more deals happening next year because the moratorium has come to an end and there are not too many cases of restructuring. So there will be only two options — either these accounts will be sold to ARCs or banks will start recovery actions themselves, whether through IBC or Sarfaesi.” While recovery action can be carried out in parallel, asset sales could be a viable option for banks, he added.

Asset pricing, too, could improve in 2021, according to some executives. Jyoti Prakash Gadia, managing director, Resurgent India, said, “In the next year, the market is expected to stabilise, which will help in arriving at a proper pricing for the assets.” This, he added, will lead to more transactions happening, particularly in relation to those projects which are generating revenues and are indicating reasonable viability, including those in the infrastructure sector.

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