Sale of bad loans by public sector banks to asset reconstruction companies (ARCs) gained momentum in 2013-14, but failed to retain its pace in 2014-15.

With the RBI raising the bar in August last year, and demanding a minimum of 15 per cent down payment from ARCs, aggressive sale of assets have come to a standstill. In 2013-14, close to ₹51,000 crore assets were sold by banks to ARCs, a sharp jump from ₹10,000 crore assets sold in 2012-13. But in 2014-15, banks sold ₹50,000 crore of bad loans, a tad lower than what they offloaded a year ago.

Better price In a bid to reduce their stock pile of bad loans, banks aggressively sold their assets to ARCs in 2013-14, as they were able to obtain better prices for their sales. From about 20-30 per cent of the value of loans, ARCs were willing to pay a higher 55-60 per cent to take the loan off the banks’ books. In 2012-13, for instance, ARCs paid about ₹2,100 crore to acquire ₹10,000 crore of bad loans. But in 2013-14, ARCs paid ₹20,600 crore to acquire ₹51,000 crore of assets. The increase in pricing was due to deals done through the security receipts (SR) route. Instead of taking upfront cash payment, banks were willing to accept delayed payment in the form of ‘security receipts’ or SRs. ARCs made a down payment of minimum 5 per cent and the balance 95 per cent was redeemed against the SR, when the amount was finally recovered.

By demanding a 15 per cent down payment from the ARCs, the RBI appears to have upset the apple cart. Post-August, sale of bad loans have dwindled. A higher upfront payment from ARCs, have dissuaded them from offering better prices.

Siby Antony, CEO, Edelweiss Asset Reconstruction Company, said: “Upto August the sale was good, because it was on the earlier 5/95 structure. In the 15/85 structure, return to ARCs has come down substantially, in fact below the sustainable level. At 1.5 per cent management fee, the internal rate of return (IRR) works out to 7 per cent. In the earlier 5/95 structure the IRR was 20-22 per cent, which is reasonable considering the risk profile of assets. So, there has been a huge hit.” While the move has impacted sale of assets, it has brought in more realistic pricing, which was the RBI’s intent in the first place.

“In September 2013, the RBI had urged banks to use the ARC tool for selling fresh NPAs. In a 5/95 structure it worked well for both banks and ARCs. But 15/85 is also a very good structure because pricing of NPAs would tend to be more realistic. It is important that banks adjust to the new pricing,” said Antony.

Banks provide 15 per cent provision on NPAs, which means that the net book value of the loan comes to 85 per cent of the value of loan. Banks should be willing to accept a price much lower than this.

“Banks should price the assets reasonably. If we recover more than the agreed price, then the benefit is passed on to banks in any case. Say for instance, if the asset is valued at 30 per cent, but we recover 50 per cent, then the 20 per cent upside is split between the banks and the ARCs in 80:20 proportion,” he added. Banks incentivising early recovery can help ARCs improve their returns.

“If we recover, in say, in three-five years, then banks should pay us an additional fee over and above the management fee,” said Antony.

Likely to pick up Many banks are now willing to price their assets more reasonably and sale of assets is likely to gain momentum once again in the current fiscal. With bad loans on the rise and the window for restructuring no longer available, banks are likely to resort to selling their bad loans to ARCs. The RBI extending the one-time dispensation on sale of such loans may further boost sales.

In January 2014, the RBI had allowed losses incurred on sale of assets below the net book value by banks to be amortised over two years. This window was opened until March 2015. The RBI recently extended this leeway for another year.

“Banks are likely to make use of this window to sell off their bad loans in 2015-16,” Antony said.

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