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New norms will temper ARC growth
But they will improve price-discovery and recovery prospects
Pawan Agrawal
Senior Director – CRISIL Ratings
Rajat Bahl
Director – CRISIL Ratings
August 7, 2014
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Key messages
Growth will settle at a lower level for ARC industry
– AUM reached Rs.42,000 crore by June 2014, a 4 times increase in a year
– Growth to moderate to 30 per cent in the current year, given the recent regulations
Capital and earnings will emerge as challenges
– Recent regulatory changes significantly increase the capital requirements of ARCs
– ARCs that can raise capital in a timely manner will be better positioned
Track record of asset resolution critical for long term sustainability of ARCs
– ARCs have successfully reconstructed several large accounts
– However, experience shows that the recovery till date has not been up to potential
– Cumulative redemption ratio* till June 2013 stood at 53 per cent
Better recovery prospects ahead
– Lower vintage and quicker debt aggregation to be the key drivers
Recent regulations structurally positive for the sector
* Redemption ratio = SRs redeemed / SRs issued; Source: RBI
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Trend in Assets Under Management (AUM; SRs outstanding)
Growth will settle at a lower level for ARC industry
Regulatory support coupled with high level of NPAs fuelled recent growth
– Shortfall on sale of assets permitted to be booked over 2 years for banks
– Upfront booking of profit on sale of assets to ARCs permitted for banks
Industry will need to adjust to the minimum 15 per cent requirement now
– Aligning pricing strategy with expectation of selling banks will be challenging in the near term
– Proportion of cash deals is likely to go up
Source: RBI, CRISIL estimates
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8,800
42,000
55,000
-
10,000
20,000
30,000
40,000
50,000
60,000
Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 E Jun-15 P
Rs.
Cro
re
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Capital and earnings will emerge as challenges
Given the nature of assets, ARC business has traditionally been equity-
funded
Aggregate net worth is modest at ~Rs.2,500 crore as on June 30, 2014
– Gearing has increased to 1x as on June 2014 from 0.1x as on June 2013
– Gearing philosophy varies significantly among ARCs
Capital raising will emerge as a significant challenge
– Earnings will come under pressure due to revision in management fees norms
– Regulatory restrictions on sponsor shareholding and listing can act as a constraint…
– …may be partly offset by higher regulatory limit for FDI and FII investment in ARCs
– Could result in lower growth or higher gearing
Ability to raise capital in a timely manner will become a differentiator
Source: CRISIL estimates
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Reconstruction has been used as preferred
strategy for large accounts*
– Reconstruction includes restructuring and sale of
business strategies
ARCs have successfully reconstructed several large
accounts
Re-construction77%
Sale of assets/Settlement
23%
* Large accounts = principal debt of over Rs.100 crores
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Timely debt aggregation by ARCs
Unprecedented increase in land prices –
promoters have more skin in the game
Delay/inability in aggregating debt
High vintage of NPAs
Prolonged litigations
What has worked well? What has not worked?
Several success stories over the past decade
– Company 1 (redemption ratio of 85%)
– Company 2 (80-90%)
– Company 3 (90-100%)
– Company 4 (90-100%)
– Company 5 (60-70%)
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Sale of assets drive recoveries from small accounts
Sale of assets has been used as
preferred strategy for small accounts*
– Includes settlement with promoters as well
Redemption ratio is better at ~63%
# Principal debt of below Rs.100 crore
Re-construction21%
Sale of assets/Settlement
79%
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Relatively higher asset coverage offers
better cushion
Quicker implementation of resolution
strategies being sole lender
Promoters’ ability to bring in funds also
played an important role
Poor availability of documentation related
to security creation
High vintage of NPA
What has worked well? What has not worked?
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Trend in Industry Redemption Ratio
Overall recovery has not been up to the potential
Cumulative redemption ratio till June 2013 stood at 53 per cent
Source: RBI
9%
32%
53%
0%
10%
20%
30%
40%
50%
60%
-
2,000
4,000
6,000
8,000
10,000
12,000
Jun-05 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13
Red
em
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atio
(%)
Rs.
Cro
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Aggregate Redemption (LHS) Redemption Ratio (RHS)
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Outlook: Better recovery prospects ahead
Recent regulatory changes will improve quality of debt acquired…
– Early formation of, and participation at, Joint Lenders’ Forum is a significant positive step
– Lower threshold (60%) for consent to enforce SARFAESI to speed up debt aggregation
…due to vintage of NPAs coming down
– The vintage has come down to < 2 years for recent sales, from ~5 years earlier
– Recent sale of NPAs of a shipyard and a hotel company are testimony
…and quicker debt aggregation
– A key enabler for faster resolution
– The average time taken for debt aggregation was ~2 years in the past
ARCs are arranging additional funding for revival; expedites resolution
– Examples: A textile company and a mid sized Bangalore based residential developer
Implementation of learnings from past experience to help ARCs
Regulatory attention should now be focused towards quicker legal process
– Will need to address the challenge of prolonged litigation
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Recent regulations structurally positive for the sector
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Regulations Impact
Increase in minimum investment
requirement in SRs to 15%, from 5%
Will lead to higher capital requirement for ARCs
Will significantly impact growth
ARCs to have more skin in the game – will drive
better recovery in the long term
Will lead to efficient price discovery in long term
Management fees to be calculated
on NAV rather than acquisition
value
Will have negative impact on earnings
Will incentivise ARCs to recover more
ARCs to be member of JLFs Will quicken the process of NPA sale
Good for NPA resolution in long term
More time for due diligence to ARCs Will enhance robustness of due diligence process
Requirement of rating in six months Quicker fair value assessment for banks
Greater disclosures Will increase transparency
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CRISIL Limited
www.crisil.com
LinkedIn YouTube FacebookStay Connected | | | |Twitter
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Primer on ARCs and CRISIL’s experience in
the sector
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CRISIL’s wide coverage provides a 360° view of the
ARC industry
Ratings of bank loans
Ratings of banks
Ratings of ARCs
Recovery risk rating
of SRs issued by
ARCs
Rated more
than 13,000 firms
Rated ~50 banks
Rated 5 ARCs
Rated SRs
~Rs.12,000 cr
Loans
NPAsRecovery
Redemption proceeds
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What are Asset Reconstruction Companies?
Specialised institutions to deal with NPAs in India; regulated by RBI
Play an important role of putting back the assets for productive use
Industry is in nascent stage even with more than 10 year history
Arcil was set up as first ARC in 2002; currently 14 ARCs operational in India
ARCs set up a trust which issues Security Receipts (SRs)
Key industry statistics (as on June 30, 2014*)
– Principal debt acquired: ~Rs.90,000 crore
– SRs issued: ~Rs.54,600 crore
– SRs redeemed: ~Rs.12,600 crore
– SRs outstanding (Assets Under Management; AUM): ~Rs.42,000 crore
* Source: CRISIL estimates
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