AUM rises but ARCs face challenges due to higher cash needs: Crisil

Mumbai: The total assets under management (AUM) of bad loan aggregators in India has crossed Rs 1 lakh crore in fiscal ended March 2019 but the pace of growth has eased as asset reconstruction companies’ (ARCs) face challenges due to higher cash portion in acquisition of bad loans.

In a report on Tuesday, rating agency Crisil said that the growth in ARC assets has fallen to 7% in fiscal 2019 from 25% a year ago mainly as the redemption rate for security receipts (SRs) has improved. SRs are issued to banks pending recovery from a bad account. These SRs are then encashed after the loan is recovered.

Crisil rates ARCs accounting for around 75% of overall industry AUM. The rating agency estimates that redemption of SRs increased to around 15% in fiscal 2019, from 8% a year earlier mainly due to the resolution of a few large stressed accounts.

Higher provisioning requirements for banks has also increased cash settlement by banks. New RBI norms effective from April 2017 said that if SRs make more than 50% of the value of the asset under consideration, banks have to continue to provide for these loans as if the loans continue in the books of the bank, increasing provisioning requirements for banks and making it less lucrative to put fresh stock of bad loans on the block. This has pushed banks towards cash settlements. Cash as a portion of total acquisition cost for the fiscal 2019 was around 90%, up from 28% last fiscal.

“With selling banks unwilling to invest more than 10% in most cases, the business model for ARCs has become more capital intensive, with a need to either put in their own funds, or bring in other investors. In such a scenario, quicker recoveries by ARCs becomes even more critical as it helps free the capital deployed by them to make way for newer acquisitions and also attract new and repeat investors,” said Krishnan Sitaraman, senior director, Crisil Ratings.

In 2016, ownership norms were also eased, allowing foreign investors to take 100% stake in ARCs. This together with a functioning bankruptcy law has led to an increase in foreign fund interest in the bad loan market in India. Crisil said ARCs’ ability to tap this Rs 9.4 lakh crore opportunity and grow sustainably will hinge on their ability to collaborate with other investors and accelerate their pace of recoveries.

Such foreign funds and investors picked up 59% of the SRs in fiscal 2019 according to Crisil’s estimates up from 8% in fiscal 2018 and from about 1% in fiscal 2017. “ARCs have been able to rope in external investors to subscribe to the SRs. In fact, in fiscal 2019, for Crisil-rated ARCs, foreign banks, stressed assets funds and global pension funds, subscribed to around 60% of total SRs issued. Two years ago, this was negligible,” said Subha Sri Narayanan, director, Crisil Ratings.

Going ahead, given the increased requirement of capital, Crisil said that ARCs could partner with funds through various routes – ranging from investment in ARCs themselves to investment in SRs to direct investments in stressed assets.