With growing stress in balance sheets of stressed companies and that of large banks, role of Asset Reconstruction Companies (ARCs)- envisaged as an institutional response to tackle growing NPAs- have come into sharper focus.
Out of 19 Public Sector Banks (excluding State Bank Group), majority i.e. 10 are under Prompt Corrective Action (PCA) by RBI. Stressed Assets of the system are at a significantly elevated level of around a Million crores and growing.
To address the alarming problem, Government of India have passed the Insolvency and Bankruptcy Code (IBC) which, amongst others, provide for change in management of defaulting company and time bound resolution in a period of maximum 270 days or the defaulting company moves into liquidation.
The Government has further taken the initiative to advise the Regulator RBI to advise banks to refer large NPAs. In the first instance, 12 large NPAs popularly referred as the "Dirty Dozen" having NPAs of over Rs 2 lakh crores have been referred to NCLT and other cases are being referred periodically thereafter.
The eco system around resolution of NPAs is evolving fast with slew of enabling regulations. The positive regulatory environment has encouraged a lot of players in distressed debt- both global and domestic- Special Situation Funds, Hedge Funds, Long Term Funds including Pension Funds, Sovereign Funds, PE Investors, Strategic Buyers, Turnaround Specialists, Specialised Transaction Advisory etc to come forward in large hordes.
And in this NPA space crowded with several stakeholders, how do ARCs stand out and pursue their effective role play, that is where ARCs to have to retrospect, introspect and reinvent themselves.
There are 4 key challenges which restricts ARCs scale up to a leading role in whole NPA play. First and foremost- Funds available with ARCs which is minuscule compared to the vast NPA market. Second, even if funds are available, the price expectation mismatch between selling bank (s) and buying ARC and ever elusive consensus on an acceptable valuation framework.
Third, even if an ARC acquires the NPA of a particular bank, how to expeditiously aggregate loans from all other creditors who have complex and deep rooted inter creditor issues to achieve threshold level for driving resolution- generally 75% of debt, though for sale of asset through SARFAESI it is 60%.
More important component in resolution beyond debt aggregation, is how to address challenges in resolution including finding fresh money, management and technology to revive the Asset. Finally, how to have an exit clause for the investors.
The ARCs have to address all these, which have been discussed at various levels and possible solutions are visible. Starting from the weakest link, absence of a vibrant distressed debt market in India. In a recent function of ARCs organized by an Industry body, RBI DG Viral Acharya rightly focused on this single factor alone.
He suggested setting up of a Distressed Loan Sales Trading Platform and advised formation of a body like Loan Syndication and Trading Association comprising of ARCs, Banks and Rating Agencies to work together for evolving such a platform. Selling of NPAs should be as smooth as selling Sachin Tendulkar's Bat, he added.
The next big challenge for ARCs is to develop and possess requisite skill sets in managing turnaround story. The RBI has already advised ARCs for preparing a panel of sector specific management firms/ individuals having expertise in running firms/ companies which could be considered for managing the (acquired distressed) companies. In fact, ARCs can choose niche area for scope of their operations for greater success in portfolio management.
With regulatory arbitrage over provisioning in banks and ARCs gone, role of ARCs as an exit structure for balance sheet management of banks is largely over. Banks will now look forward to more cash transactions particularly in recent NPAs with little provisions.
This will require ARCs to necessarily have extensive support from deep pockets with risk capital and risk appetite for their survival. For ARCs to get this support, they have to showcase their capability and preparedness to handle complex NPAs and inspire confidence of the investors that they can generate market expected IRR.
The debate on haircut has been ignited by Chairman of India's largest bank recently. How much cut is a cut, and beyond which it is bald for the bank- that is the question.
There is no ready answer. The banks, ARCs and the rating agencies, because they have been associated now for over a decade with Recovery Rating Scale i.e. valuing how much money can be realized from Security Receipts with underlying NPAs, have to devise an acceptable valuation framework and leave it to market forces for efficient price discovery.
Market is right, provided the issues of information asymmetry is addressed. With time, data on Credit Defaults, Loss Given Default, Expected Credit Loss i.e. expected present value of losses that arise if borrowers default on their obligations at some time during the life of the financial asset will evolve and risk pricing can be more quantified.
ARCs are now at a historic juncture. They can recreate successful ARC story by being alive to challenges above and transform into new Avtar. The choice before ARCs is between ability to script and execute a good turnaround story or being consigned to history.
Hari Hara Mishra is a Director, UV ARC Ltd and Advisor to Assocham on ARC, Banking and Financial Services. (Views are personal).