Investment grade to bad bank's SR will attract mutual fund money: ARCs

The security receipts (SRs) to be issued by the National Asset Reconstruction Company (NARCL), which will carry a government guarantee, should get investment-grade status to attract investments from mutual funds (MFs) and insurance companies. This, say ARC executives, will help unlock value and nurture the secondary market trading in these financial instruments.

At present, banks and financial institutions hold most of these SRs till maturity. The NARCL's receipts will carry a sovereign cover, offering investment safety comfort. This should make receipts eligible to investment-grade rating, paving the way for MFs and insurance companies to take exposure.

Last week, the Government of India said it would provide Rs 30,600-crore sovereign guarantee for SRs issued by NARCL. The sovereign guarantee (for a five-year period) will cushion SR investors against potentially lower recoveries. This could, in turn, potentially enable the development of a secondary market in SRs, which, so far, has proved elusive, said rating agency CRISIL.

A director with a mid-sized ARC said at present, banks and financial institutions hold the maximum numbers of securities, followed by ARCs, foreign institutional investors, and qualified institutional buyers. MFs and insurance companies, which have sizeable long funds at their disposal, have very little exposure due to rating concerns.

Given the guarantees for NARCL's receipts, there is stability and certainty about cashflow. If it gets an investment-grade rating for receipts, it should give comfort to MFs and insurance companies to buy them from the market, added the director.

At present, SRs are required to be valued at their net asset value. The valuation of SRs is linked to the recovery ratings assigned, based on the assessment of recovery from the underlying non-performing assets. SRs have a feature similar to equity - the absence of a defined repayment schedule. Hence, MFs and insurance companies are hesitant to invest in them. The guarantee (by the government) gives cashflow succour at the end of the redemption period in the case of SRs, said an analyst.

Based on the financial profile (including profit levels), banks could look at offloading SRs in the market within five years. This would provide liquidity. Banks are getting 15 per cent cash upfront for transfer of bad loans and the balance 85 per cent in the form of receipts.

Foreign brokerage Jefferies said SRs will be typically booked at a nominal value of, say, Rs 1 and gains/loss (offset by government guarantee) will be booked on redemption. However, after the excision of government guarantee, banks will have to bear the loss on the unredeemed SRs.

According to CRISIL, banks prefer to retain only a limited share of SRs for assets sold due to the stringent provisioning norms for banks holding them. On the other hand, ARCs in most cases hold only the regulator-mandated 15 per cent of SRs. This results in a gap that has to be bridged either by ARCs holding a larger proportion of SRs or by attracting external co-investors.

This marks a significant shift from the past where, till 2017-18, almost all SRs were subscribed to by either the selling institutions or the ARCs. 

After the revised provisioning norms, the share of external investors in cumulative SRs issued increased sharply to 12 per cent as on March 31, 2019, from 3 per cent as on March 31, 2018. However, the trend has not continued at a similar pace and co-investors have been selective. This is partly responsible for the lower growth of ARCs in 2019- 2020 and 2020-21.