Kotak Mahindra Bank’s Phoenix ARC plans to buy big-ticket bad loans

Kotak Mahindra Bank-promoted Phoenix ARC’s CEO Eshwar Karra, says RBI’s new provision rules will force banks to put up more stressed assets for sale

Uday Kotak, executive vice-chairman and managing director of Kotak Mahindra Bank. Photo: Abhijit Bhatlekar/Mint
Uday Kotak, executive vice-chairman and managing director of Kotak Mahindra Bank. Photo: Abhijit Bhatlekar/Mint

Mumbai: Kotak Mahindra Bank Ltd-promoted asset reconstruction company Phoenix ARC Pvt. Ltd, which has so far bought bad loans from small and medium enterprises, has decided to tap large corporate loans, a top company executive said. 

According to the Reserve Bank of India’s (RBI’s) December 2016 Financial Stability Report, 88% of the Rs8.3 trillion worth stressed loans belong to large borrowers. This number could get bigger, as the 18-month moratorium period for 60 large cases identified under the RBI’s asset quality review ended in March in fiscal year 2017.

Banks will then have to make higher provisions for these loans, and may choose to sell some of them to ARCs. 

“We expect more banks to offload more special mention accounts (SMA-2) or accounts where interest payment has been delayed for more than 60 days. With the increase in provisioning requirement, banks will have no choice but to put up these accounts for sale,” said Eshwar Karra, chief executive officer, Phoenix ARC, which manages Rs6,000 crore of stressed assets.

In the last fiscal, Phoenix had bought as much as Rs4,200 crore of non-performing assets (NPAs), or about 10.5% of the banking industry’s sales to ARCs.

Uday Kotak, executive vice-chairman and managing director of Kotak Mahindra Bank, said last month that the group’s strategy is to build the stressed asset resolution and turnaround business in the coming years.

Kotak had noted that the Indian banking industry has about Rs14 trillion worth of stressed assets parked as non-performing loans and in various resolution schemes.

But buying distressed corporate loans may also not be easy.

One, from the beginning of this fiscal, if a bank invests in more than 50% of security receipts created against the sale of its own stressed assets, it has to set aside more money as provisions. From 2018-19, this threshold of 50% will be reduced to 10%. This will prompt banks to seek all-cash deals for their stressed assets, something not easy for the capital-starved asset reconstruction industry. 

Karra is, however, confident that the ARC is well-capitalized to go for big-ticket purchases this year.

He also doesn’t rule out 15:85 deals, where ARCs give 15% of the net asset value as upfront cash and issue security receipts for the rest of the amount.

“The steel sector is showing some revival owing to the rise in domestic demand led by strong orders from government projects. We will, therefore, look at sectors other than power and engineering procurement construction (EPC) companies ,” he added.

According to a 2016 report by EY, the capitalization of all ARCs put together adds up to around Rs3,000 crore.

With the cash component increased to 15%, the net worth of ARCs would be sufficient to acquire only Rs2 trillion of stressed assets. Assuming ARCs acquire the NPAs at 60% of book value, all the ARCs put together can garner Rs33,300 crore of NPAs. With gross NPA and restructured advances of banks touching Rs8 trillion, ARCs can acquire approximately only 3% of these assets from banks. Another key challenge for ARCs is the ability to fund the working capital needs of stressed loans to enable a revival. As a result, global distressed asset funds are increasingly seeing an opportunity in this space.

Karra, however, is clear that the ARC will focus only on long term-financial restructuring of these large assets and will avoid getting into operational turnaround. “We have been in the business of asset restructuring for the last 20 years. We believe that bankers don’t have enough skills to run a business,” he added.

But experts are sceptical of this model.

“Earlier, ARCs used to deploy Rs3,000 crore over 20-30 deals. Now, they invest the same Rs3,000 crore over two deals. ARCs like Phoenix are therefore moving towards such big deals. However, most ARCs expect value from incremental capital value growth. Liquidation values are much lower than turnaround value. We are not sure how these ARCs will work if they are not looking at turnaround of large companies,” said Abizer Diwanji, partner and national leader at EY.  

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