What is ARC?

 

What is ARC?

• Asset reconstruction company (ARC).
• They buy NPA (Bad loans) from Banks and try to extract maximum money out of it=profit.
• They’ve to register with Reserve Bank of India.

Examples:

1. ARCIL (India’s first and largest asset reconstruction company (ARC))
2. Reliance Asset Reconstruction Company Limited by Anil Ambani

• In our example, SBI has NPA worth Rs.40 crores.
• ARC will buy the NPA file from SBI at a lower rate say 35 crores. (well, SBI is making loss, yes, but something is better than nothing.)
• Besides, banks have hundreads of bad loan cases, they donot have time or manpower to pursue individual case, sometimes no bidders are interested in auction. All the filework and donkey labour, In such cases, it’s better for bank to transfer NPA to ARC.
• But that doesn’t mean ARC will give 35 crores to the SBI from its own pocket!
• Then how will the Asset reconstruction company (ARC) arrange for the money?= via Security Reciepts.

What are Security Reciepts (SR)?

• In above example, ARC needs Rs.35 crores to buy a Non performing asset from SBI.
• So ARC will issue “security reciepts (SR)” worth Rs.35 crores.
• Only Qualified Institutional buyers (QIB) can buy these security reciepts (SR).
• SR are not “bonds”, they donot carry fixed interest rate.
• ARC will promise to pay money on SR, when it gets money the bad loan.
• Although, ARC usually promise 9% profit on “security reciepts (SR)”.
• So, three possible situations:

1. Qualified institutional buyers (QIB) buy those security reciepts (SR). So Rs.35 cr cash goes from QIB -> ARC -> SBI.
2. SBI itself recieves SR worth Rs.35 crores for free. (that means ARC will gradually pay the money to SBI).
3. combination of both: QIBs buy SR worth 30 crores + SBI recieves free SR worth 5 crores.

What is Qualified Institutional Buyer (QIB)?

These people have the expertise and the financial muscle to evaluate and invest in the capital markets.

Examples: (click on each to read previous articles on them)

1. Scheduled Commericial Banks
2. Foreign Institutional Investor
3. Mutual Funds
4. Venture Capital Investors
5. Insurance Companies
6. Pension/ Providend Funds

Foreign investment in ARC

• ARC =buy bad loans from banks.
• ARC =arrange money from QIBs to buy bad loans from banks.
• Problem= Indian QIBs do not invest much in ARCs.
• Therefore ARC’s capacity to buy NPA= very low.
• And bank themselves don’t have enough expertize or manpower to dispose those NPAs quickly.
• Previously Foreign investors could invest only upto 49% in ARC=minority shareholder=cannot influence company decisions.
• Now, Government also increased foreign investment limit in ARCs. This would attract more investment in ARCs and help in quicker purchase and disposal of NPAs.

Foreign investment in ARC	%
Earlier	49%
Now (December-24-2012)	74%

Anyways, back to the topic, let’s recap:

1. SBI had NPA. First solution: auction the property. Did not work out.
2. Second solution: sell it to ARC.

So, ARC purchased the NPA worth Rs.40 crores (at Rs.35 crores).

ARC’s aim= extract maximum money out of this investment. But how?

1. Auction the assets fully or partially. (sell the machinary now, rent the building and wait for land prices to go up for two years and then sell it.)
2. Sell the property in combination with other NPA properties of other defaulters. (similar to “buy one large pizza and get 20% discount on any medium sized pizzas”).
3. Restructure the EMIs of Mr.Paraajay. E.g. instead of 1 lakh per month, give us 75,000 per month.
4. Change the Management of that asset, appoint its own directors/officers.
5. Order Mr.Paraajay to outsource or lease his business to a another company.

^SARFAESI act empowers ARC to do such things. The amendment Bill adds a new power to the ARC.

ARC New Power: convert Debt into equity

Before reading further, Make sure you know the pros and cons of Debt Vs. Equity (else refer to Mrunal.org/ECONOMY)

The new Amendment in SARFAESI, empowers ARC to convert debt into equity.(fully or partially).

Share holding Before:

Shares	Rupees Cr.	%
Paraajay and his family	20	40%
Juntaa	30	60%
Total shares worth	50	100%

Share holding After

Shares	Rupees Cr.	Approx. %
Paraajay and his family	20	22%
Juntaa	30	33%
ARC	40*	44%
Total shares worth	90	100%

*that is the paper value of original debt (NPA loan of SBI to Mr.Parajaay), Otherwise ARC purchased it @Rs.35 crores.

Anyways, This leads to two situations:

1. If company starts making more profit in future, ARC will receive more share from that profit. (because more profit=more dividend to shareholders.)
2. If price of company’s shares go up in the sharemarket, ARC can sell those shares to third party and make decent profit.

Anti-arguments: Debt to Equity conversion

Critiques says this “debt to equity”provision will be abused. This provision is made to help bad corporates. How so? Well consider following:

Bank’s loss

• SBI gave Rs.40 crores loan to Mr.Parajaay
• He refuses to pay loan=bad loan/NPA.
• Then SBI sells this bad loan file to an ARC company @Rs.35 crores.
• Hence, SBI’s loss is 40-35=5 crores. (actually more than 5 crores, if we count the possible interest rate that he would have paid, if he had not defaulted. And loss figure will be different if he had paid a few installments earlier. Anyways, let’s keep the loss at 5 crore for the moment.)

ARC’s profit

• Now ARC owns the NPA assets. (their investment Rs 35 crores)
• Paraajay offers Rs.37 crores and ask ARC to sell the assets to his relative, friend or proxy.
• Hence, ARC’s profit is 37-35=Rs.2 crores.
• And yet Mr.Parajaay successfully saved Rs.3 crores (because originally he had to pay Rs.40 crores to SBI, but he walked away by paying just Rs.37 crores!)
• Few years back, CVC had held a meeting with Bank chairmans and CBI officers. They alleged ^this type of mischief going on, in many loan default cases.

Now under the new provision: if ARC converts its debt into equity (shares), then what will happen?

1. It is very unlikely that Parajaay’s company will start making huge profits (otherwise it wouldn’t be in bad loan problem in the first place!)
2. It is very unlikely that share-price of Parajaay’s company will go up in sharemarket. (because it has negative publicity due to NPA).

Hence it is very unlikely that ARC will make huge profit out of this “Equity”.

Then Mr.Parajaay can simply offer them a way out : “sell those shares to me, in my friend,relative,driver or peon’s name @Rs.37 crores.”

And ARC would agree, because 37-35=Rs.2 crores profit!