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New norms will temper ARC growth

But they will improve price-discovery and recovery prospects

Pawan Agrawal

Senior Director – CRISIL Ratings

Rajat Bahl

Director – CRISIL Ratings

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

– 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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Trend in Assets Under Management (AUM; SRs outstanding)

Growth will settle at a lower level for ARC industry

Regulatory support coupled with high level of NPAs fuelled recent growth

– 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

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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8,800

42,000

55,000

-

10,000

20,000

30,000

40,000

50,000

60,000

Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 E Jun-15 P

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Capital and earnings will emerge as challenges

Given the nature of assets, ARC business has traditionally been equity-

funded

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

Ability to raise capital in a timely manner will become a differentiator

Source: CRISIL estimates

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Reconstruction has been used as preferred

strategy for large accounts*

– Reconstruction includes restructuring and sale of

business strategies

ARCs have successfully reconstructed several large

accounts

Re-construction77%

Sale of assets/Settlement

23%

* Large accounts = principal debt of over Rs.100 crores

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Timely debt aggregation by ARCs

Unprecedented increase in land prices –

promoters have more skin in the game

Delay/inability in aggregating debt

High vintage of NPAs

Prolonged litigations

What has worked well? What has not worked?

Several success stories over the past decade

– Company 1 (redemption ratio of 85%)

– Company 2 (80-90%)

– Company 3 (90-100%)

– Company 4 (90-100%)

– Company 5 (60-70%)

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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

Redemption ratio is better at ~63%

# Principal debt of below Rs.100 crore

Re-construction21%

Sale of assets/Settlement

79%

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Relatively higher asset coverage offers

better cushion

Quicker implementation of resolution

strategies being sole lender

Promoters’ ability to bring in funds also

played an important role

Poor availability of documentation related

to security creation

High vintage of NPA

What has worked well? What has not worked?

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Trend in Industry Redemption Ratio

Overall recovery has not been up to the potential

Cumulative redemption ratio till June 2013 stood at 53 per cent

Source: RBI

9%

32%

53%

0%

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4,000

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Jun-05 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13

Red

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Aggregate Redemption (LHS) Redemption Ratio (RHS)

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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

– Will need to address the challenge of prolonged litigation

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Recent regulations structurally positive for the sector

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Regulations Impact

Increase in minimum investment

requirement in SRs to 15%, from 5%

Will lead to higher capital requirement for ARCs

Will significantly impact growth

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

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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CRISIL Limited

www.crisil.com

LinkedIn YouTube FacebookStay Connected | | | |Twitter

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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

Ratings of bank loans

Ratings of banks

Ratings of ARCs

Recovery risk rating

of SRs issued by

ARCs

Rated more

than 13,000 firms

Rated ~50 banks

Rated 5 ARCs

Rated SRs

~Rs.12,000 cr

Loans

NPAsRecovery

Redemption proceeds

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What are Asset Reconstruction Companies?

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

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

* Source: CRISIL estimates

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