Debt Relief: ARCs to play a bigger role in the resolution of stressed assets

Asset reconstruction companies (ARCs) are key players in India’s asset resolution mechanism. They were established as part of the centre’s efforts to clean up the balance sheets of banks and financial institutions and help restore India’s lending and in­vest­ment cycle. The evolution of Indian ARCs has been ma­r­ked by stages of progress and slowdown, whi­­ch have been determined by emerging mac­ro­economic conditions and legislative changes.

As debt aggregators, ARCs serve the purpose of recovering non-performing loans by en­abling their resolution. However, ARCs have dri­fted significantly from their intended course, with exit through the sale of stressed loans to ARCs remaining largely subdued. As per the

pa­t­tern of stressed loans, the majority emana­te from the infrastructure sector, with a notable share originating from the power sector.

The capital base of ARCs largely compriseds domestic sources (banks and financial institutions), while foreign sources remain weak. A breakdown of ARCs’ borrowings also exposes their reliance on banks. In recent yea­rs, howe­ver, the share of bank borrowings has plummeted, with bonds and debentures being the primary source of borrowings for these businesses.

Regulatory initiatives

Given the significance of ARCs, it has been dee­m­ed necessary to assess their functioning structure. Since their inception, the number and size of ARCs have risen, although their pot­ential for resolving stressed assets is yet to be realised. The Reserve Bank of India (RBI) has evaluated the existing regulatory environme­nt and has proposed some changes in the framework based on recommendations by stakeholders. Some of these measures pertain to the composition of co­mmittees and their obligations within the ARCs, while others pertain to the conduct of me­etings, chairman of the boa­rd, quorum, etc.

The framework has imposed a slew of measures and modified several existing guidelines in an effort to strengthen the companies’ competence. For instance, the mandate for increased disclosure norms pertaining to financial information, track record of returns generated and recovery ratings on security receipts (SRs) in offer documents is expected to inc­re­ase transparency and investor appetite.

ARCs were previously required to invest a minimum of 15 per cent in each scheme of SRs. The amended regulatory framework mandates that ARCs invest at least 15 per cent of a transferor’s investment in SRs or 2.5 per cent of the total SRs issued, whichever is higher.

The former regulatory framework allowed ARCs to create board-approved debt settlement policies and transfer proposal-decision powers to a committee or officers. Now, these proposals must be evaluated by an independent advisory committee that makes recommendations after weighing the borrower’s financial position, recovery time, and predicted earnings and cash flows. RBI requires ARCs to maintain a credit rating for at least three years. In addition, the guidelines for charging management fees might incentivise ARCs to resolve assets promptly.

In addition to raising the capital requirement from Rs 1 billion to Rs 3 billion (which may be challenging for smaller companies), the central bank has authorised ARCs to act as resolution applicants under the bankruptcy law, thereby widening the scope of their activities. Only four of the 29 ARCs control 80 per cent of almost Rs 1 trillion in assets. The increase in capital will result in the silent exit of many, ensuring that only serious players with sufficient liquidity and patient capital continue to operate.

Revitalising growth

Even with the Insolvency and Bankruptcy Code (IBC), ARCs, and the Securitisation and Re­cons­truction of Financial Assets and Enforce­ment of the Security Interest Act, the Ministry of Finance and public sector banks desire an additional option to eliminate bad debts and clean up their books. The necessity for government-backed security receipts arose as a result of the fact that despite the availability of 29 private ARCs, sales of bad loans have not increa­s­ed, as the banks and ARCs disagree on the fair value of these assets.

The establishment of National Asset Reconstruction Company Limited (NARCL) has been a promising sign for the banking industry, which had been struggling under the weight of bad debts. As it is supported by the governme­nt, it will not postpone resolution owing to governance shortcomings, a sluggish judicial ar­chitecture, poorly planned regulation, etc., which are the most significant problems plaguing ARCs. Overall, it will give an impetus to the macroeconomy. NARCL is intended to resolve stressed loan assets above Rs 5 billion each amounting to about Rs 2 trillion. In Phase I, fully provisioned assets of about Rs 900 billion are expected to be transferred to NARCL, while the remaining assets with lower provisions would be transferred under Phase II.

The National Bank for Funding Infrastruc­tu­re and Development (NaBFID), a development financial institution in India, is also anticipated to relieve commercial banks of their long-term financing obligations. In addition to providing long-term lending, it is anticipated that NaBFID will play an active role in the development of the bonds and derivatives markets required for infrastructure financing. For the NARCL exercise to be cost- and time-efficient, continuous policy support and operational transparency will be essential. NaBFID will have to tread a delicate line between two contradicting objectives – being profitable and achieving econo­mic development objectives.

Recent takeovers

Significant cost and time overruns are extremely prevalent in infrastructure projects in India. Typically, projects incur 50-100 per cent cost overruns, largely owing to delays, which cause financial strain in this industry.

In a latest development, the US-based al­ter­native investment firm Varde Partne­rs in­ten­ds to invest approximately $1 billion to expand its portfolio in India, as part of a broader strategy to capitalise on the enormous potential oppo­rtunities in the credit market, particularly for distressed assets. Recently, Varde Partners acquired a 15 per cent interest in Reliance Power Limited for Rs 9.33 billion, and invested approximately Rs 5.5 billion in Reliance Infra­structure Limited. Despite being part of a group that has been under immense financial stress in recent years, Varde Partners assess­ed both of these companies as having huge po­t­ential. Aditya Birla Capital and Varde Partners have formed a strategic alliance to leverage the glo­bal asset firm’s ARC arm. Some of the rece­nt transactions that Varde concluded through this route include transactions with GMR Airports and GMR Infrastructure as well as the deal to buy out Punjab National Bank’s debt exposure to the KSK Mahanadi Power project.

After battling for a year to acquire bad loa­ns, NARCL has boosted its pace of operation. It in­tends to acquire 18 accounts totalling almost Rs 400 billion in the next two months. NARCL’s anchor offer of Rs 10.03 billion for Meenakshi Energy represents a 28 per cent recovery for le­nders. Vedanta and Jindal Power are also in the fray to acquire the company under corporate in­sol­­vency. For Helios Photo Voltaic Limi­ted, NARCL has proposed a recovery of 5 per cent of its Rs 6.14 billion debt, am­ounting to Rs 0.35 billion. It has also acquired Rs 92.34 billion of Jay­pee Infratech’s debt, marking its first acquisition.

Kotak Mahindra Bank-backed Phoenix Asset Reconstruction Company emerged as the highest bidder (Rs 4.05 billion) for Mittal Corp, as against the offer of Rs 2.28 billion by NARCL. In the near future, the ARC also plans to purchase the debt of two engineering pro­cu­re­ment and construction companies, McNally Bharat Engineering and Consolidated Cons­truc­tion Consortium Limited, after receiving written consent from the lenders.

The Adani Group has made substantial pro­fits by acquiring distressed assets. Adani Ports and Special Economic Zone Limited (APSEZL) acquired Dighi Port Limited for 7.05 billion un­der IBC, in February 2022, after acquiring the Krishnapatnam and Gangavaram ports in 2021. With these expansions, APSEZL now controls 30 per cent of India’s port traffic. Si­milarly, it bought a controlling share in Mu­mbai International Airport Limited when the comp­any’s debt load became unsustainable. Due to these successful developments, the Ad­ani Group has applied for a licence from the RBI to open an ARC that will acquire distressed assets in infrastructure and real estate.

In sum

Introduced in the Recapitalisation and Finan­cial Services Industry Development Act, 2002, ARCs are specialised financial institutions created to acquire and manage bad assets. The establishment of bad banks may prove beneficial for alleviating banking stress in India. NARCL is projected to act as a time-efficient me­chanism in India, while reviving investor in­te­rest in both the primary and secondary markets for stressed assets and SRs, respec­tively. With strategic factors such as abundant supply of stressed assets, regulatory transpa­rency, favourable currency rates, and robustness and potential for greater investment re­turns compared to global stressed assets, the Indian stressed asset market promises attractive long-term returns.