What’s an Asset Reconstruction Company, and why does it even matter to NPAs?

As is suggestive of the name, ARCs are required to repackage assets to make them more saleable. But, in the context of bad loans, or non-performing assets, such companies often falter to garner enough firepower to root out the surging menace of NPAs. The Indian context is caused primarily by a systemic rot involving faulty practices of project finance and subsequent difficulties in recoveries on loans. ARCs are constituted to precisely address such hurdles. With their status as centralised agencies, these are programmed to buy up stressed/distressed and non-performing assets and repackage them to sell them to prospective promoters/buyers. ARCs are programmed to buy NPAs at a discounted price, which in turn help the banks and lenders to clean up their sticky balance sheets. ARCs can either be public, private or jointly owned, and are also armed to float bonds to recover dues from borrowers. Even if on paper the concept of an ARC looks robust with scalability to concoct a bad asset with a performing one in order to increase its saleability, in reality, ARCs are prone to failures for lack of buyers for their packages and limited by capital concerns. But, there are challenges galore for ARCs viz. debt aggregation is a far cry, and unless this is done, resolution will always be expeditious; hunt for fresh financial support; and discrepancy between banks and ARCs in pricing of assets, unless reached a commonality would continue to remain a contentious issue.

The whole concept of Asset Reconstruction Companies (ARCs) is closely modelled on the US model of Asset Management Companies (AMCs), and is thus a large industry in itself as far as buying and selling off of debts are concerned. It resembles a time to strike as the ducks are now lined, and the opportunities galore in private equities as ARCs get a chance to own the entire capital structure and reinstall management echelons, all thanks to Budgetary recommendations with a 100% FDI welcomed. But, it still is going a bit too far, and hence let us examine the evolution first.

arc

The real trigger for ARCs to flourish came with Raghuram Rajan’s exhortation to banks to clean up its mess. A switch of trajectory happened sometime in 2013, when ever greening bad loans was put on to back burner and let ARCs face up. This is where banks were obligated to turnaround loans until then considered unredeemable. Adding to that trigger point is another one banking on Bankruptcy Code, which promises discount to buying off bad debts or distressed assets at a discount pitting them more profitable a venture compared with greenfield projects of similar magnitude.

ARCs are born out of SARFAESI Act, 2002, (The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002) and enable the banks to acquire the securities which had been pledged. all of this was achievable without any interference from the jurisdiction of the civil courts thus lending authoritarian power to banks to cope up with NPAs. But regulatory directives prevented the smooth functioning of transactions involving bad debts, thanks to the decrepit system for enforcing securities. Sale of loans to ARCs is however the last resort banks undertake as statutory hurdles and deposed promoters speed break.

Basically, road to recovery is a step by step process involving, Bank selling a bad loan to ARC; ARCs paying 15% upfront, and issuing the remaining 85% as securities in the form of Security Receipts (SRs), which primarily deals with 5% upfront payment as was the case a year back; ARCs initiating the turnaround and in the process earning 1.5% management fee; recovery proceeds thus accrued get shared by the banks and the ARCs; and if the ARCs fail to recover the bad loans for eight years, the investments get written-off. Now, this can be seen as a clear shift from ever greening, or even liberal funding by the government year-on-year, and aptly reminds internal recapitalization as indispensable. Budgetary infusion or capital infusion or recapitalisation is putting capital for the purpose of helping the ailing public sector banks. The very understanding of PSBs would imply such an infusion required from time to time, but the problem lies in its ritualistic nature. On the contrary, if banks were to internally raise funds for recapitalisation, it would indicate a healthy practice. One reason the government does infusion is to meet Basel III norms, as reliance upon internal fund recapitalisation would not let that be accomplished. But, there is a caveat here to be always kept in mind. Written-off doesn’t necessarily mean that defaults and defaulters are not chased. They are undoubtedly sought after, with the only difference being the clean-up of balance sheets for the year such defaults happen for the banks. And, if they don’t write-offs, or alternatively called charge-offs effectuate helping banks not only erase the mess off their balance sheet, but saving them enormous tax liabilities. The real tussle is between charging-off loans and becoming industrious in selling them off. The winner takes it all, which in this case is hedging equivalent to selling off bad debts, and which is promulgated by the RBI and the government in jettisoning this messy baggage.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s