Developing the Asian Markets for Non-Performing Assets

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Developing the Asian Markets for Non-Performing
Assets Indias Experience
Presented By Mr. S. Khasnobis

• November 11, 2003

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Agenda
NPAs in the Indian Banking System
ARCs Indian Context
ARCs Legal Framework
Indias Premier ARC - Arcil
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NPAs in the Indian Banking System

• Indian banking system witnessed gradual increase
  in levels of NPAs in the post-liberalisation
  period
• Shake-up in real sector
• However NPA levels did not threaten to undermine
  the banking system
• Tightening of prudential and capital adequacy
  norms by the regulator
• Selective recapitalisation support and mergers of
  weaker institutions

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While the problem is not as intense
Including exposure to bubble sectors
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NPA stock merits a systemic response

• Gross NPA levels on the rise
• NPA holding cost 25 of the net profit of the
  banking system

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Agenda
NPAs in the Indian Banking System
ARCs Indian Context
ARCs Legal Framework
Indias Premier ARC - Arcil
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ARC Indian model

• ARCs in India are set up as a non-government
  vehicle
• Minimal government participation in the ARC
  resolution process
• Market forces to consolidate and attractively
  package lender interests
• Create investors interest
• Support from the banking system an essential
  requirement

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ARC Indian model

• Fiscal Incentives to banking system
• Tax set-offs on sale of asset to ARCs
• Gains from buy-back of high yield government
  bonds to be used for set-off of losses from asset
  transfer to ARCs
• Provision for operation of multiple ARCs

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The business model Indian context
ARCs - Generic business models
Rapid Disposition Agency
Risk Rewards transferred to the investor
Immediate sell down of debt to third party
investors
Debt ResolutionAgency
Risk Rewards retained by the banking system
Focus on Asset Management Resolution
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Indian ARCs a Debt Resolution Agency (DRA)

• Expeditious resolution of NPA stock- a priority
• Indian NPA profile suggests
• Recoveries from NPAs would be over a longer
  time-frame as against rapid realisation
• Predominantly in industrial sector (Low exposure
  to bubble sectors Real estate/ Capital
  Markets)
• Banking landscape necessitates debt-aggregation
• One borrower, many lenders (inter-creditor
  issues)
• Different security classes and structures
• Moral hazards related issues

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Indian ARCs Debt Resolution Agency (DRA)

• Markets for NPAs Non-existent
• Absence of market makers (limited participation
  of foreign lenders in Indian credit market)
• No pricing bench marks
• Debt aggregation and resolution approach is
  likely to succeed
• Focus on recoveries from NPAs
• Improved leverage over debtor through aggregation
• Eliminates moral hazards
• Regulatory empowerment

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Structured along the DRA model
Acquisition
Management Resolution
Sell Down
Sell asset
Sell debt
Banks/FIs
ARCIL
Investor
Proceeds
SRs
Debt servicing
Restructuring
Company
Time line
t 0
t 5
t 1
Value capturing at resolution stage becomes
critical for final exit
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Agenda
NPAs in the Indian Banking System
ARCs Indian Context
ARCs Legal Framework
Indias Premier ARC - Arcil
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Addressing the NPA levels

• Proactive response of government and Central Bank
  aimed at NPA resolution
• Setting-up of Corporate Debt Restructuring (CDR)
  forum
• Enactment of Securitisation and Reconstruction
  of Financial Assets and Enforcement of Security
  Interest (SARFAESI) Act, 2002
• Proposed formation of National Company Law
  Appellate Tribunal

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Addressing stock and flow problem
Regulatory Empowerment
Regulator Central Bank
Self empowered body
Debt Aggregation
Agencies CDR ARC
Resolution strategies
Restructuring
Asset Sale
Access to legal mechanisms
Regulation
Tribunal
Special Court
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Legal Framework (1/2)

• Act introduced two important new initiatives to
  bring about structural reforms to the Indian
  credit market
• Setting up of Asset Reconstruction Company
• Enforcement of securities without the
  intervention of the court
• ARCs requirements
• Registered with Central Bank
• 15 capital adequacy
• Arcil is the first ARC which has been granted
  license by the Central Bank

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Legal Framework (2/2)

• ARCs empowered to take following measures for the
  purpose of asset reconstruction-
• Take possession of secured assets
• Sell or lease a part or whole of the business of
  the borrower
• Change or take over of the management of the
  business of the borrower
• Rescheduling the payment of debt payable by the
  borrower
• Settlement of dues payable by the borrower

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Enforcement of Security Interest
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without court intervention
No intervention of court Overcoming cumbersome
procedural delays Expeditious recovery
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Agenda
NPAs in the Indian Banking System
ARCs Indian Context
ARCs Legal Framework
Indias Premier ARC - Arcil
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Arcil brings together the complementary strengths
of the three largest players in the Indian
financial sector

• Sponsors hold 40 of NPAs of the system
• Private sector character- 51 shareholding with
  private banks/ institutions

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Resolution
Building Blocks
Structure
Approach
Investor
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Resolution strategy framework

• Loan management strategy
• Restructuring of loan based on transparent policy
• Maximise overall recovery value
• Fair treatment to all stakeholder
• Settlement
• Asset management strategy Asset restructuring
• Sale of business/collateral
• Preservation and enhancement of value of
  business/collateral
• Orderly disposition through transparent process

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Participation from Indian banking system at
initial stage key to value retention
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Return Expectations



Rerating
Rerating as normal debt
T0 T1 Time
NPA Implementation of resolution A performing asset A performing asset
Banks can capture value by staying invested in
the assets till the resolution stage
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Resolution strategy framework

Settlement with Existing promoters
Restructuring
High
Management quality
Strip sale of Assets
Sale of business/ Induction of JV partner
Low
Industry viability
Low
High
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Resolution
Building Blocks
Structure
Approach
Investor
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Transaction structure - Asset Specific Trust
Banks/ FIs
Sale of loan assets
ARCs/ Trusts
Scheme Borrower wise
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Pooling and sale/ Securitisation at Subsequent
Stage Exit for original investors
Borrowers A,B
Pooling of SRs
Redemption of Original SRs
Cash realization
Master Trust / Scheme
Payment for subscription to fresh SRs
Redemption of SRs
SRs
Investors
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Resolution
Building Blocks
Structure
Approach
Investor
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Distressed debt investment opportunity
CORPORATES
INVESTORS
MULTIPLE OPTIONS AVAILABLE
Restructuring fund/private equity option
Distressed Company
Direct investor
Partner with ARC
Direct from Bank / ARC
Securitization
Asset Pool
Fund level
Large Portfolio
Ideally suited for all classes of investors
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Geared to unlock value

• Indian economy buoyant and future outlook is
  positive
• Right time to tackle NPA problem
• Maximize value and distribute it back to the
  system
• Re-energize the financial sector
• Unlock under utilized productive assets
• A Win-Win model - provides a medium-term
  structural banking sector solution

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Thank You