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Contents Impact of global financial crisis: Role of asset reconstruction “Sub-Prime” reasons cause a prime crisis All eyes on the governments All thoughts on asset reconstruction Prime issues for considerations NPA valuation “Standardised” sale process approved by the regulator Flexibility in controlling structure of an ARC Reduction and standardization of registration fee and stamp duty Simplification of consent required for enforcement of security Relaxation of the requirement to take consent of the borrower Life of trust set up by ARC for asset resolution Abbreviations used 2 .
GDP growth trend 14% 12% 10% 8% 6% 4% 2% 0% -2% 2005 2006 2007 2008 USA UK Japan Germany China Australia India Source: EIU Reports Movement of stock indices 500 450 400 350 300 250 200 150 100 50 2005 2006 2007 2008 USA . The crisis originating in the US has now spread across the integrated financial world engulfing countries and sectors that have little to do with the root causes.FTSE 100 Germany .DAX 30 Australia Base year 2005 =100 Source: EIU Reports 3 . The crisis itself is a manifestation of aggressive lending with inadequate appraisals. Nationalisation of institutions – a thought inconceivable a couple years back – is turning out to be an attractive option for institutions grappling for survival. many others have been pushed to the brink. The economic indicators are gloomy as the recessionary phase sets in and market indices have reduced investors’ wealth across the globe by a whopping US$ 50 trillion.Impact of global financial crisis: Role of asset reconstruction “Sub-Prime” reasons cause a prime crisis The sub-prime crisis and its consequent effects on the global economy saw some of the established financial institutions getting consumed in the turmoil that ensured.Nikkie China .S&P 500 Japan .BSE 30 UK .Shangai A India . lax regulatory supervision and questionable credit ratings of complex instruments.
#Rescue plan for UK banking system of US$ 692 bn Source: EIU Reports Stimulus package (US$ bn) 787 38 586 14 180 693 35 Various governments while extending the helping hand to overcome the immediate challenges. from the below 7% levels projected for the next fiscal. are likely to review policies and state new measures to ensure long term stability of their respective financial markets: thus 2009 could very well turnout to be a year which would be all about policy. Governments across the globe have announced economic stimulus packages and have earmarked funds to bail out financial institutions. Stimulus packages by select countries Country US Japan* China India UK# Germany Australia *Slated to increase by US$ 320 bn. is going to be a daunting task. It is realised that simultaneous increase in spending by the Governments is the best bet to beat the crisis. 4 .to salvage. but to intervene. Going forward. Concerted and supplementing efforts by various Governments could be expected in the next fiscal. the crisis induced problems have relatively been contained due to factors like: • A well capitalised and prudently regulated Indian banking system • Domestic demand which constitute 60% of GDP and is likely to be only moderately affected by the ongoing crisis • Lack of exposure to equity and asset markets for a significant proportion of the Indian population • Liquidity crunch unlikely to affect agriculture and mandatory priority sector lending At the same time bringing the Indian GDP growth back to the 9% trajectory.All eyes on the governments The sheer magnitude and enormity of the crisis have left no option for Governments. China and India have been the fastest growing economies and are relatively better positioned to tide over the crisis. preserve and rejuvenate assets of economic value. asset reconstruction would be the focus area – for all . In India.
and rightly so. GoI has encouraged the asset reconstruction space to develop in a competitive manner.728 58. As a result. The actions and recoveries across these resolution channels are as under: Recoveries through various channels (Amount in Rs.090 21.44 2. there was no imminent financial crisis to justify direct Government intervention.49% FY 2007 160.17 33.028 91.65 12. has become more conducive for resolution of impaired assets with the introduction of Lok Adalats.76 8. Simultaneously.48% 41.35 75.39% FY 2008 186.82% 60. Source: RBI 5 .535 21.534 62.36% 3.98% DRTs No. ARCs came into being in response to the growing NPL levels in the financial system and the need to have mechanisms to resolve them in a timely manner.63 39.942# 72.180# 85. of cases referred Amount involved (a) Amount recovered (b) (b) as a % of (a) FY 2006 268.56 34. Debt Recovery Tribunals and SARFAESI.All thoughts on asset reconstruction Asset reconstruction is likely to play an increasingly important role as (a) the number of impaired assets in the financial system increase and (b) learnings from the ongoing crisis lead to evolution of speedy systems and procedures for asset reconstruction.73 47.19 30.63 44. the legal system has been revamped to enable the institutions and ARCs implement quick resolutions of impaired assets.29 60. has over a period of time.42 1.90% 83.20 51.63 37.49 41.178# 90. of cases referred Amount involved (a) Amount recovered (b) (b) as a % of (a) SARFAESI Act No. bn) Resolution/recovery channel Lok Adalat Particulars No.58 1.06 13.58 37.368 7. At the same time. of cases referred Amount involved (a) Amount recovered (b) (b) as a % of (a) #: Number of notices issued under section 13(2) of the SARFAESI Act. The legal framework. In India.98% 4.22% 3.
.58 68. a.36 As on 30th June.60 83.94 4. 2.47 6. Deloitte has been associated with institutions like Industrial Investment Bank of India Ltd.35 bn.14 106. b.08 1.99 6 . bn) Sr. Certain gaps like procedure for change of management in a distressed company by an ARC should be specified at the earliest so that the objective of the Act can be operationalised. SARFAESI has been conceived to provide the required “teeth” to secured creditors to pursue rapid resolutions. 2008 414. The table below provides a snapshot of the resolution activity done by ARCs in recent times. 1. Union Bank of India and Bank of Baroda on sell side mandates and Bank of America and Barclays Bank on buy side mandates. has been associated in many of these transactions that have resulted in resolution of NPLs aggregating approximately to Rs. the number of NPL transactions is on the rise. 2007 285. Certain other suggestions with respect to the Act are highlighted in the sections below.The creditor friendly provisions of SARFAESI has seen intense activity in the Indian reconstruction space that resulted in the formation of as many as 11 ARCs in quick succession. Snapshot of resolution activities by ARC’s (Amount in Rs. Source: RBI Particulars Book value of assets acquired Security receipts issued Security receipts subscribed by Banks SCs / RCs Others (QIBs) Amount of security receipts completely redeemed As on 30th June. No. Deloitte.44 74. 4. as an advisor.19 16. 3. With the deepening of the asset reconstruction space.92 12.34 6. c.
Going forward. This encouraging trend has been reversed as the available data for FY 09 indicates. 2008 total foreign investment was a mere US$ 12 bn. financial viability of many projects would become uncertain resulting in the possibility of an increase in impaired assets. concerted efforts by banks to reduce NPA levels and the role played by ARCs have collectively resulted in marked improvement in the NPA levels in the banking system. GoI has initiated measures to contain the impact by announcing a stimus package of US$ 14 bn. India received total foreign investment of US$ 45 bn.%) Source: RBI Although the situation until the end of FY 08 has been encouraging in the Indian context. 7 . Some of the reasons which compel us to be cautious are enlisted below: • Fall in total foreign investments Foreign investments in the country has seen a growing trend during the period FY 04 to FY 08. If interest rates were to spike. pressure on interest rates to harden could build. NPA movement as a % of advances of SCB’s 8% 7% 6% 5% 4% 3% 2% 1% 0% FY 04 FY 05 FY 06 FY 07 FY 08 Gross NPA to gross advances (SCB . As foreign inflows dry up and government borrowings increase to finance increased spendings in the backdrop of reduction in its own revenues. During the period April – November. During FY 08. The ongoing liquidity crunch in the global markets is unlikely to hold promise for the remaining months of the current fiscal. signs of economic distress have become visible from the second quarter onwards of FY 09. prudent regulation by RBI. concerns on liquidity remain.%) Net NPA to net advances (SCB . While RBI has announced series of reductions in the repo rate. the focus should be retained or else the encouraging numbers of FY 08 can get changed in a flash.The efforts by the government to develop the asset reconstruction space and make the legal framework more effective.
greater the probability of NPA formation. During the period FY 04 to 08. Advance to GDP 50 45 40 35 30 25 20 15 10 Rs. advances by SCBs grew at a CAGR of 23%. while the GDP grew at a CAGR of 11%. During FY 08. in tn 70% 60% 50% 40% 30% 20% 10% 5 0 FY 04 FY 05 FY 06 FY 07 FY 08 0% GDP at current price (base 1999-2000) Gross advances to GDP (%) Source: RBI 8 . the advances by SCBs as a percentage of GDP reached an all time high of 58%. It will be reasonable to expect that level of NPA could increase from current levels not only because of the ongoing economic crisis but also because of the sheer increase in advances by SCBs.• Rapid growth in the advances by SCBs The advances by SCBs have far exceeded the growth in GDP. Formation of NPA is a natural phenomena to lending: higher the quantum of lending.
These thoughts have been outlined in the next section. Having an efficient asset reconstruction mechanism would be the key to enable the Indian economy to sharply and swiftly recover as the global situation improve. it is likely that some would record losses and a few would become unviable. as enlisted above. RBI. Deloitte. the companies in BSE 500 (excluding banks) recorded lower profits as compared to the corresponding periods in FY 08. As companies experience profit reductions. the lending institutions and ARCs needs to be further bolstered to ward off the stress that the economy may experience. optimal price discovery and higher number of successful transaction closures – all of which would result in maximisation of economic benefit. It is supremely important for the above reasons that the transactions in the asset reconstruction space get consummated in a timely manner to preserve the economic value of assets and to ensure faster turnaround of capital. This would lead to generation of fresh NPL accounts in the Indian banking system. In this regard. The efforts initiated by GoI. 9 . if addressed. which are worrisome. On the balance. increased NPA levels are likely to be observed. in its role as an advisor for many successful transactions in this space. in bn Q3 Lending to corporates is the most remunerative earning channel for the lending institutions. could result in quicker resolution. there are reasons. it may be noted that the relaxation in guidelines for NPA recognition may not lead to immediate rise in NPA levels but during the course of next fiscal or so. PAT of BSE 500 (excluding banks) 800 700 600 500 400 300 200 100 Q1 FY 08 FY 09 Source: Capitaline Q2 Rs. while India is not affected as much as its western counterparts.• Corporate results are worrisome In the first three quarters of FY 09. has made certain observations which.
Unless there are real opportunities to rapidly restructure an account while ensuring its continuity. In almost all transactions. 10 . • Early sale of NPAs for better valuations A contentious issue for the sellers is that buyers rarely offer bids that value the account on a going concern basis even though grounds for such valuation exist. As NPA resolution often involves resorting to legal options. While business valuation would always remain an area where diversity of viewpoints of sellers and buyers is certain. it is important to expedite the process that the sellers undertake from the point of recognition of a NPA to its eventual transfer to an ARC. Valuation of NPA has emerged as the most prevalent “deal breaker”. The main reason is that the NPL accounts that are typically offered for sale have a long history of being non-operational which obviates the possibility of valuation assuming business continuity. As sellers originate transactions. bridging the “valuation gap” would remain a challenge for successful transaction closure especially for accounts that have a turnaround potential. CDRs etc. instances of transactions that have fallen through at the last stages due to irreconcilable valuation differences between the seller and the buyer are on the rise.Prime issues for considerations NPA valuation With an increase in the number of transactions in the Indian asset reconstruction space. concerns on estimating resolution period would come in the way of attractive valuations by potential buyers. Some of the key issues that need to be addressed in this regard are discussed below: • Estimating the recovery period Valuation of NPA involves estimation of recovery periods to arrive at present value. is likely to result in better valuations by potential buyers. OTS. Resolution options like SARFAESI. the number of parameters where the seller and the buyer could potentially differ is far more as the underlying asset is non-performing to start with. resolution through these means. have better process visibility. estimation of recovery period becomes tricky as legal proceedings could become lengthy. buyers offer bids based on asset valuation. Otherwise. wherever possible. Setting pre-specified timelines for legal proceedings would facilitate convergence of views of buyers and sellers as far as estimation of recovery period is concerned. in case of NPA transactions. There is hardly any valuation in the Indian context where valuation is carried out on a “going concern” basis. The sellers need to make the first move by offering such accounts for transfer in a timely manner before significant value erosion of the account happens.
steeper is the valuation. Seller banks should engage in active monitoring and follow up of the NPL accounts so that updated information is shared during the sale process. A fragmented data room process also requires buyers to incur significant upfront costs and often many buyers choose not to participate. Centralised data room with adequate senior level supervision is not an option but a necessity for successful transaction closure. NPL transactions hinge critically on the quality of the underlying data. The key reason for this has been fragmented data sources that need to be referred to when sellers launch processes which require buyers to visit branches where the account is based rather than making all the relevant information available at one central data room which is manned by professionals who understand the accounts offered for sale and also the sale process. as are legal updates.• Account information and data collation One of the key reasons that inhibit proper valuation by potential buyers is the lack of adequate information that is made available for the account offered for sale. It has also been observed that at times even the available information could not be shared with bidders. there is always the problem of accurately determining the share of the seller in a particular loan account offered for sale as the outstandings for other lenders are often unavailable. 11 . There is a need to improve inter-lender communication and coordination that would result in better exchange of information. In the absence of such critical information. buyers heavily discount their bids. Better the underlying data. In consortium funded accounts.
there was no imminent financial crisis that was emerging to galvanise direct government intervention. The ARCs in India consequently either have a private sector ownership or have bank based ownership. As it would not be possible for the regulator to prescribe valuation methodologies that the seller banks could follow as the conditions associated with each asset varies thereby making any standardisation attempt ineffective. Transparent and competitive bid processes are already being conducted. There are firms who specialise in resolution of stressed assets in specific industries and have an edge over “generic” reconstruction companies as they bring in superior industry specific knowledge and expertise. At the same time. As a result. Presence of such firms would expedite the resolution process and is also likely to enhance realisation which would eventually maximise benefit for the overall economy. to have a presence in this space bringing more depth to this sector. including foreign players. ARCs came into being in response to the growing NPL levels in the financial system and the imperative need to have mechanisms to resolve them in a timely manner. the disposition of the seller should be to close the transaction when the fair market price has been discovered. Reduction and standardisation of registration fee and stamp duty The registration fee and stamp duty payable at the time of assignment to the buyer varies from state to state. there are restrictions on controlling stake by a single party in an ARC which in the background of allowing competitive forces to develop the asset reconstruction space appears to be restrictive. the next best option would be to have sale processes prescribed by the regulator for sale involving a single asset or a portfolio. and rightly so. GoI should initiate the process of rationalisation of the registration fee and the stamp duty to simplify the post sale processes and reduce the overall transaction cost across all states. received as a result of a competitive bid process is often subjected to a fresh evaluation by the seller. A formal approval by the regulator and a buy in of the stakeholders would go a long way in instilling confidence to sellers to close such transactions. Flexibility in controlling structure of an ARC Depending on the background under which ARCs are formed in a country. GoI has encouraged the asset reconstruction space to develop in a competitive manner. While the seller bank should have a right to negotiate with the highest bidder to explore the possibility of enhancement of the highest bid. It should be possible to introduce guidelines to check potential for misuse which a flexible ownership structure could be prone to.“Standardised” sale process approved by the regulator Bid representing the highest value. we have now the following structures that are prevalent globally: • ARCs that are owned / sponsored by the government • ARCs that are owned by the banks • ARCs that are in the private sector domain In India. It is necessary that all stakeholders address these problems so that processes that are conducted in good faith and in a transparent manner are not shelved. 12 . Nevertheless. A relaxation of this norm would encourage more private sector entities.
no bids are received at price above the reserve price. The requirement to take the consent of the borrower often results in avoidable delays and further erosion of the underlying asset value.passu charge holders for security enforcement and only the loan amounts pertaining to such senior and pari-passu charge holders should be considered for evaluating the applicability of 75% of value requirement. can enforce securities only if they have the consent of 75% of lenders in value. Relaxation of the requirement to take consent of the borrower Rule 9(2) of The Security Interest (Enforcement) Rules. be helpful if the said rule is relaxed. therefore. it would be appropriate to have consent of only the senior and pari. The Act does not modify the charge to any lender group in any manner but the consent of junior charge holder becomes necessary nonetheless. as they would get compensated to the extent possible after the claim of the senior charge holders have been settled. consent of the borrower and the secured creditors would be required to conclude the sale at a price lower than the reserve price. It would. This provision needs to be modified to enable speedy recovery when the assets underlying a NPL account is still in good condition and worthy of productive economic use. Life of trust set up by ARC for asset resolution The life of the trust set up for asset reconstruction has been specified to be a maximum of five years in accordance with the Securitisation Companies and Reconstruction Companies (Reserve Bank) Guidelines and Directions. 13 .Simplification of consent required for enforcement of security SARFAESI specifies that secured lenders. The junior charge holders do not stand to lose in the process. It can be safely concluded that in most of the complex and sticky NPL accounts. the number of secured creditors are too many which acts as a major deterrent in aggregation efforts. in case of joint financing. 2002 specifies that if for sale of an immovable property. There should be flexibility for extending the life of the trust if resolution is ongoing or appears to be likely in the foreseeable future. 2003. Consequently.
com Deepak Netto Head. For further information and thoughts. Avinash Gupta National Leader.com Rahul Choudhry Director Tel: +91 22 6622 0517 Email: rachoudhry@deloitte. we have highlighted some of the important issues which can encourage faster transaction closure in the asset reconstruction space which is going to become increasingly important for the long term stability of the financial sector. Cuffe Parade Mumbai – 400 005. 4th Floor. India Tel: +91 22 6622 0500 Fax: +91 22 6622 0501 14 . please feel free to contact one of the specialist listed below. Financial Advisory Services Tel: +91 22 6622 0515 Email: email@example.com Deloitte Touche Tohmatsu India Private Limited Maker Towers E. Reorganisation Services Tel: +91 22 6622 0506 Email: dnetto@deloitte.In this report.com Rajgopal Pai Manager Tel: +91 22 6622 0563 Email: rpai@deloitte.
Abbreviations used ARC: Asset Reconstruction Company CAGR: Compounded Annual Growth Rate CDR: Corporate Debt Restructuring DRT: Debt Recovery Tribunal FDI: Foreign Direct Investment FY: Financial Year GDP: Gross Domestic Product GoI: Government of India NPA: Non Performing Asset 15 NPL: Non Performing Loans OTS: One Time Settlement RBI: Reserve Bank of India SARFAESI Act: Securitisation and Reconstruction of Financial Asset and Enforcement of Security Interest Act SC / RC: Securitisation Company / Reconstruction Company SCB: Schedule Commercial Bank QIB: Qualified Institutional Buyers .
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