IBC: Potential game changer for asset reconstruction companies
The jury is still out on whether asset reconstruction companies (ARCs) have been able to turn around assets, but there is still huge interest in even setting up new ARCs. In a panel discussion at the summit, participants said the IBC could be a potential game changer for ARCs. The panellists were Harsh Pais, partner, Trilegal; Nalin Kumar, executive vice-president, IDBI Capital Markets; Sharad Bhatia, managing director, Multiples Alternate Asset Management; Venkattu Srinivasan, group head of asset reconstruction and structured credit and member of executive board at Kotak Mahindra Bank Ltd; Eshwar Karra, chief executive officer, Phoenix ARC; and Harish Chander, executive vice-president, Edelweiss. K.V. Karthik, partner, forensic, financial advisory, Deloitte, moderated the discussion.
ARCs have now been in existence for 14 years, have ARCs been able to instil confidence?
Srinivasan: To understand the role of ARCs, we need to look at the background. When the Sarfesi (Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest) Act was introduced, the basic thinking of ARCs’ roles were reconstructing and rehabilitating companies, aggregating the debt and resolving the NPA problem.
But what happened thereafter (was that) ARCs were not reconstruction companies but asset warehousing companies. Banks have used them largely to transfer assets at fairly book value in order to minimize accounting and to have a larger period to write off. From these perspectives, ARCs have done their job.
Now, let’s look at the inhibiting factors. One, ARCs didn’t have much capital for the size of the problem they had. Two, the regulations didn’t allow ARCs to fund those companies in order to revive them. Typically, the ARCs which acquired the debt had to run through seven or eight years to hold and resolve the assets. They didn’t have the intermediary player in between who could bear some part of the brunt.
Largely, the structuring of transactions between banks and ARCs were not based on resolution capabilities, but who gave the highest value to the bids. To my mind, ARCs played as per the rules of the game but the rules of the game were set by the banks.\
Chander: I would want to add two points. One is ARCs are like a last resort in the sense that they are recovery agents. So give the assets which are in a run-down condition or which had no chance of getting revived because if revival was possibility, then bankers would have definitely tried their hands.
But this changed in 2015 when the Reserve Bank of India stipulated the 15:85 structure, which gave ARCs more skin in the game. That is when the operating assets also started getting sold to ARCs. Since I have jumped to 2015, it doesn’t mean that from 2003 to 2014 there were no success stories. There were a few.
But since 2015 onward, out of over 6,000 books that have been acquired, about 800 are in 5:95 and rest in 15:85 structure. We ourselves have revived one paper company, one port company, one logistics company and one power company, involving about Rs18,000 crore of debt.
ARCs have been largely acquiring assets based on sector-to-sector basis. Do you think they will be able to redeem these SRs (security receipts)?
Bhatia: Let’s go back to history. First, the bankers always knew that assets are being sold at an inflated price and the recoveries are going to be much lower.
Second, as an ARC, they were more interested in the fees because then there was just no alignment. It met the short-term requirements of both the bankers and ARCs. The longer the ARCs held on to the asset without doing any resolution, the more money they made.
To an extent it was sold with the objective of warehousing, which was met. But the real objective of resolution was not met. It should have gone to the ARCs with a better track record, which was not the case. Resolution has not happened except in very few cases.
Resolution was never the expectation. Is that right, Eshwar?
Karra: There are basically three products which ARCs deliver. One is the regulatory arbitrage. Unfortunately this constituted a major portion of the market in the past, but ARCs are actually designed to create the best structure for co-investment to happen. Going forward, since the regulatory arbitrage is over, selling to an ARC will entail more provisioning for the bank than holding on to its own books.
Now, we have to focus on other two main factors. One is bringing co-investment which means putting out capital and second is resolution. Resolution, both in terms of enforcement and management turnaround. I think this is what we were designed to do at start.
I am quite positive with things that are happening and also with the new regulation change which allows ARCs to hold upto 100% of the turnaround company. We are going to get incentivized and I see greater prospects in the future.
In the changed environment now, having IBC and others in place, do you think ARCs can actually look at turning around assets now?
Kumar: I think they have no choice anymore and therefore they need to add the skill sets.
The problem in the system is fairly acute at this point in time because the problems really started more after 2010. What happens generally is there’s a denial period and ARCs took the brunt of the denial. So it was all shoved under the carpet and the hope was the economy will take off or something will happen, which didn’t work. ARCs are now looking at different ways of performing similar tasks.
The government and the regulators have realized that the capital with the ARCs is not sufficient. So on one side they’re pushing banks to recognize the problem and do the resolutions. While on the other, they are enhancing capital sources to take over the problem. So today, there are many more players with capital who have a chance of coming in.
Do you think the ARCs have the size (capital base) to be really active in the stressed assets space?
Pais: If we look at ARCs as a pooling vehicle, there is no reason why over a period of time they will not have access to capital given the track record. The government has now expanded the types of investors who can hold assets and there is already a lot of interest. Over time, they may attract a disproportionate share of capital because they do have some of the tools and advantages which other players in the market for distressed assets space don’t have.
What are the specific reasons for a lot of interest of private equity (PE) players in ARCs?
Pais: PE players are taking a long view and they feel that over time the disadvantage from the additional provisioning requirement will be overcome simply because banks will have to remove assets from their books. It also seems a natural opportunity to aggregate debts and take a large positions on the insolvency code.
Kumar: PE is simply seeing it as an opportunity to create a return which is higher than what they can get in many other asset classes.
But with increase in provisioning norms that have been in existence now, do you still see banks selling a lot of assets to ARCs?
Kumar: Clearly, the playing field has changed and the banks have been pushed in a different direction to actually recognize the problem and do something about it. The fundamental problem is that in the process of lending, NPAs will get created but banks are not designed to resolve the NPAs. The banks do not have that skill sets and those assets have to move to a different entity which has the skill sets. Today the banking system has more choices to sell its assets.
There are a lot of infrastructure companies that might come up for restructuring. Do you think ARCs are equipped to handle this?
Bhatia: The ARCs will have to raise money based on their resolution capabilities. In the meantime, ARCs will probably have to partner with PE funds and management teams. ARCs by themselves cannot do it but a network, which has a spill-over effect, will be able to deliver.
Karra: All the media and PE funds are all focusing only on large accounts. But there are over 500 accounts admitted in NCLT...Out of 500, there are 480 odd cases which have no bidders. Now with the new ordinance coming in where the promoter can’t bid for those assets, there are only ARCs who will come in and who have to hold these.