2014 is expected to be a very exciting year for ARCs with accelerated volume of NPAs, new players, complex transaction structures for value maximization

Asset Reconstruction Companies (ARCs) were created as a systemic response to contain growing NPAs in the system. Their effectiveness lies in:

  • Ability to aggregate debt and overcome inter creditor issues in driving a focused resolution strategy
  • Being a specialized entity, develop superior capabilities / skill sets in handling NPA resolution
  • Role as Asset Manager in managing Trust structure contemplated in the SARFAESI Act  and  to attract capital from Qualified Institutional Buyers (QIBs) with adequate risk capital and risk appetite

In all the parameters above, ARCs have had, at best, limited success so far. Constraints in the operating, regulatory and legal environment have retarded timely resolution of assets acquired. The very Act, SARFAESI Act 2002, which gave genesis to ARCs in India was challenged and its validity was upheld by the Supreme Court. Acquisition/ Debt Aggregation efforts of ARCs have been affected by expectation mismatch in valuation between banks and ARCs. Add to it, the trust deficit increased as NAV of Security Receipts (SRs) held by banks (as investors) declined in the last few years sharply, based on rating assigned by rating agencies. As the foreign investment in the sector was restrictive until recently, foreign investors have largely stayed away from the sector

One of the overarching objectives of setting up ARCs is to recycle capital and improve capital efficiency. This bears larger significance particularly in a capital scarce banking sector like India’s, under pressure to meet Basel III requirements. However, flow of NPAs to ARCs has been rather tardy, against acceleration in growth of not only NPAs, but also restructured advances particularly in the last two years.






Gross NPAs of Banks





YoY Growth





Book Value of Assets sold to ARCs





YoY Growth





Restructured Advances





YoY Growth






The Gross NPAs and Restructured Assets put together have exceeded 10% of the Advances  as per Financial Stability Report of RBI as on December 2013 – an unprecedented alarming level not seen in a decade.

Against this background, Reserve Bank of India has issued a Framework for Revitalizing Distressed Assets in the Economy, which outlines a corrective action plan that will incentivize early identification of problem cases, timely restructuring of accounts which are considered to be viable, and taking prompt steps by banks for recovery or sale of unviable accounts. The Framework more particularly section 10, on NPA Sales and ARCs, after issue of necessary  Guidelines and Directives by RBI , are expected to kick start a moribund ARC Sector.  The entire framework will be operational from 1st April 2014.

Catch them Young – Demographic Composition of NPAs in ARC will change

The Framework mandates sale of assets to ARCs at a stage when the assets have good chance of revival and fair amount of realizable value, for rehabilitation and reconstruction With younger NPAs likely to flow into ARCs, the resolution strategy adopted by ARCs will be inclined more towards Restructuring/M&A- instead of Asset sale/ Settlement which dominate as at present. This will provide opportunity for ARCs to visibly demonstrate ‘Value Addition’ that they can make to the broader economy.

ARCs will have to look out for strategic alliances for integrated role-play

There will be various opportunities in transaction structuring with infusion of capital, debt equity swap, management control, and take out financing. ARC will find the role play challenging. The RBI Framework makes reference to PE Firms/ specialized outfits with support from Government/ International Institutions and envisages developing an appropriate incentive structures so as to provide greater role to PE firms and other institutions in restructuring of troubled company accounts. These institutions can be expected not only to bring additional funds for restructuring but also bring in expertise for management of the business unit.

Flow of Assets from banks to ARCs to accelerate in 2014

The flow of assets to ARCs is likely to improve noticeably because of the factors as contained in RBI Framework

a)    Ability of banks to book profit, if any, on sale to ARCs- hitherto they were required to credit it to a reserve account to meet shortfall in sale in respect of other accounts, if any

b)    Regulatory dispensation being proposed to stagger the loss on sales to a period of 2 years upto March 2015

c)    Allowing banks to  use of floating provisions towards additional provisioning of NPAs for sale to ARCs without prior approval of RBI

Vibrant Distressed Debt market

The Framework makes reference to various proposals that will improve transparency and attract more players and ultimately pave the way for creation of vibrant distressed debt market.

a)    Permitting inter ARC Sales- Debt aggregation is key to resolution success and this will permit exit routes. Some ARCs may choose to operate in a sector that they are comfortable with. Specialized sector play by select ARCs.

b)    Banks being required to accept bids should it match their reserve price- and upfront disclosure of reserve price.

c)    Large NBFCs being permitted to sell NPAs to ARCs. This will add depth to the market.

d)    More players like PE Firms/ Turnaround special entities. This will improve the efficiencies across the value chain and act as a game changer

Foreign Money

As per RBI report, out of Rs 18,900 crore of SRs issued by ARCs as on June 2013, banks have invested Rs 12,600 crore i.e. 67% as investors. In other words, banks risk exposure to these toxic assets continues in one form or other.

For a real clean up of the system, as borne by international experience foreign money plays an important role. They have both the risk capital and risk appetite. However, FII investment in SRs issued by ARCs is a pittance 1% of SRs issued by ARCs.

To encourage foreign investment, of late, Government of India has opened up FDI/FII of 100% in ARC Sector. Further, FIIs are permitted to invest 74% in SRs issued by ARCs

Summing Up..

2014 is expected to be a very exciting year for ARCs with accelerated volume of NPAs into the sector, entry of new players, complex transaction structures for value maximization. How they enhance their capabilities to meet the emerging opportunities will decide the course of growth of the ARC sector and its contribution to the economy at large.

By Hari Hara Mishra

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