Deconstructing asset reconstruction

Deconstructing asset reconstruction
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First Published: Mon, Jan 21 2008. 12 01 AM IST
Updated: Mon, Jan 21 2008. 12 01 AM IST
Birendra Kumar, managing director and CEO of International Asset Reconstruction Co. Pvt. Ltd (Iarc), is a happy man these days. India’s newest asset reconstruction company (ARC)—such companies buy stressed assets from banks and make money by recovering them—has recently bought 99 stressed accounts worth Rs410 crore from Bank of Baroda at around Rs67 crore. For every dollar worth of bad loan, Iarc has paid 16.5 cents.
Both banks and ARCs can buy stressed assets of the Indian financial system, which exceeds Rs1 trillion. Apart from Kotak Mahindra Bank Ltd, Standard Chartered Bank and Deutsche Bank are the other two active players in this space. Among ARCs, Asset Reconstruction Co. India Ltd (Arcil) is the oldest, set up in 2003. It has bought more than Rs32,000 worth of assets at around Rs8,000 crore. There are other ARCs, but none of them has been as aggressive. IFCI, Punjab National Bank, Life Insurance Corp. of India and a few others have set up Asset Care Enterprise Ltd, and the specified undertaking of UTI joined hands with a few banks to set up ASREC (India) Ltd.
Then, there are Pegasus Asset Reconstruction Pvt. Ltd, set up by a few individuals including big broker Rakesh Jhunjhunwalla, and Dhir and Dhir Asset Reconstruction and Securitisation Co. Ltd, besides Iarc, where a few private banks and individuals hold stakes.
At least half a dozen applications have been lying with the Indian central bank seeking licences to float ARCs. Reliance Capital Ltd of the Reliance-Anil Dhirubhai Ambani Group is such an applicant. It wants to float an ARC along with General Insurance Corp., Indian Bank, Corporation Bank and two foreign funds. In a booming economy, rising stock market and surging real estate prices, returns from the recovery of bad assets are going up. In some of the cases, industry insiders say, the recovery is more than 50% of the price at which the firms have been buying the stressed assets. Typically, 80% of the upside is shared by investors in such bad assets and 20% by the firm.
The law allows the sellers of bad assets to double up as investors. So, when an ARC buys bad assets from banks, it issues security receipts (SRs) to such banks and instead of being a lender to bad assets, the banks become investors in such assets. Bad assets bought from different banks are pooled and SRs are issued against such a pool. Banks keep on getting money as and when ARCs recover them and if the recovery is beyond the promised returns, the difference is shared by the investor and the ARC involved. This is, however, for such deals where SRs are issued. ARCs can buy bad loans paying cash also. In such cases, banks do not get a share of the extra money made through recovery.
ARCs employ various ways to recover bad debt, depending on the outlook of the industry to which the borrower belongs and the credibility of the management. For instance, if the industrial outlook is good but the quality of management is bad, an outright sale of the company is the best way to recover money. If the outlook is bad but the management is good, asset sale becomes the preferred way of recovery.
Ahead of the recovery, debt aggregation is a tougher task for ARCs. They can use the law and sell the assets only when they are able to buy at least 75% of one asset. As too many banks are involved in most corporate loans, it is not easy to convince each of them to sell their bad assets at a price that is acceptable to all.
With the economic boom and relatively faster recovery of bad loans by Arcil, expectations of banks from auctions of such loans have gone up. A recent directive of the Reserve Bank of India asking banks to lay down policies and guidelines of valuation of bad assets is also slowing down the process as there cannot be a uniform policy for such loans and the recovery depends on many things, including the quality of collaterals, the management of the borrower and the industry to which the borrower belongs.
A larger problem is ARCs’ ability to buy such loans. Under the law, those ARCs that do not have Rs100 crore net worth must have a capital adequacy ratio of 15%. This means, for every Rs100 crore worth of assets (at their discounted price), an ARC needs Rs15 crore capital. So, Kumar’s Iarc, which has an equity of Rs15.98 crore, cannot buy too many assets unless it raises its capital. Even those firms that have Rs100 crore net worth need money to buy assets as banks prefer hard cash to SRs when they sell bad assets. Arcil has an equity of Rs220 crore and reserves of another Rs330 crore. It is now planning to raise another Rs1,120 crore through a rights issue. Besides, it has floated a Rs300 crore fund with a few banks and financial institutions to buy SRs. According to S. Khasnobis, managing director of Arcil, even this is not enough and another $1 billion fund is being planned. Foreign institutional investors (FIIs) can invest 49% in such funds but no single investor can contribute more than 10%. This is a stumbling block as FIIs generally look for a larger share in such funds to have a say in the recovery process. While a single foreign investor can pick up 49% equity in an ARC, where is the justification in limiting a single foreign investor’s stake in funds at 10%? Possibly the regulator feels that foreign funds will take over the sick companies that are put on the block to recover the stressed assets.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as the Mumbai bureau chief of Mint. Please email comments to bankerstrust@livemint.com
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First Published: Mon, Jan 21 2008. 12 01 AM IST