Asset reconstruction companies (ARCs) are a classic case of losing steam after a promising start because of two challenges — a dynamic macroeconomic environment, and changes in the regulatory landscape impacting growth.
After a scorching pace of growth between fiscal 2014 and 2018, fuelled by enabling regulations, growth in assets under management (AUM), as measured by security receipts (SRs) outstanding, fell to low single-digits in the next four fiscals.
In FY23, growth is estimated to have improved to just short of the double-digit mark, riding on some large transactions. However, ARCs are far from realising their full potential. There are a number of challenges they face amid the constantly changing external environment. How effectively they navigate these is key to future growth.
The foremost is mismatch in pricing expectation between lending institutions (which sell loans to ARCs) and ARCs, though there has been progress from the era of 5:95 transactions. Banks have their own criteria, including having to justify low sale prices, and hence, not all of them may be fully aligned with this paradigm.
The second challenge is debt aggregation. While the time taken for it has come down from the past, it is still onerous; and lack of consensus among lenders often delays the resolution process.
Resolving these inter-creditor issues to achieve the required majority for a specific resolution plan can be taxing. The third challenge is with funding access, including debt and equity. As a segment, ARCs find it challenging to get bank funding, given the nature of their business of dealing in non-performing assets (NPAs). Hence, some of them have resorted to structured borrowings, which carry higher costs.
The revised regulations increased the minimum net worth requirement to ₹300 crore on an ongoing basis and this could lead to consolidation in the industry. Given the funding limitation for ARCs and their increasing capital requirement, with the move to the 15:85 structure and the subsequent constraints for selling banks to invest in the security receipts (SRs) pertaining to their own assets, partnerships with co-investors have become critical. But not all ARCs have been successful in stitching up partnerships.
They have participated in a few large assets and the trend hasn’t been widespread. Fifth, the fundamental transformation of the stressed assets ecosystem compared with when ARCs started operations has resulted in lenders now having multiple options for resolution when dealing with NPAs.
The Insolvency and Bankruptcy Code has seen many takers; the June 2019 Prudential Framework for Resolution of Stressed Assets of the RBI gives lenders the option to resolve stressed assets outside the legal process; an ARC may not necessarily be the first port of call.
With corporate sector NPAs trending downward since hitting a peak in fiscal 2018, the opportunity in this segment has been declining for ARCs. However, the micro, small and medium enterprises and retail segments continue to offer opportunities due to factors such as the pandemic and higher growth in loans to these segments.
The share of non-corporate debt acquired in FY22 rose to 32 per cent of total debt acquired from 5 per cent in FY20.
This trend is expected to continue with private ARCs focussing more on non-corporate segments, even as NARCL scales up business in line with its state mandate of acquiring large corporate loans. Overall, while ARCs remain an important constituent of the stressed-assets ecosystem, their ability to quickly realign business models will be critical for their long-term sustainable business growth.