Asset Reconstruction Co.

8/6/2019 Asset Reconstruction Co.

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What is an asset reconstruction company/ asset management company?

The word "asset reconstruction company"

The word asset reconstruction company is a typical Indian word - the global equivalent of which is assetmanagement companies. The word "asset reconstruction" in India owes its origin to Narsimham I which

envisaged the setting up of a central Asset Reconstruction Fund with money contributed by the Central

Government, which was to be used by banks to shore up their balance sheets to clean up their non-performing

loans. This idea never worked: so Narsimham II thought of asset reconstruction companies, the likes of whichhad already been successful in Malaysia, Korea and several other countries in the World. To keep the tune the

same as the original idea of asset reconstruction fund, as also to give an impression that ARCs are not merely

concerned with realisation of bad loans but they are going to do "reconstruction", that is, try and resurrect badloans into good ones, the word ARC has been used in India.

Would the ARCs to any "reconstruction" or merely realisation?

On the face of it, it is difficult to see the ARCs doing substantially more than mere realisation of bad loans.

Even the definition of the word "asset reconstruction" in the Ordinance talks of mere relisation and notreconstruction. As ARCs would anyway not have the capital to do any further funding of bad loans, it is

difficult to see them doing any such "reconstruction" to qualify for that term.

Why Asset management companies or ARCs?

Asset management companies have been set up in various countries internationally as an answer to the globalproblem of bad loans.

Bad loans are essentially of two types: bad loans generated out of the usual banking operations or bad lending,

and bad loans which emanate out of a systematic banking crisis.

It is in the latter case that banking regulators or governments try to bail out the banking system of a systematic

accumulation of bad loans which acts as a drag on their liquidity, balance sheets and generally the health ofbanking. So, the idea of AMCs or ARCs is not to bail out banks, but to bail out the banking system itself.

There are essentially two approaches to taking care of these systematic bail out efforts: one, leave the banks to

manage their own bad loans by giving them incentives, legislative powers, or special accounting or fiscal

advantages. The second approach is to do the same thing on a concerted, central level, through a centralisedagency or agencies.

The former approach is called the decentralised approach and the latter approach is called centralised approach.

AMCs arise out of the second approach - that is, a centralised agency for resolving bad loans created out of a

systematic crisis.

Each approach has its own advantages and disadvantages and there is no clear evidence of any of the two being

better over the other. Various countries have tried either of the two approaches with success stories and failures

in either case.

What are the advantages of an AMC approach?

Centralisation of bad loans in one or a few hands and therefore obviously more clout It is possible to give special legislative powers to a few AMCs rather than to each bank


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Banks are left with cleaner balance sheets and do not have to deal with problem clients. Regular banking

relations with the group are not affected. Because it deals with a larger portfolio, it can mix up good assets with bad ones and make a sale which

is palatable to buyers.

It is easier to do a capital-market based funding for an AMC than for the banks themselves.

Non Performing Loans (NPLs) are a natural by-product of the business of lending. Every process or activitygenerates by-product(s) during the process intended for certain core product or service. Of course the efficiencyof the overall intended process is inversely proportionate to the quantum of the by-product as certain quantum

of resources is consumed and embedded in such by-product. These being undesired, is often referred as waste

and dealing with the same is perceived as unwanted challenge in the system. However, undesired by-product fora given system may be a desired input for another system. The overall efficiency from a larger perspective is a

factor of how effectively the resources embedded in such by-product are recovered and probably transformed

for more desired use. Therefore, undesired by-product is a relative position of a particular system that has to be

transformed into more desirable products and services, by deploying specialized processes and know-how.Banking is no different from the above and as part of its business of contracting credit risks, does generate

distressed loans or NPLs as popularly known. NPLs deprive the bank not only of the income on account of its

exposure, but calls for further investment in resources - financial, managerial, etc. The adverse impact to thebank's profitability is further compounded on account of the provisioning requirements of the capital blocked in

the NPLs.

The proportion of NPLs in the bank books is an important indicator of financial health of the bank and anyadverse indicator shall impact the bank's rating in the system, its ability to raise capital for its business

efficiently. Result will be the bank's difficulty to price its opportunities competitively leading to compromise in

credit quality. Poor credit quality exposes the banks to vulnerability of further distress in its portfolio and

adverse effect on profitability that leads to vicious cycle.Experience indicates that any NPL, if not resolved at an early stage loses value over time. Some of them on

account of inability to revive in a fast changing environment, like technological obsolescence, etc. and the

others due to lack of investors interests over time. Experience further indicates that both the above work

simultaneously leading to a faster value loss to the banks.NPLs arise due to many factors including overall performance of the economy, cyclicality of the businesses

supported by the banks, technological obsolescence, managerial deficiencies to deal with the changing businessenvironment, financial indiscipline and intentional defaults, to name a few. This means resolution of each of the

account is an involved exercise, time consuming and calls for tailor-made solution for each of them. Thus the

need for unlocking the capital blocked in the NPLs can't be undermined, which is better approached effectivelyby accessing specialized solutions like transferring the NPAs to distressed debt buyers, like Arcil. Arcil

provides a win-win mechanism for clean-up by offering an optimal structured solutions.

The strategic advantage of addressing the NPA resolution and recovery in a timely manner is well understood

by the banking sector. One of the important aspect being unlocking financial and human capital of the banks, itis important to decide to deal with it by selling down to ARCsOnce decided, identifying the cases for transfer and constituting a portfolio is the second important step. Due

care must be taken to constitute the portfolio based on the requirements of the selling banks. It is also important

that once a portfolio is constituted, the same should not be modified during the process of sale having regard tothe substantial efforts put in by the prospective buyers as well as the selling banks during the process. The

portfolio is identified as of a reference date commonly known as "cut-off date", with information frozen as of

that date and offered to prospective sellers. The offers are invited as of the cut-off date and any changes in the

portfolio after the cut-off date are promptly informed to the prospective buyers and adjustments made for thesame accordingly.


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It is important for either party to be aware and be sensitive to the expectations of the other. While sellers

expectation is to maximize value out of the portfolio on sale, the same is to be seen from perspective of transferof various risks relating to the NPLs . The value expectation by the sellers should be from the perspective of net

present value of the expected realization from the underlying NPA related risks, associated probability of

realization after considering costs of resolution, legal and other risks, relative security status with reference toother participating lenders and most importantly factoring estimated time to realize. While the buyers should be

aware of the maximum value expectation in the hands of the seller based on the above, the sellers should also be

aware that the buyers interest would be waning unless the transaction is commercially viable taking into

consideration the risks and reward equation.Accordingly the seller establishes documentary back up to justify its value expectation, and shares the same

with the prospective buyers in a transparent manner during the sale process. Any lack of evidence to support the

expected realization for the selling bank shall affect the value perception from the buyers view as the same ispredominantly dependant on the information provided by the seller during the due diligence process. Some of

the important value drivers are fair estimation of the realization cash-flow in the NPA accounts, security status

of the bank with respective to other participating lenders, share of each of the participating lenders in theborrower accounts, legal status of any recovery action, challenges in executing the recovery strategies, crown

liabilities (including worker claims, statutory claims, etc.) decision of other participating lenders, borrowers

initiative, if any towards resolution etc. In short like any other product sale in a NPA sale situation, it iscritically important for the sell side to provide adequate information to maximize value.

The process then involves setting up a data room by the seller with all the relevant legal and operational files tosupport the value expectation for the prospective buyers to conduct their due diligence. The dealing officials of

the accounts are present during the process to address queries with respect to each of the account. The buyersare assisted to conduct the due-diligence with all the relevant information to facilitate them decide on

appropriate valuation of the portfolio. Information provided by seller is the key for value driver. Whenever the

prospective buyer is in ARC, the selling bank needs to also decide whether to exit clean for cash or risk-participate by staying invested in the SRs issued by the ARC. The buyers enter into the transaction, where there

are possibilities of value addition and are commercially beneficial. The same is achieved by focused

deployment of resources, legal empowerments and adopting appropriate resolution strategies. The sellers,depending on the risk appetite may decide upfront, whether to benefit by staying invested in SRs out of the

value addition by the buyers upon resolution or to exit clean by accepting up-front payment.

Maximization of value, which is the primary objective of the selling NPLs can only be achieved by ensuringactive participation by the buyers, sharing maximum information which is the value driver and timely dealconsummation. Any lack of confidence of the buyers leading to failure of or delay in the deal closure can have a

negative impact on overall perception of the market.

FAQs

On Asset Reconstruction Companies:Q1. What do asset reconstruction companies (ARC) do, and why were they set up?

A. ARCs aqcquire from the banking system and resolve then under legal and regulatory empowerment provided

by the Government. ARCs act as debt aggregators and isolate NPLs from the banking system, allowing banks to

focus more on their core banking business. Globally, ARCs, were formed for a system-wide clean up of theNPLs in the aftermath of economic crises.

Q2. What is the genesis of ARCs in India?A. The genesis of ARCs in India can be traced back to constitution of Narasimhan committee by Government of

India (GoI)as far back as 1997. The Committee highlighted the need to reduce the high level of NPLs as a

critical component of the continuing reform process. Unlike other countries where ARCs were set up after thefinancial crises for bailing out the banking system, in India the GoI proactively initiated certain measures to

control NPLs and expedite the recovery process. Firstly, nthe Recovery of Debts due to Banks and Financial

Institutions Act, 1993 was enacted, providing for setting up of the Debt Recovery tribunals (DRTs) and DebtRecovery Appellate Tribunals (DARTs) exclusively to consider the recovery proceedings filed by banks and


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Financial Institutions (FIs). As a corollary, the Securatisation and Reconstruction of Financial Assets and

Enforcement of Security Interest Act. 2002 (the Securitisation Act, 2002) was enacted by the GoI.

Q3. Which are the models on which ARC are formed?

A. Different countries have tried out varying models of ownership of ARCs. However, two basic models usedare (a) bank based model, which is decentralized approach or (b) government based model, centralized

approach. In a government based model, an agency is sponsored by government which acquires and resolves the

bad assets. The NPLs are owned by the government and managed by the ARC or partially contracted out to

private managers. A bank based model has two approaches viz workout units and bad banks. In workout units,NPL are moved to a separate bank department but remain in the bank?s books. On the other hand the bad bank

approach includes the transfer of NPLs to a separate affiliated organization which specialized in the

management of bad assets.

Q4. Brief background of the asset reconstruction companies internationally?

A. ARCs have been used world wide to overcome the non-performing loans challenges:

In 1980s, USA used the government sponsored ARC ? Resolution Trust Corporation to overcome thethrift crisis

In the early 1990s, Mexico and Sweden demonstrated successful use of the ARC mechanism (Fobaproa

and Securum respectively) as ?bad bank? and to clean and re-privatize/ re-capitalize the banks Korea used KAMCO as the nodal agency for acquiring and disposing NPLs

In Malaysia, Danaharta is the centralized ARC set up at the instance of the government

In Taiwan, the ARC model envisages liquidation of assets through sale of assets to investors

Japan, China, Thailand and Indonesia have also used the ARC mechanism during the South- East Asian

crisis

Q5. What are the criteria for formation of ARCs?

A. Every ARC needs to obtain a certificate of registration under Section 3 of the Securitisation Act, 2002 fromthe RBI upon fulfillment of the conditions of the Section 3 (3) thereof. Additionally, it must have an owned

fund of not less than 15 per cent of the aggregate NPLs acquired or Rs. 100 crore, whichever is lower, subject to

a minimum of Rs. 2 crore. Having obtained the certificate of registration, an ARC can undertake bothsecuritisation and asset reconstruction activities. Any entity not registered with the RBI under Section 3 of the

Securitisation Act, 2002 may also conduct this business, but outside the purview of the Securitisation Act, 2002.

Q6. Who can conduct the business of securitisation and asset reconstruction?A. A securitisation company or reconstruction company, which has obtained a certificate of registration issued

by RBI under section 3 of the Securitsation Act, 2002, can undertake both securitisation and asset

reconstruction activities.Any entity not registered with the RBI under section 3 of the act may conduct thebusiness of securitisation and asset reconstruction outside the purview of the Act.

Q7. The acts and laws which guide recovery process of NPA in India?

A. The two important act guiding recovery process of NPA in India is:i) Recoveries of debt due to banks and financial institutions (RDDBFI) Act, 1993

ii) Securitisation and reconstruction of financial assets and enforcement of security interest act 2002

(Securitisation Act, 2002)

Q8. Which is the regulatory framework for operation of ARCs in India?

A. ARCs in India operate under the regulatory framework covering the Securitisation Act, 2002 and rulesthereunder, applicable corporate laws and guidelines issued by the RBI, i.e. the Securitisation Companies and

Reconstruction Companies (Reserve Bank) Guidelines and Directions, 2003 which came into force from April

23, 2003 (the RBI Guidelines) and the Guidelines on declaration of Net Asset Value of Security Receipts issuedby Securitisation Companies / Reconstruction Companies, which were issued on May 28, 2007 (the NAV


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Guidelines). ARCs are also ?Financial Institutions? under the Recoveries of Debt Due to Banks and Financial

Institutions Act, 1993 and can file and pursue recovery suits in the DRT / DRAT.

Q9. What is the Securitisation Act, 2002 and how has it empowered secured lenders?

A. The Securitsation Act, 2002 was enacted to regulate securitisation and reconstruction of financial assets,enforcement of security interest and matters related thereto. The Securitisation Act, 2002, inter-alia, provides

majority (75 per cent or more by value) secured creditors the powers to take possession of defaulting

borrowers? secured assets and sell them without intervention of the judicial system, thus reducing or removing

the NPLs through measures for recovery and reconstruction. The Securitisation Act, 2002 has expedited therecovery process as the banks and FIs can exercise their unfettered right of recovery, resulting in speedy and

hassle-free realisation from underlying assets. Further, steps initiated by secured creditors for such sale of

secured assets also results in abatement of references pending before the Board for Industrial and FinancialReconstruction (BIFR).

Q10. How are ARCs more effective in recovery under Securitisation Act, 2002?A. ARCs are empowered by the SARFEASI act to conduct the business of acquisition and resolution of NPAs.

Their core business being NPL management they possess domain expertise which enables them to be more

effective in recovery.

Q11. Why should banks / fIs sell NPLs to ARCs?A. Banks / FIs should sell their NPLs to ARCs primarily for the following reasons:

Sale to ARCs enables the NPLs to be taken off their books, reduces recovery expenditure and releasescapital andresources for core banking operations

Sale to ARCs brings about faster debt aggregation and resolution of inter-creditor issues, single point

responsibility andensures speedy implementation of resolution strategy. To enable ARCs to achieve this,

banks need to sell their NPLs inrespect of a borrower company in a coordinated fashion Sale of NPLs on a portfolio basis enables loss on sale of any one account to be set off against gains on

another, subject to RBI guidelines on provisioning / valuation norms

Sale of distressed assets to ARCs as a long term business strategy will result in considerable risk

mitigation and consequent value enhancement for the stakeholders Since NPLs accumulate simultaneously with growth assets in the books of lenders, by selling such NPLs

to ARCs, banks can send a strong signal to the system that they are dealing with NPLs in the bestpossible manner

ARCs are better positioned to capture value by converting excess debt in the borrower companies into

equity and capturing the upside therefrom. Resolution / recovery being their core activity, ARCs areexpected to be better equipped for the value management of NPLs

Q12. Do lenders need to have a policy for transfer of NPLs to ARCs? What are the key components of such a

policy?

A. The RBI guidelines to banks/ FIs on sale of NPLs to ARCs provide that banks/ FIs should ensure that the

sale is conducted in a prudent manner in accordance with a policy approved by their Board of Directorscovering, inter alia,

Financial assets to be sold;

Norms and procedure for sale of such financial assets;

Valuation procedure to be followed to ensure that the realizable value of financial assets is reasonably

estimated; and

Delegation of powers of various functionaries for taking decision on the sale of the financial assets etc.

Q13. Can the borrower have any say in the transfer of NPLs to ARCs?A. Under the Securtisation Act, 2002 an ARC can acquire the NPLs from any bank or FI in India. The


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borrower, pertaining to whom the NPLs is acquired by an ARC cannot oppose this move of the banks / FIs.

However, the banks / FIs, if considered appropriate, may give a notice of sale / transfer of NPLs to theconcerned borrower.

Q14. 14. If an ARC acquires 75 per cent of the secured debt of a borrower, what are the options available to thelenders who have not transferred their debt to the ARCs?

A. The Guidelines issued by the RBI on sale of NPLs by banks / FIs to ARCs provide that in the case of

consortium / multiple banking arrangements, if the banks / FIs holding 75 per cent or more of the debt (by

value) of any borrower have accepted the offer of the ARC, the remaining banks / FIs are obligated to acceptthe offer by the ARC.

Q15. 15. Will ARC acquire debt with second charge on fixed assets/first charge on working capital or viceversa? Will debenture holders also be able to transfer their holdings to ARC?

A. ARCs are empowered to acquire all secured debt (whether carrying first charge and / or second charge on

fixed assets and / or current assets). If banks / FIs hold secured debt in the form of debentures then they will beable to transfer their holdings to ARCs.

Q16.In case additional funding is required to reconstruct an financial asset, will the existing lenders need tocontribute?

A. ARCs shall arrange for additional funding on a case-to-case basis depending on the nature of fundrequirement. There is no compulsion on the part of the existing lenders to provide additional funding.

Q17. How does the asset resolution strategy of ARC differ from that under the Corporate debt restructuring

mechanism?

A. The essential objective of both CDR and ARCs is the same, which is unlocking value from non-performing /distressed assets. Hence, they can be seen as complementary resolution efforts in addressing the same problem.

The ARCs route has the advantage of taking the asset off the banks? books and creating a secondary market for

it, thereby enhancing the value potential. ARCs are focused towards resolution rather than the reschedulementof debt. Debt aggregation by ARC will enable single point responsibility and ensure speedy implementation of

resolution strategy based on sustainable level of debt within a reasonable timeframe.

Q18. How is the purchase consideration in a deal for acquisition of NPLs generally structured?A. The purchase consideration for acquisition of NPLs may involve the selling lenders? subscription to SRs

where the seller is interested in staying invested or entirely cash consideration where the seller desires a clean

exit. It can be even a combination of the two. The transaction structure for any acquisition deal is finalised afternegotiation with the lenders. The banks / FIs desirous of selling their NPLs to ARCs should ensure that the sale

is conducted in a prudent manner in accordance with a policy approved by their Board of Directors.

Q19. What are security receipts or SRs?

A. ARCs generally acquire NPLs under a trust structure, wherein funds for financing the acquisition of NPLs

are raised by issue of Security Receipts (SRs). SRs are instruments in the nature of pass through certificates,

evidencing an undivided right, title or interest of the holder in the underlying assets. Only Qualified InstitutionalBuyers (QIBs) as defined under the SECURITSATION ACT, 2002 Act are authorised to hold or trade in SRs.

QIBs include domestic investors such as banks and FIs, Insurance Companies, Trustee or ARC registered with

RBI under the SECURITSATION ACT, 2002 Act, non-deposit taking Non-Banking Financial Companiessatisfying certain criteria as also Foreign Institutional Investors registered with the Securities and Exchange

Board of India (SEBI). The trustee periodically declares the Net Assets Value (NAV) of the SRs in terms of the

NAV Guidelines issued by the RBI. As regards banks / FIs, the SRs are classified as non-SLR investments andare valued on the basis of the NAV declared.


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NON-PERFORMING ASSETS

What is NPA

Non performing advances or non-performing

Assets (or non-performing loans) are loans

that are not being repaid or serviced through Interest payments on time.

def : when interest or other dues to a bank remain unpaid for more than 90 days the entire bank loan

automatically turns a Non-Performing Asset

Indian Economy and NPAs

The Indian Economy has been much affected due to lack of infrastructure facilities, sticky legal

system, cutting of exposures to emerging markets by FIIs,etc.

Under such a situation it goes without saying that banks are no exception and are bound to face theheat of a global downturn.

Banks and FIIs in India hold NPAs worth around Rs 1,10,000 crores.

Global Developments and NPAs

The core banking business is of mobilizing the deposits and utilizing it for lending to industry.

Lending business is encouraged which helps in productive purposes which results in economic

growth.

However lending also carries credit risk, which arises from the borrowers inability to repay it .

How much risk can a bank afford to take? Recent happenings in the business world-Enron, Worldcom, Xerox, global crossing do not give muchconfidence to banks.

The history of FIIs also reveals the fact that the biggest banking failures were due to credit risk.

Due to this, banks are restricting their lending operations to secured avenues only with adequatecollateral on which to fall back upon in a situation of default.

Why NPAs have become an issue for banks and FIIs in India?

The origin of the problem of burgeoning NPAs lies in the quality of managing credit risk by the

banks concerned.

What is needed is having adequate preventive measures in place namely, fixing pre-sanctioned

appraisal responsibility & having an effective post-disbursement supervision. Banks concerned should continuously monitor loans to identify accounts that have potential tobecome non-performing.

Resolution of NPAs

At present, local banks are saddled with the management of NPAs for which they do not havemanagement time for proper resolution.

As a result, they are reluctant to make new loan to industrial or commercial enterprises as NPAs have

strained their resources.

The unavailability of new loans has therefore hindered economic growth and development.

Contd

ADB intends to assist local banks resolve their problems with NPAs by facilitating the financing of

SPVs and other mechanisms designed to acquire and service such assets. This will enable the local banking system to focus on its core operations and provide financing to

productive sectors of economy.

In addition ADB will assist distressed companies in their restructuring & rehabilitation efforts.

Indian Banking systems some hard facts

Gross NPAs of the financial system is placed at Rs 1,35,000 crore, of which, over Rs 98,000 crorepertains to Scheduled Commercial Banks (SCBs) and FIIs.

Gross NPAs showed increasing trend over the yrs and accretion to gross NPAs by SCBs during last

two fiscals were Rs 24,824 crore(2001-02) & Rs 21,862 crore(2002-03).

Contd.


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This accretion is not considering the cases restructured through CDR mechanism during 2002-03 andthereafter (Rs 46,000 crore).

On account of low Loan to GDP Ratio (around 60%) in India, the enormity of NPAs in India in

GDP term appears to be low in comparison with china, korea, etc.

43% of the capital base of the financial system stands eroded on account of net NPAs.

RBI Guidelines on classification of bank advances

According to RBI guidelines, bank advances are mainly classified into:

Standard assets: such an asset is not a Non-Performing Asset.

Sub-standard assets : it is classified as NPA for a period not exceeding 18 months.

Doubtful assets: Asset that has remained sub standard for a period of 12 months (w.e.f. March 31,

2005).

Loss Assets: here loss is identified by the banks concerned or by internal auditors or by RBI

inspectors.

Financial statements in assessing the risk of default for lenders

For banks and Financial Institutions, both the balance sheet and income statement have a key role to

play by providing valuable information on a borrowers ability

The key accounting ratios generally used for the purpose of ascertaining the creditworthiness of abusiness entity are that of debt-equity ratio & interest coverage ratio.

Measures to reduce NPAs Provision of bad debts from net profit.

Implementation of Securitisation Act 2002.

Increasing the share of Retail business i.e., personal loans, vehicle loans, home loans, credit cards, etc.

Increasing the deposits.

Increase lending share to priority sector.

High cost of funds due to NPA

Quite often genuine borrowers face difficulties in raising funds from banks due to mounting NPAs.

With the enactment of the Securitiastion and Reconstruction of Financial Assets and enforcement of

Security Interest Act, 2002, banks can issue notices to pay up the dues

And the borrowers will have to clear the dues within 60 days. If the defaulters dont pay the dues, then the banks can takeover the possession of assets & also

takeover the management of the company.

Credit Risk And NPA

NPAs are a result of past action whose effects are realized in the present

Credit risk is a much more forward-looking approach and is mainly concerned with managing the

quality of credit portfolio before default takes place

Credit Rating

Credit rating has been explained as forming an opinion of the future ability, legal obligation and

willingness of a bond issuer or obligor to make full and timely payments on principal and interest due to the

investors

Definition by Moody

Tangled By Huge NPAs..WHY

Indian banks so far were encircled by the chains of regulation and aegis of protection

No formal policies, procedures, systems, tools and techniques of credit risk assessment

At The Mercy Of Balance Sheet

Operating margin

Current ratio

cash flow

Fund flow

Perception and reality may differ 180*


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Accounting policies has loopholes

Chartered Accountants make their balance sheet look as they want it to look like

Past performance is no indicator of the future performance ideally

Darling Of Bourses Takes A Hit

Hasty commitments to expand rapidly by rediff have brought it to red

Its share price is ruling well below its issue price

So relying completely on the past ratios meant no monitoring of the management decisions and no

control over their decisions Collateral-A Defensive Approach

Collateral was another way to judge the credit quality

A client is good if she had attractive assets to put as collateral and bad otherwise.

Poor decision making-accepted clients of poor quality and rejected the clients of good quality

Collateral is hardly a security

Credit Risk Techniques

Quantitative

Ratio analysis

Fund flows

Mathematical models

Qualitative

Policies

Procedures

Concentration

Playing with Precision

Altman's Z Score predicts whether or not a company is likely to enter into bankruptcy within

one or two years

the algorithm has been consistently reported to have a 95 % accuracy of prediction of bankruptcy

Consideration-current assets, total assets, net sales, interest, total liability, current liabilities, market

value of equity, earnings before taxes and retained earnings

Play or Leave 3.0 or more : Most likely safe

2.8 to 3.0 : Just safe

1.8 to 2.7 : likely to bankrupt in two years

Below 1.8 : Recovery least expected

Getting The Combination Right

Credit metrics works on the statistical concepts like probability, means, and standard deviation,correlation, and concentrations

Credit Metrics-Application

Reduce the portfolio risk : reevaluate obligors having the largest absolute size arguing that a single

default among these would have the greatest impact reevaluate obligors having the highest percentage level of risk arguing that these are the most likely to

contribute to portfolio losses

Balancing Act

Identifying the correlations across the portfolio so that the potential concentration may be reduced and

the portfolio is adequately diversified across the uncorrelated constituents

Concentration may lead to an undue accumulation of risk at one point.

ARCIL

system-wide clean up of NPAs result in creation of Asset Reconstruction Company


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Governments may also provide special powers to ARCs that are not otherwise available to bankingsystem

ARCIL Objectives

Convert NPA into performing assets

Act as nodal agency for NPA resolution

Create a vibrant market for NPA estructured debt

Re-energize the financial sector.

Transaction Structure

Transaction Structure- Stage-2

ARCIL- International Examples

In 1980s, U.S. used government sponsored ARC - Resolution Trust Corporation (RTC) to overcomethrift crisis. RTC acted as a bad bank and functioned as an effective sales mechanism for disposal of assets

In early 1990s Mexico and Sweden demonstrated successful use of ARC mechanism (Fobaproa and

Securum respectively) as a bad bank and to clean and reprivatise/ recapitalise the banks

Korea used KAMCO as the nodal agency for acquiring and disposing NPAs. KAMCO has used

securitisation and joint venture route for investor participation in the assets

Indian Financial System -2003-04

Quantitative Factors

Carrying Cost of NPAs 6.50% Management Cost 0.75%

Total Cost 7.25%

Net NPAs of banks/FIs is Rs. 470 billions

Total holding Cost comes to Rs. 35 billions p.a. for banks/FIs.

Which is around 20% of the reported Net profit (i.e., including non-core income)

Qualitative Factors

Banks fail to get Interest spread on the net realizable value of NPAs so long they carry them in theirbooks.

Reduction of Risk Adjusted Capital Adequacy Ratio (RACAR). RBI deducts net NPA from capital

and risk weighted assets to compute RACAR. Carrying NPAs in books affects Rating and Capital mobilization.

MANAGING NPA

There are two issues, which, if tackled properly, would efficiently solve the problem of NPAs viz.

o STOCK ( accumulation of NPAs) problem and

o FLOW ( accretion ) problem.

Several measures like Lok Adalat, DRTs( Debt Recovery Tribunals),Strengthening of credit appraisaland monitoring system have been initiated by the regulators to tackle the flow problem.

Towards resolution of the stock problem of NPAs GOI took proactive steps and enacted the

Securitasation & Reconstruction Act 2002 in December 2002.

MANAGING NPA- Models

Globally there have been two models:

o A central disposition agency which takes

bad loans from all financial institutions or

o An entity specific to a particular bank or a group of banks e.g. Arcil.

MANAGING NPA- Resolution Strategy

There are primarily two strategies

Loan Management Strategy

Restructuring of loan on sustainable debt considerations

Maximise overall recovery value


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Fair treatment to all stakeholders

One Time Settlement

MANAGING NPA- Resolution Strategy

Asset Management Strategy

Disposition by strip sale

Change in management

Takeover of assets

Legal route / Foreclosure MANAGING NPA-Indian Approach

The Indian system envisages multiple ARCs(Asset Reconstruction Company) as non government

entities with equity support of promoters.

The ARCs in India are not supported by through Govt. funding and are not structured like a Central

disposition agency.

MANAGING NPA-Through ARCs

ARCs are governed by the provisions of

Securitisation Act 2002 and operates within the perview of RBI guidelines.

The salient features of the Securitisation Act in respect of ARCs are as follows:

Unfettered right to the lenders acting in majority (> 75% by value) to enforce

security rights without judicial intervention

Salient Features .

Establishment & empowerment of ARCs

No single investor / sponsor to have majority control over ARCs

Paves way for debt aggregation in ARCs by enabling acquisition of assets

Accords ARCs the rights of the lenders

Additional rights to ARCs not available with lenders

Sale or lease of businesses by superceding board powers

-Enables foreign investor participation

MANAGING NPA

MEASURES FOR RECONSTRUCTION ( SECTION 9) Change in or takeover of management of business of the borrower

Sale or lease of part or whole business of the borrower

(Above two powers not available as of now, because RBI guidelines have not been issued for thesame)

MANAGING NPA

Rescheduling of payment of debt

Enforcement of security interest in accordance with the Act

Settlement of dues payable by the borrower

Taking possession of secured assets in accordance with the Act

Key Isuues before ARCs Valuation of NPA

Debt Aggregation

Legal & Regulatory

Suggestions and Conclusion

Siphoning off money or diversion of loans from banks should be erased from criminal offence.

Government funding/guarantee in some form should be available for transfer of assets to ARCs.

Banks should restrain itself from lending to just about anything that is in fashion.

Asset Reconstruction Co.

Documents

Transcript of Asset Reconstruction Co.