Book building for the new ARC may be easy, but its success will depend on the ability to develop a vibrant distressed debt market
In her Budget speech, Finance Minister Nirmala Sitharaman referred to stressed asset resolution by setting up a new structure. She proposed that an Asset Reconstruction Company (ARC) and Asset Management Company (AMC) would be set up to consolidate and take over the existing stressed debt, and then manage and dispose of the assets to Alternate Investment Funds (AIF) and other potential investors for eventual value realisation.
However, so far, the details of the proposed set up have not been officially spelt out. The sooner the ‘design’ and ‘structure’ of the proposed ARC/AMC are articulated and deliberated, the better it is to end speculation around it.
Who will parent and fund the ARC? It is believed that banks themselves may have to contribute to the equity and funding. But take a look back. The experiment of a bank-led ARC structure is not new. Almost two decades back, top three lenders joined together and started the first ARC in India. Many of the present ARCs, too, have banks as their sponsors/equity contributors. After few years of its operations, concerns were voiced on the ARC(s) being used as warehouse of NPAs by the promoting banks.
Fear of accountability
What will be the criteria for identification of assets to be sold? It is learnt that the Indian Banks Association (IBA) has called for data in respect of consortium lending above ₹500 crore with some riders, such as exclusion of liquidation cases, fraud cases and cases under resolution in IBC where resolution is in sight, from all banks.
So, let us assume this is the target NPAs to be acquired. The next logical question is about the purchase consideration. Valuation is one of the major constraints in transfer of loan accounts to ARCs. How to bridge price expectation mismatch? The ARC can resolve only when it acquires at a value thatattracts investors and buyers. And more often than not, a bank’s valuation expectations are much higher and for any sale below this price, there is a fear of accountability.
And what about treatment of lenders with different charges – first charge, second charge, parri passu charge with different categories of security such as land and building, plant and machinery and current assets. Will there be a structured forum to deal with inter-creditor issues around priority of charges, waterfall mechanism and distribution of proceeds?
There have been some talks that the Security Receipts (SRs) issued by the proposed ARC will be guaranteed by the government. And going by the basic characteristics of SRs, government guaranteeing SRs indirectly means it will pay to the bank for recovery shortfall from defaulting borrower which has moral hazard issues.
While single point debt aggregation is a huge plus for the mega ARC, what’s next? Who will decide the resolution? As per current fair practice code for ARCs, there has to be a consultative process with seller bank holding SRs. What will be the treatment of dissenting creditors/ SR holders and mechanism to break stalemate, if any, while pursuing resolution/ finalising the terms and conditions of sale.
Issues around funding
The next issue is around interim finance and funding working capital to ensure that the unit is running. Who will take care of banking needs, including non-fund facilities? In the absence of clarity on this, the units transferred to ARCs will most likely head for asset sale only, with attendant value destruction.
For a successful turnaround, many policy support measures may be required, particularly in respect of stressed assets in highly regulated sectors such as power, telecom, infrastructure etc. How to build up forward linkage structurally with these sector regulators will be a key challenge that need to be addressed. In India, we already have 28 ARCs existing at present. However, due to paucity of capital, they have not been able to scale up the performance. In the preceding three financial years, the sale of NPAs to ARCs have been 6 per cent of outstanding NPAs of the banking system. With a possible spike in NPAs, there is a need for more ARCs.
The best possible design
However, the mega ARC/ AMC or any other structure is no magic wand. All stakeholders need to brainstorm the best possible design and structure for optimal results in a time bound manner. The factors that have constrained the effective functioning of the existing ARCs need to be critically evaluated and lessons from history learnt to avoid pitfall in design and structure of the proposed mega ARC.
From international experience, the success of an ARC depends on its ability to attract ‘new money’ from investors with risk capital and having risk appetite to invest in distressed debt. With focussed approach by the government and banks, book building for the new ARC may be easy. But its success will depend on its ability to develop an ecosystem and a vibrant distressed debt market. New money can only give real exit to banks. Else, the proposed ARC will remain like a NPA Corporation that acquires NPAs from promoter lenders by giving minimum support price for the assets, as decided by the same lenders followed by a value erosion in warehoused NPAs.
Hari Hara Mishra is an ex-banker and has been associated with various ARC initiatives, including the drafting of a Key Advisory Group on ARC sector reforms. Views expressed in the column are personal and do not represent any organisation or association he belongs to