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Mastering the art of asset reconstruction


ASSET reconstruction was evolved as an answer to the distressed debt management problem faced by banks and financial institutions in this country. So, has the experiment succeeded?


Going by the improvement in non-performing assets (the all banks’ gross NPA ratio declined to 2.3% in 2008 from 4.6% in 2002) and the number of players it has attracted, the experiment has certainly succeeded.


But what needs to be emphasised is that no other country in the world operates an ARC (asset reconstruction companies) model like we do. Internationally, ARCs were set up as centralised government agencies for tackling the bad-debt problem in a banking crisis. Funded by the government, ARCs generally enjoyed special powers to cut short legal procedures and engaged in wholesale purchase of banks’ bad loans.


By contrast, Indian ARCs are private sector entities that operate under a tightly-controlled regulatory regime and enjoy no special powers. They acquire NPAs through a transparent bidding process and pay for their acquisitions either in cash or through security receipts (SRs).


ARCs face four challenges: Debt aggregation (in case of corporate loans) so as to be able to put pressure on the borrower; sourcing funding from co-investors so as to be able to make acquisitions in cash; working out the acquisition price to be paid; and finding a way to speed up the resolution/recovery process.


The first one is actually not a challenge but a value addition that ARCs can and must make and finding a long-term solution to the second is imperative. The third and fourth are core asset reconstruction challenges and the way they are addressed pretty much determines whether the ARC’s gamble in a given case will pay off or not, since the law does not grant any special powers to them.


In terms of the price paid, the private sector ARC model has delivered far better results than its counterparts elsewhere. Thus, whereas IBRA, the Indonesian ARC, acquired assets at practically zero value and KAMCO, the Korean ARC, at an average discount of 64% to the appraised value (or, at 3% of the face value), the acquisition price-to-face value ratio for Asset Reconstruction Company of India (ARCIL) works out to 25.7%.


But the pendulum may have swung to the other extreme. With banks auctioning mainly portfolios and allowing less-than-full due diligence on them, it is pertinent to ask: Are the ARCs getting compensated appropriately for the risks they are taking? Earning sub-8% internal rate of returns is not enough; ultimately, their survival will depend on their ability to earn a decent return on investment.


ARCs must look beyond cleaning up banks’ balance sheets. One area they may turn their attention to is corporate restructuring or rehabilitation. Some time back, RBI issued draft guidelines in respect of one of the two asset reconstruction measures (out of a total of six stipulated under the SARFAESI Act) that can be taken only by ARCs — “proper management of the borrower’s business by effecting a change in, or takeover of, its management.” (Guidelines for the second one — sale or lease of a part or whole of the business of the borrower — are still awaited.)


These two measures can be powerful tools in the hands of ARCs for tackling difficult, going concern cases. A case of successful rehabilitation/revival, to which the first measure applies, could add much greater value than, say, seizure & sale action. The right to sell or lease business under the second can be an effective antidote to recalcitrant management.


Together, these two measures have the potential to reconstruct asset reconstruction. But that will happen only when objective conditions for successful rehabilitation are created.


Corporate restructuring invariably needs infusion of fresh funds (debt and equity) and conversion of a part or whole of the borrower company’s debt into equity. It is imperative that the final RBI Guidelines contain explicit enabling provisions for both. Certain legal cobwebs — such as precipitate action by a statutory authority after action for revival has been initiated, long-winded procedure for debt-equity conversion, etc. — also need to be cleared.


Reconstructing asset reconstruction will involve making progress on two fronts — one, correcting the balance in case of portfolio auctions; and two, facilitating corporate restructuring/rehabilitation and opening up the opportunity for equity upsides.

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