Financial crisis gives a leg-up to asset reconstruction business

Financial crisis gives a leg-up to asset reconstruction business

Mumbai: What does M.N. Singh, former Mumbai police commissioner, have to do with the world of finance? He’s just got a licence from the Reserve Bank of India (RBI) to start a company that buys distressed assets.

Singh, along with his co-promoters—G.N. Bajpai, former chairman of the Securities and Exchange Board of India; Pankaj Gupta from auditing firm Shah Gupta and Co.; R.K. Singh, a former IAS officer; and the Chatterjee Group, which has interests in petrochemicals, information technology and real estate—had applied for the licence in 2003.

He is not unhappy with the delay because he thinks the business opportunity for an asset reconstruction company (ARC) is greater now than it ever was. And he is not alone in betting on the business.

Also See Growing Distress (Graphic)

Tight liquidity, high interest rates, a falling rupee and a distinct slowdown in economic growth have got many Indian financial services firms to zero in on asset reconstruction as their next big business opportunity.

“With the economy under stress, there is a possibility that more companies will start defaulting this year. And that’s an opportunity for those in asset reconstruction," said Birendra Kumar, managing director and chief executive officer of International Asset Reconstruction Co. Pvt. Ltd.

Along with Singh’s Invent Assets Securitisation and Reconstruction Pvt. Ltd, Mumbai-based JM Financial Consultants Pvt. Ltd also received its ARC licence last month, taking the total number of ARCs in India to 11. Three other firms to receive ARC licences this year are Prithvi Asset Reconstruction and Securitisation Co. India Pvt. Ltd, and the ones promoted by Reliance Capital Ltd and Kotak Mahindra Bank Ltd.

“We feel that in a year’s time, non-performing assets (NPAs) of banks will rise, especially in the retail segment and small and medium-sized enterprises," said Venkattu Srinivasan, business head of asset reconstruction at Kotak Mahindra Bank.

Raising funds

The issue for all these new ARCs will be how to raise funds. Asset Reconstruction Company India Ltd (Arcil), the first ARC in the country that got its licence in 2003, is in the process of tripling its equity capital from Rs500 crore to Rs1,500 crore through a rights issue and private placement of stakes.

“Usually we try to maintain debt-to-equity ratio of 1:1 or 1.5:1," said S. Khasnobis, managing director and chief executive officer of Arcil.

Partnering with some banks, Arcil has so far committed about Rs10,000 crore to distressed assets. Apart from its own equity capital and the debt raised on this, it had also raised a domestic fund of Rs250 crore.

According to Khasnobis, rasing capital and leveraging the balance sheet are the only two options left with him and other ARCs, as raising a fund may be difficult in the current market. For such a fund, 51% has to come from domestic entities and within the 49% limit on foreign funding, no single entity can contribute more than 10%. Banks, insurers and non-banking finance companies are the domestic entities that participate in such fund-raising.

“In the current scenario, it doesn’t make sense for banks to commit to additional risk in the distressed segment,"?he said.

Rising defaults

An ARC buys NPAs from banks at a discount, and then recovers its investment by turning around the defaulting firms, selling off some of its non-core assets, or revamping the business.

For the year ended 31 March 2008, the average NPAs for the Indian banking industry amounted to 1% of overall lending, but since then it has grown as higher interest rates turned many borrowers into defaulters.

The opportunity is attracting many firms to asset reconstruction. Edelweiss Capital Ltd, a domestic financial services house, is in the process of raising a $150 million (Rs732 crore) distress fund. It will apply to the regulator for an ARC licence, according to Siby Antony, executive vice-president of Edelweiss Alternative Asset Advisors, an arm of Edelweiss.

While the fund can invest in distressed assets, it prefers to have an ARC licence as that enables a company to settle any dispute directly with the defaulting firms without having to take recourse to legal channels.

Ambit Capital Pvt. Ltd too plans to float an ARC. “We will apply to the regulator to launch an ARC, and will then raise a fund," said Nilesh Shah, chief executive officer of Ambit Capital.

“Textiles and sugar are probably two sectors where there is already a lot of distress," said Antony of Edelweiss. “The real manifestations of distress will be felt in one or two years down the line."

Overseas funds

Most overseas funds that deal specifically with distressed companies and take stakes in them are also keenly watching the space.

Clearwater Capital Partners Llc., ADM Capital, Wilbur Ross and Co., Spinnaker Capital Group and Avenue Capital are some of the overseas entities that had bought Indian distressed assets in the past.

“Over 2006 and 2007, some of these funds were doing deals to capitalize on the growth of good companies. But now, many of them will come back to their core thesis of investing only in distressed assets," said the head of an India-dedicated private equity fund, who did not wish to be named.

The real estate sector will offer many opportunities, he said, and added, “The most stressed sector today is real estate, followed by non-banking finance companies."

Rising interest rates and the liquidity squeeze have created the biggest problems for these two sectors, in which some firms have over-leveraged themselves to cash in on India’s recent economic growth.

Graphics by Sandeep Bhatnagar / Mint