Track record for asset resolution critical for long-term sustainability
Pawan Agrawal
Subha Sri Narayanan
Senior Director – CRISIL Ratings
Team Leader – CRISIL Ratings
Nitesh Jain Associate Director – CRISIL Ratings
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What is bad for banks is good for ARCs
August 7, 2014
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Key messages
Growth will settle at a lower level for ARC industry –
AUM reached Rs.42,000 crore by June 2014, a 4 times increase in a year
–
Growth to moderate to 30 per cent in the current year, given the recent regulations
Capital and earnings will emerge as challenges –
Recent regulatory changes significantly increase the capital requirements of ARCs
–
ARCs that can raise capital in a timely manner will be better positioned
Track record of asset resolution critical for long term sustainability of ARCs –
ARCs have successfully reconstructed several large accounts
–
However, experience shows that the recovery till date has not been up to potential
–
Cumulative redemption ratio* till June 2013 stood at 53 per cent
Better recovery prospects ahead –
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Lower vintage and quicker debt aggregation to be the key drivers
Recent regulations structurally positive for the sector
* Redemption ratio = SRs redeemed / SRs issued; Source: RBI
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Growth will settle at a lower level for ARC industry Trend in Assets Under Management (AUM; SRs outstanding) 60,000
55,000
50,000 42,000
30,000 20,000 8,800
10,000 Jun-08
Jun-10
Jun-11
Jun-12
Jun-13
Jun-14 E
Jun-15 P
Regulatory support coupled with high level of NPAs fuelled recent growth – –
Jun-09
Shortfall on sale of assets permitted to be booked over 2 years for banks Upfront booking of profit on sale of assets to ARCs permitted for banks
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Rs. Crore
40,000
Industry will need to adjust to the minimum 15 per cent requirement now – –
Aligning pricing strategy with expectation of selling banks will be challenging in the near term Proportion of cash deals is likely to go up
Source: RBI, CRISIL estimates
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Given the nature of assets, ARC business has traditionally been equityfunded
Aggregate net worth is modest at ~Rs.2,500 crore as on June 30, 2014
–
Gearing has increased to 1x as on June 2014 from 0.1x as on June 2013
–
Gearing philosophy varies significantly among ARCs
Capital raising will emerge as a significant challenge –
Earnings will come under pressure due to revision in management fees norms
–
Regulatory restrictions on sponsor shareholding and listing can act as a constraint…
–
…may be partly offset by higher regulatory limit for FDI and FII investment in ARCs
–
Could result in lower growth or higher gearing
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Capital and earnings will emerge as challenges
Ability to raise capital in a timely manner will become a differentiator
Source: CRISIL estimates
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ARCs have successfully reconstructed several large accounts Reconstruction has been used as preferred strategy for large accounts* –
Reconstruction includes restructuring and sale of business strategies
Several success stories over the past decade –
A thermal power plant (redemption ratio of 85%)
–
An integrated textile co (80-90%)
–
A large steel co (90-100%)
–
A railway supplier (90-100%)
–
A large petchem and fertilizer co (60-70%) What has worked well?
Sale of assets/ Settlement 23%
Re-construction 77%
What has not worked?
Timely debt aggregation by ARCs
Delay/inability in aggregating debt
Unprecedented increase in land prices – promoters have more skin in the game
High vintage of NPAs
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Prolonged litigations
* Large accounts = principal debt of over Rs.100 crores
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Sale of assets drive recoveries from small accounts Sale of assets has been used as preferred strategy for small accounts* –
Includes settlement with promoters as well
Re-construction 21%
Redemption ratio is better at ~63% Sale of assets/ Settlement 79%
What has worked well?
What has not worked?
Relatively higher asset coverage offers better cushion
Poor availability of documentation related to security creation
Quicker implementation of resolution strategies being sole lender
High vintage of NPA
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Promoters’ ability to bring in funds also played an important role # Principal debt of below Rs.100 crore
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Overall recovery has not been up to the potential Recovery Ratio – 5 yr plus vintage
Trend in Industry Redemption Ratio 60% 53%
Rs. Crore
50%
8,000
40%
32%
6,000
30%
4,000
20%
9% 2,000
10%
-
Redemption Ratio (%)
10,000
Actual recovery till Dec 2013 (A)
4,800
Principal debt acquired till Dec 2008 (B)
13,200
Recovery Ratio (C=A/B*100)
36%
0% Jun-05 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13
Aggregate SRs issued till Dec 2008 Aggregate Redemption (LHS) Source: RBI
Redemption Ratio (RHS) Source: CRISIL estimates based on experience in rating SRs
Cumulative redemption ratio till June 2013 stood at 53 per cent
The recovery ratio is even lower at ~36 per cent –
Recovery ratio defined as recovery as a percentage of principal debt acquired
–
Recovery ratio better reflects effectiveness of ARCs from bank’s perspective
–
The analysis covers SRs of 5 years or older
7,700
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12,000
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Outlook: Better recovery prospects ahead
Recent regulatory changes will improve quality of debt acquired… –
Early formation of, and participation at, Joint Lenders’ Forum is a significant positive step
–
Lower threshold (60%) for consent to enforce SARFAESI to speed up debt aggregation
…due to vintage of NPAs coming down –
The vintage has come down to < 2 years for recent sales, from ~5 years earlier
–
Recent sale of NPAs of a shipyard and a hotel company are testimony
…and quicker debt aggregation –
A key enabler for faster resolution
–
The average time taken for debt aggregation was ~2 years in the past
ARCs are arranging additional funding for revival; expedites resolution –
Examples: A textile company and a mid sized Bangalore based residential developer
Implementation of learnings from past experience to help ARCs
Regulatory attention should now be focused towards quicker legal process –
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Will need to address the challenge of prolonged litigation
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Recent regulations structurally positive for the sector Impact
Will lead to higher capital requirement for ARCs Will significantly impact growth Increase in minimum investment requirement in SRs to 15%, from 5% ARCs to have more skin in the game – will drive better recovery in the long term Will lead to efficient price discovery in long term Management fees to be calculated on NAV rather than acquisition value
Will have negative impact on earnings Will incentivise ARCs to recover more
ARCs to be member of JLFs
Will quicken the process of NPA sale Good for NPA resolution in long term
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Regulations
More time for due diligence to ARCs Will enhance robustness of due diligence process Requirement of rating in six months
Quicker fair value assessment for banks
Greater disclosures
Will increase transparency
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Primer on ARCs and CRISIL’s experience in the sector
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CRISIL’s wide coverage provides a 360° view of the ARC industry Rated ~50 banks
Rated SRs ~Rs.12,000 cr
Recovery risk rating of SRs issued by ARCs
Recovery
Loans
Ratings of bank loans
Rated more than 13,000 firms
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Redemption proceeds
Ratings of banks
NPAs Ratings of ARCs
Rated 5 ARCs
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Specialised institutions to deal with NPAs in India; regulated by RBI
Play an important role of putting back the assets for productive use
Industry is in nascent stage even with more than 10 year history
Arcil was set up as first ARC in 2002; currently 14 ARCs operational in India –
Arcil, Edelweiss ARC and JM Financial ARC are the Top-3 players
ARCs set up a trust which issues Security Receipts (SRs)
Key industry statistics (as on June 30, 2014*) –
Principal debt acquired: ~Rs.90,000 crore
–
SRs issued: ~Rs.54,600 crore
–
SRs redeemed: ~Rs.12,600 crore
–
SRs outstanding (Assets Under Management; AUM): ~Rs.42,000 crore
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What are Asset Reconstruction Companies?
* Source: CRISIL estimates
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ARC model in India
Payment for NPA sale
CRISIL
Rating of SR issuances
Recovery
Investor
NPA Sale
Investment in SRs
Issuance/ Redemption of SRs
ARC
Resolution strategy
Distressed Asset/NPA
ARCs acquire NPAs from banks/Fis through trust
Trust issues Security Receipts
SRs are issued in senior-subordinate structure, as well, called as Class A and Class B SRs, respectively
Selling banks are primary investors in SRs
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Bank/FI
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CRISIL’s recovery risk rating scale Range
R1+
Indicates 150% and above recovery of outstanding face value of SRs
R1
Indicates 100% to < 150% recovery of outstanding face value of SRs
R2
Indicates 75% to < 100% recovery of outstanding face value of SRs
R3
Indicates 50% to < 75% recovery of outstanding face value of SRs
R4
Indicates 25% to < 50% recovery of outstanding face value of SRs
R5
Indicates less than 25% recovery of outstanding face value of SRs
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