ARCs to face capital challenges despite Budget booster

Currently, there are 16 ARCs in India; their assets under management were estimated at Rs 55,000 crore in June 2015

Asset reconstruction companies (ARCs) might face capital constrains, at least in the short term, despite the government's efforts to empower these.

Market players have said even with the changes announced, it was unlikely that capital would begin to flow in immediately. As a result, with the ARCs grappling with their own challenges, it was unlikely that they would be in a position to buy off the huge concentration of loans, thus resulting in a bad-loan crisis.

In the Budget, Finance Minister Arun Jaitley had proposed to amend the Securities and Reconstruction of Financial Assets and Enforcement of Security Interest (Sarfaesi) Act, 2002, to allow sponsors to hold 100 per cent equity stake in ARCs. Non-institutional investors would be allowed to invest 100 per cent in security receipts, making the fund-raising process easier for ARCs.

However, ARCs said these changes were unlikely to ease funding challenge in the near future.

According to "our meetings (with ARCs), the combined net worth of all ARCs is Rs 3,500 crore and assets managed (is) Rs 40,000 crore. Many conservative ARCs are operating at low leverage and do not wish to increase this. Sponsor capital will only flow after changes to the Sarfaesi Act," said a report by Religare.

Apart from the changes in the Sarfaesi Act, the banking industry has also asked for strengthening of the Debt Recovery Tribunal (DRT) and litigation process to ensure faster resolution.

"The move to ease conditions to attract funds into ARCs has to be backed by facilitating legal environment. Given the present slow pace of decision-making and practices, nothing is expected to change in the near term and that dampens outlook," said a senior public sector bank executive.

At present, the sponsor's stake is capped at 49 per cent and the rest has to be held by an individual, making capital-raising a challenge. However, these proposals will come into effect only when Parliament passes the Bill.

To get more investment in ARCs, the government had proposed to allow complete pass-through of income-tax to securitisation trusts, including trusts of ARCs. As a result, this income would be taxed in the hands of the investors, mainly banks, instead of the trust.

However, the trust would be liable to deduct tax at source. As of now, confusion has been prevailing over who pays the taxes on the interest income from the recovery.

Analysts said even though the aforementioned changes would ensure steady capital flow and would help in diversifying the capital base, it was unlikely that the impact would be felt in the short term.

In the Budget, the government had proposed to permit 100 per cent foreign direct investment (FDI) in ARCs via the automatic route.

Till now, FDI up to 49 per cent was allowed via the automatic route; this move would allow foreign ARCs to enter the Indian market.

However, reaching a valuation at which both banks and ARCs would agree remained a challenge.

"Budget proposals are going to be beneficial for resolving stressed assets. Banks, especially public sector lenders, are becoming flexible in the pricing of bad loans.

But change is happening at a slow pace. So even if ARCs get resources for acquiring assets, the pace of deals may not see immediate improvement," said a senior executive with Arcil.