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Mumbai: When Edelweiss Asset Reconstruction Company (ARC) bought a majority of the 8,000 crore debt owed by Bharati Defence and Infrastructure Ltd to banks, the largest single asset to be taken over by an ARC, no one expected the recovery process to be easy.

Bharati Defence, formerly known as Bharati Shipyard, had undergone debt restructuring in 2013, but the company had shown no signs of revival. For the financial year ended 31 March 2014, the company reported a net loss of 293 crore and its interest coverage ratio (ICR), reflecting its ability to service debt, had fallen to -1.01. An interest coverage ratio less than 1 indicates that a company is not capable of servicing debt.

Banks were no longer interested in handholding the company and in August 2014, the first tranche of Bharati Defence’s loans was bought by Edelweiss ARC.

Over the next 18 months, Edelweiss bought 70-75% of the total loans to ensure that it had control over the asset.

“Typically when we bid for assets, we look at whether it has good potential to come back to health, with or without additional funding. This was the same rationale we applied when bidding for Bharati Shipyard," said Siby Antony, managing director and chief executive officer, Edelweiss ARC explaining the decision to take over the loans.

Bharati was the largest industrial asset to be taken over by an ARC in India; it was among a clutch of such assets that went from the books of banks to ARCs in the first eight months of 2014. Between April and September 2014, ARCs bought 10,000-15,000 crore in bad assets from banks.

While no exact data is available, industry participants say that the proportion of industrial asset sales to ARCs went up during the period although there was no certainty on the ability of reconstruction firms to revive these assets.

Headway in revival

“The jury is still out on whether these ARC’s have been able to turn around assets or not. In the case of Bharati Shipyard it was sold by banks for a 70% haircut. It is just over the last one-and-a-half years that we have started seeing that banks have started selling loans to going concerns and are being realistic enough to let go of assets," said a consultant with a foreign risk advisory firm who did not wish to be identified.

ARCs are making some headway in reviving stressed assets, even though its been a slow and painstaking process.

In the case of Bharati Defence, the time since the ARC sale has been a tumultuous one. The shipyard has made unsuccessful fund raising attempts; confronted a number of winding-up petitions by unsecured creditors and eventually a reference to the Board for Industrial and Financial Reconstruction (BIFR) to protect the firm from such petitions and demands.

“Apart from unsecured lenders, the sudden surprise that we received was in the form of statutory dues. There is a lot of information deficit," said Antony, while detailing some of the issues the ARC has been grappling with in the revival process.

After paying off the pending dues, the company is now on its way to completely orders which will allow cash flows to pick up. For now, Edelweiss ARC is funding the company from its own books.

“We have identified 10-12 ships where the work is 80% complete. Of these we have shortlisted four ships to start with and we are planning to invest about 100 crore or so in the initial phase," said Antony.

‘Constructive approach’

Some of these ships have been ordered by the ministry of defence for which, in October 2015, Bharati has received an extension on the delivery schedule. The completed ships will help the company to bring in much needed liquidity, which will help in executing new orders. An email sent to Bharati Defence on Monday remained unanswered. The progress, if any, is yet to show up in the company’s earnings. Bharati’s net loss as in the quarter ended 30 September stood at 220 crore. Its interest coverage ratio as of 31 March 2015 was -2.04.

“In the case of Bharati, there has been a constructive approach towards resolution where assets which can be completed are being focussed on to ensure cash flows. Whether this approach will be successful is a matter of time," said Abizer Diwanji, leader-financial services at EY India.

He added that buying a majority of the loans has helped smoothen things out by reducing differences between creditors.

A shift in ARC strategy?

The attempted revival of Bharati Defence could represent a change in the way ARCs are looking at the assets they buy.

In the past, ARCs largely focussed on asset stripping, where they would buy loans from a bank and then auction securities. As banks would take security receipts for a majority of the asset value, the returns from the auction would go to them. In exchange, the ARCs would earn an annual management fee for the duration they held the asset.

This seems to be slowly changing.

“The move towards 15% upfront cash payment and linking management fees to the fair value of the asset has ensured that ARCs have more skin in the game. This means that they are now focussing on productive ways of getting the asset back on track, rather than depending on measures such as asset stripping," said Diwanji.

“Turnaround is now of critical importance to them," he added.

In January 2014, as part of its guidelines for managing stressed assets, Reserve Bank of India (RBI) said that banks should make use of the ARC mechanism to off-load stressed asset sooner than later. This would ensure that ARCs had a fair chance at recovery through rehabilitation of the stressed assets and banks would write off fewer loans.

However, in August 2014, the RBI increased the upfront payment required for purchases by ARCs to 15% from 5% earlier due to fears that banks were simply parking bad assets with ARCs. In the April-September 2014 period, banks were able to sell 10,000-15,000 crore worth of assets to ARCs.

Realizing that a higher upfront payment meant a greater commitment to the asset, purchases of bad loans by ARCs slowed and only an additional 5,000 crore of assets were purchased in the second half of fiscal 2015.

Arcil

To be sure, not all ARCs are comfortable taking exposure to large corporate assets. Last week, the country’s oldest ARC, Asset Reconstruction Co. (India) Ltd, or Arcil, said that it will shift its focus back towards retail and small and medium enterprises (SME) loans. Currently 80% of its 10,000 crore assets under management are from the corporate segment.

Vinayak Bahuguna, managing director and chief executive officer of Arcil, explained that the fee charged for retail and large corporate assets is not very different but the recovery in retail assets is much faster.

According to an August 2014 report by rating company Crisil Ltd, the recovery rate by ARCs, as represented by the redemption ratio of securities receipts issued to banks, has been just 53% over the last 10 years.

Redemption ratio is the ratio between security receipts redeemed and the receipts issued by the asset reconstruction industry.

More updated data is not available, but the track record is unlikely to have changed much, said the consultant with the foreign risk advisory firm cited above.

Still, banks may have little choice but to use the services of ARCs as they try and clean up their books by the March 2017 deadline set by RBI governor Raghuram Rajan.

According to Bahuguna, about 3-4 trillion worth of bad loans may come up for sale by then. “Presently, 10-15% of the assets up on sale are being bought by reconstruction companies on an average. We are expecting this to go up to 30-35% in 2017 as the prices will be more reasonable and the bankruptcy code will make resolution easier," Bahuguna said.

The ratio of stressed advances (which include restructured loans and gross bad loans) to total advances rose to 11.3% as of September 2015 from 11.1% in March, according to the RBI’s financial stability report released in December.

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