Not secure

The role of asset reconstruction companies (ARC) is back in the focus as public sector banks recorded the highest level of stressed assets (that is, gross non-performing assets plus restructured assets) at 13.5 per cent of gross advances as on March 2015, as per the Reserve Bank of India’s Financial Stability Report 2015.

The gross NPAs of the banking system stood at 4.6 per cent. Under various stress test scenarios done by the central bank in the FSR, there was even a probable scenario of scheduled commercial banks losing all profit should the gross NPA move up to 7.6 per cent.

There is now a greater need for flow of NPAs to ARCs. However, the sales of NPAs to ARCs are settled mostly through issuance of security receipts(SR).

As on March 2015, banks had sold NPAs to the tune of ₹62,500 crore, of which ₹61,300 crore was settled in the form of security receipts. So, 98 per cent of sale transactions have been settled through the SR structure.

Highest bid, and… Public sector banks run a NPA auction process and assign the NPA to the highest bidder. That sounds perfectly logical. And if the payments were in full cash, this is certainly the best system.

But most sales to ARCs are under the SR route where the seller (banks) gets the security receipt, which essentially is an entitlement to the extent of recovery from underlying assets.

So irrespective of the purchase consideration, banks get back, at the end of the day, value that is based on how much the ARC recovers actually.

This basically depends on intrinsic underlying valuation and value-add by ARC post acquisition.

Hence, two factors stand out — correct valuation and skill sets and the capability of ARC as asset manager. Highest bid, per se, in SRs, which is not a guaranteed payment, may not be the best option.

Besides, higher amounts of SR mean higher cost outgo for banks in terms of management fee and assignment related expenses.

Further, the insecurity over security receipts held by banks is growing. In a recent CRISIL report (June 2015), 75 per cent of such investments in SRs are clubbed as weak assets.

From an independent perspective, this shows there has been a lot of window dressing in the pricing of NPAs.

In such a back drop, one-dimensional approach to auction of NPAs to highest bidder needs a critical review and introspection.

Third-party intermediation Many NPA auctions are failing due to the mismatch in price expectation between the seller bank and the buying ARC.

As things stand today, almost all transactions are based on security receipts, whose value is determined periodically by a rating agency, after the transaction is completed.

If the value assigned by a rating agency is accepted post transaction, the same agency can be roped in for an acceptable valuation before transaction too in cases where best bid by ARCs does not match reserve price fixed by bank.

This will avoid sharp diminution in NAV post acquisition and migration of rating of SRs, if any, will only be orderly.

The writer is president, UV ARC Ltd, Delhi. The views are personal

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