about 2 years ago
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RBI put out some very significant data on Asset Reconstruction Companies (ARCs). This data came up through an RTI and shows that the existing 27 ARCs in India book value of loans purchased as at 31st March 2018 stood at Rs.3.23 lakh crore. This is vis-à-vis the Rs.10 lakh crore worth of gross bad loans held by banks at end of FY18.

RBI also stated that between March’18 and March’18, book value of loans held by ARCs rose by Rs.66,778 crore while gross NPAs of banks surged by Rs.2.6 lakh crore.

What does this data show? Very simply that the ARCs are not doing what they are supposed to do – clean up the books of banks. Given the record high rate of NPAs, this ideally should have been booming times for ARCs but sadly it’s not so.

Banks unwillingness to take a haircut and inability to collate and sell 100% of the outstanding loans is at the root of the problem. The major bone of contention remains pricing of the asset as banks prefer to calculate that on the basis of going business value while the unit has already gone phut.

Another issue is the payment method. As per the rules, ARCs have to offer a minimum of 15% in cash and balance in security receipts. But Banks want more cash upfront to enable MTM adjustment for security receipts.

There are currently some 27 ARCs in India and Arcil is the market leader with a 40% market share. The Govt is trying to get encourage setting up of more ARCs and even opened it up for FDIs. Yet there have been no major takers.

Setting up new ARCs will not help clean up the banking system. More than new ARCs, the banking system, especially the way in which PSU banks, which currently works like the fiefdom of politicians, should be changed.

These questions apart, what comes to mind is why on earth would someone want to buy these rotten apples or NPAs?  What do these ARCs gain? A quick pathshala…

What are ARCs?

These are Asset Reconstruction Companies and as the name suggests, it is engaged in acquisition of NPAs from the banking system and resolving the assets acquired.  These are neither owned nor supported by the Govt. These ARCs are basically something like facilitators and they exist because there is a business opportunity even in distressed assets. They buy the NPAs and then try to unlock value and maximize returns to the investors. They do so by trying to restructure the distressed assets, either by formulating a CDR type package with the existing promoters or sell the business to strategic investors, who are willing to buy or see a potential in such assets. It is indeed something like buying old and dead goods and then recycling it, giving it some life and then putting it back on the block for sale. In short, refurbishing NPAs and then either reviving it or selling it is the business of ARCs.

How are these NPAs sold to the ARCs?

It is usually through an NPA auction by the aforesaid bank, with payment coming in either in cash or security receipts. As expected, the selling price of the NPAs put up by the bank is almost always much higher than the best bid price discovered through the auction process. The big grouse is that there is very little transparency in this auction. Banks do not offer any floor price but once they get the price, usually the highest bid from the ARCs, they go and negotiate with the borrower for a settlement and this underhand settling leads to the asset being withdrawn abruptly from the auction. This is how majority of the distressed assets are ‘sold’.

Why is it that banks have not taken to selling NPAs in a more vigorous manner?

Well, just as there is a laxity in credit history check, there is laxity in selling these NPAs too. The same ‘chalta hai’ attitude comes into play with banks becoming very lenient, especially with errant big companies, allowing them to instead opt for restructuring the stressed assets and thus increasing the burden further on the banking system. Some banks even offer fresh funds to beleaguered promoters to pay up the same bad loans! Thus despite a solution being at hand, banks prefer to work out solutions which eventually become problematic.

But banks opting for these routes too has a reason – if banks sell distressed assets to an ARC, it has to provide for the difference between the book value of the loan and the value at which it was sold to the ARC; this has to be shown immediately which impacts profits unlike its provisions on bad assets, which the bank can carry forward for few years, lessening the impact. Thus selling to ARCs is a last resort.

So is the money accrued from the sale of NPAs shown as profits in the bank books?

The rules have been tweaked and now banks are allowed to directly book the profit or sale of a bad asset to an ARC in the profit or loss account and not a separate account.

What about the Security Receipts? What do they actually do?

Referred to as SRs, suppose the ARC needs Rs.100 crore to buy a NPA, it will issue SRs worth Rs.100 crore. When the ARC puts up the asset for sale, it will get Rs.100 crore from the buyer, which it will in turn give to the bank as cash. They are not like a bond or debenture and do not carry any coupon/interest rate.  SRs are thus issued to banks pending recovery from an account and encashed by the bank once loan is recovered. shed after the loan is recovered. On the other hand, when book value is higher than sale value, RBI has stated that the shortfall can be spread over a period of two years, available for NPAs sold up to March 31, 2015.

There is the 5:95 rule which many in the ARC sector needs a relook as under this RBI stipulation, the ARC needs to subscribe to 5% of the SRs issued by them for the NPAs while banks will subscribe to the balance 95%.

Once the ARC buys the NPAs, do they show as bad loans in their books?

ARCs can buy the bad loans either directly or through a trust. Of the 14 ARCs in India, 98% of the acquired assets are through the trust structure, which means ARCs do not own the assets but they only manage the assets held by the trust. Thus their books do not show the NPAs but RBI has stipulated that when ARCs do not recover the assets with the given time frame, it has to be shown as  NPA is the ARCs books and that means no management fee for the ARC.

ARCs are essentially partners of the banks and both need to work hand-in-hand to help clean-up and strengthen the system. More power to them!

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