Asset reconstruction companies (ARCs) are expected to circle stressed accounts in the micro, small and medium enterprises (MSME) and retail segments in the near-to-medium term, given the twin challenges of inadequate funding access and intensifying competition once the proposed National ARC materialises, ratings agency CRISIL said in a report.
ARCs have been facing headwinds in the past two fiscals, with assets under management (AUM) - as measured by security receipts (SRs) outstanding - contracting after a strong run-up in the previous five, the report said. "Between fiscals 2015 and 2019, their AUM expanded steadily on supportive regulations introduced in fiscal 2014. But that trend reversed in fiscal 2020 with 4 per cent contraction. In fiscal 2021, too, as per CRISIL Ratings estimates, AUM contracted 1 per cent to Rs 1.07 lakh crore," it added.
The report said while the slowdown is partly attributable to the general macro environment, which has hindered consummation of deals and heightened risk aversion among investors, a few structural trends are also at play.
First, banks prefer to retain only a limited share of SRs for assets sold due to the stringent provisioning norms for selling banks on holding these. On the other hand, ARCs in most cases hold only the regulator-mandated 15% of SRs, it said, adding that this results in a gap that has to be bridged either by the ARCs holding a larger proportion of SRs or by attracting external co-investors.
This marks a significant shift from the past where till fiscal 2018, almost all the SRs were subscribed to by either the selling institutions or the ARCs. "Post the revised provisioning norms, the share of external investors in cumulative SRs issued increased sharply to 12 per cent as on March 31, 2019, from 3 per cent as on March 31, 2018, primarily due to some large assets that attracted investors," the CRISIL report highlights.
However, the trend has not continued at a similar pace and co-investors have been selective. This is partly responsible for the lower growth of ARCs in fiscals 2020 and 2021, the report said. Second, in contrast to the situation a couple of years back, lenders now have multiple options for resolution and enforcement frameworks, and are also more actively evaluating and utilising these options.
"The Insolvency and Bankruptcy Code, 2016 (IBC), with its subsequent modifications, has seen many takers. The RBI's June 2019 Prudential Framework for Resolution of Stressed Assets gives lenders the option to resolve stressed assets outside the legal process."
CRISIL Ratings expects the stressed assets space to see segmentation, with players having different focus areas. Availability of capital, debt aggregation capability and operational infrastructure will define the positioning of each player, it added.
"The National ARC, given its stated mandate and access to capital, is expected to dominate the large corporate segment. Mid-corporate assets, where ARCs have a relatively better recovery track record, could be a play for them as well as for stressed assets funds. In the retail and MSME segments, however, ARCs have the opportunity to create niches," Krishnan Sitaraman, Senior Director and Deputy Chief Ratings Officer, CRISIL Ratings, said.
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