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Asset reconstruction cos need a recast for survival

Asset reconstruction cos need a recast for survival
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First Published: Sun, Aug 02 2009. 09 52 PM IST

Updated: Sun, Aug 02 2009. 09 52 PM IST
When interest rates started rising a few years ago, many primary dealers, or firms that buy and sell government bonds, made trading losses. They had made money when yields on government bonds dropped early this century, but when yields started rising in 2004, they started losing heavily. Bond yields and prices move in opposite direction. When yields decline, bond prices rise and those who are in the business of trading bonds make profits, but when the yields rise and prices drop, they lose money. A few primary dealers closed shop and a few others got merged with their parent banks. Some of them tried to diversify into other businesses as rising interest rates threatened their business model.
Today, India’s asset reconstruction companies (ARCs) are facing a similar challenge, albeit for different reasons. They are in the business of buying stressed assets from banks and making money by recovering them, but banks have stopped selling their bad loans.
There are about a dozen ARCs and many more are waiting for regulatory approval to start business. Asset Reconstruction Co. India Ltd (Arcil), set up in 2003, is the oldest one. Banks, both old and new; financial institutions such as IFCI Ltd and Life Insurance Corp. of India Ltd, Specified Undertaking of Unit Trust of India, Small Industries Development Bank of India; and high-profile individuals such as broker Rakesh Jhunjhunwala, former State Bank of India chairman M.S. Verma, former police commissioner of Mumbai M.N. Singh and former chairman of the Securities and Exchange Board of India G.N. Bajpai have set up these ARCs.
When an ARC buys bad assets from banks, it issues security receipts (SRs) to the sellers and instead of being a lender of 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 get money as and when ARCs recover them and if they recover more than what they promised to banks, ARCs and banks share the money. ARCs do not share the extra money recovered if they buy bad loans, paying cash instead of issuing SRs.
Typically, investors in SRs get 80% of the upside and ARCs retain 20%. Till fiscal 2008, when the economy was booming, returns from the recovery of bad assets were fairly high, but the trend has reversed and at least one ARC has not been able to pay investors who have been holding the SRs.
But this is only one side of the story. The other side is that banks have stopped selling their bad assets. There has not been a single auction of bad loans this fiscal so far. While the mismatch between what the sellers of such assets expect and ARCs are willing to pay is one reason behind this, the other and more critical factor is that banks are not generating enough bad loans. This is because the banking regulator has allowed banks to restructure loans to help individual and corporate borrowers tide over the impact of the slowdown that gripped the economy after the mid-September collapse of US investment bank Lehman Brothers Holdings Inc. and the ensuing global credit crunch.
A loan becomes sticky when a borrower fails to pay interest on it for 90 days. Once a loan turns sticky, banks are required to provide for it in their balance sheets and the amount set aside depends on the nature and duration of default.
The Reserve Bank of India allowed banks to recast all loans. In fact, banks were allowed to recast loans not once but twice before 30 June except for those given for commercial real estate, capital market-related activities such as buying shares, and personal loans. As much as 4%, or at least Rs1.1 trillion worth of loan assets of the Indian banking industry, could be recast. The State Bank of India, the country’s largest lender, has restructured close to Rs20,000 crore worth of loans so far and will do more.
A loan recast on such a large scale is indeed a new phenomenon, but Indian banks have been restructuring corporate loans for quite some time now through a mechanism called corporate debt restructuring (CDR). This was started in 2001 when some large firms, particularly in the steel sector, got into trouble following a sharp drop in demand and prices. Till last year, 219 cases were referred to this cell, involving Rs94,735 crore of debt, and 174 firms had actually got Rs84,714 crore of debt restructured at the forum. In the recent past, many more cases have been referred to the cell, including the troubled drug firm Wockhardt Ltd and now defunct discount retailer Subhiksha Trading Services Ltd.
Arcil has shifted its focus to retail loans. It has floated a new division, Arcil Arms, to buy stressed consumer loans. It plans to buy some Rs1,500 crore worth of mortgages and automobile loans from a few banks that aggressively sold such loans and have not been able to recover them. It is giving intensive training to its employees on loan collection and creating a new incentive structure for recovery of such loans. Other ARCs are also planning to buy retail loans. But that’s not a solution because ARCs’ capability in recovering consumer loans on a large scale is suspect. Some of them will have to close shop while others may have to diversify into other businesses that a non-banking finance company can do. Of course, if the economic recovery gets delayed and the bulk of restructured loans turn bad, they will survive as banks will be forced to sell stressed assets to clean up their balance sheets. Also, if they are desperate, banks will stop haggling for a few rupees more while selling bad assets.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as Mint’s deputy managing editor in Mumbai. Please email comments to bankerstrust@livemint.com
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First Published: Sun, Aug 02 2009. 09 52 PM IST