Ratings rider for ARCs' bad loan receipts

Asset reconstruction companies (ARCs) will have to obtain a rating for securities receipts (SR) it issues against bad loans within a year from acquisition of the assets.

ARCs will have to obtain the rating from the Securities and Exchange Board of India-registered rating agencies to begin with, said the Reserve Bank of India (RBI) in a notification stating the guidelines on declaration of net asset value of SRs.

The rating will have to be reviewed at half yearly intervals. The RBI further clarified that the review would be on a continuous basis so that any further deterioration in the value of SRs is declared immediately for the information of the investors and necessary adjustment in their valuation of the same.

The ARC should declare net asset value within two months from the date of half-yearly review ""-by August 31 and February 28 respectively.

The RBI has directed the ARC to supply the necessary information rating agencies. Commonality and conflict of interest if any, between the company and the rating agency would have to be disclosed.

The rating company would have to award the rating based on the recovery risk as against default. Rating should reflect present value of the anticipated recoverability of future cash flows, said the RBI.

The recovery rating percentage picked by the ARC multiplied by the face value of the SR will give the NAV. The ARC would have to provide the rationale for selection of the particular percentage of recovery rating.

For example, if the range is between 81 per cent and 90 per cent, the ARC may pick up 87 per cent based on its judgement. The face value of the SR for instance is Rs 10 multiplied by the recovery percentage 87 per cent would give the NAV as Rs 8.70.

The ratings will be assigned on a new, specifically developed scale called recovery rating (RR) scale.

Each rating category in the recovery scale will have an associate range of recovery, expressed in percentage terms, which can be used for arriving at net asset value (NAV) of SRs.

The other key factors that should be factored in while assigning RR are the extent of debt acquired, composition of lenders, collaterals available, security and seniority of debt, individual lender vis-à-vis institutional lender, estimated cash flows, uncertainty in realising expected cash flows in initial period, management, business risk, financial risk, among others.

The RR will factor in likely cash flows from the underlying impaired assets till the maturity of the SRs.

The Recovery Rating should comprise of rating of not only the SRs of the scheme as a whole but wherever feasible a desegregation of each component in the scheme, which means the underlying assets of each entity in the scheme forming the basket should also be rated.