Developing the Asian Markets for NonPerforming Assets Indias Experience

Presented By: Mr. S. Khasnobis

November 11, 2003

FAIR III Session V

Agenda

NPAs in the Indian Banking System

ARCs Indian Context ARCs Legal Framework

Indias Premier ARC - Arcil

FAIR III Session V

NPAs in the Indian Banking System

Indian banking system witnessed gradual increase in levels of NPAs in the post-liberalisation period Shake-up in real sector However NPA levels did not threaten to undermine the banking system Tightening of prudential and capital adequacy norms by the regulator Selective recapitalisation support and mergers of weaker institutions
FAIR III Session V

While the problem is not as intense

Factors Rapid deregulation Regulatory failure Deteriorating macroeconomics Aggressive lending practices * Peak level NPAs
High Meduim

Korea Thailand Malaysia Indonesia Japan India

30%

40%

25%

50% 20% 15%

low / Non-existent

* Including exposure to bubble sectors

FAIR III Session V

NPA stock merits a systemic response

120,000 100,000 8.5%

8.0% 7.5%

Rs in crore

80,000 60,000 7.0% 40,000 20,000 1999 2000 2001 2002 6.5% Net NPA (%) Gross NPA

6.0%

Gross NPA levels on the rise NPA holding cost = 25% of the net profit of the banking system
FAIR III Session V

Agenda

NPAs in the Indian Banking System

ARCs Indian Context ARCs Legal Framework

Indias Premier ARC - Arcil
FAIR III Session V

ARC Indian model

ARCs in India are set up as a non-government vehicle

Minimal government participation in the ARC resolution process Market forces to consolidate and attractively package lender interests Create investors interest Support from the banking system an essential requirement
FAIR III Session V

ARC Indian model

Fiscal Incentives to banking system Tax set-offs on sale of asset to ARCs Gains from buy-back of high yield government bonds to be used for set-off of losses from asset transfer to ARCs Provision for operation of multiple ARCs

FAIR III Session V

The business model Indian context

ARCs - Generic business models
Rapid Disposition Agency Immediate sell down of debt to third party investors Risk & Rewards transferred to the investor

Debt Resolution Agency

Focus on Asset Management & Resolution

Risk & Rewards retained by the banking system

FAIR III Session V

Indian ARCs a Debt Resolution Agency (DRA)

Expeditious resolution of NPA stock- a priority Indian NPA profile suggests Recoveries from NPAs would be over a longer time-frame as against rapid realisation Predominantly in industrial sector (Low exposure to bubble sectors Real estate/ Capital Markets) Banking landscape necessitates debt-aggregation One borrower, many lenders (inter-creditor issues) Different security classes and structures Moral hazards related issues
FAIR III Session V

Indian ARCs Debt Resolution Agency (DRA)

Markets for NPAs Non-existent Absence of market makers (limited participation of foreign lenders in Indian credit market) No pricing bench marks Debt aggregation and resolution approach is likely to succeed Focus on recoveries from NPAs Improved leverage over debtor through aggregation Eliminates moral hazards Regulatory empowerment
FAIR III Session V

Structured along the DRA model

Management & Resolution

Acquisition

Sell Down

Banks/FIs

Sell asset SRs

ARCIL
Restructuring

Sell debt Proceeds

Investor

Time line t=0

Company
t=1 t=5
FAIR III Session V

Value capturing at resolution stage becomes critical for final exit

Agenda

NPAs in the Indian Banking System

ARCs Indian Context ARCs Legal Framework Indias Premier ARC - Arcil

FAIR III Session V

Addressing the NPA levels

Proactive response of government and Central Bank aimed at NPA resolution Setting-up of Corporate Debt Restructuring (CDR) forum Enactment of Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 Proposed formation of National Company Law Appellate Tribunal
FAIR III Session V

Addressing stock and flow problem

Regulator

Central Bank

Regulatory Empowerment

Agencies

Self empowered CDR body

ARC

Debt Aggregation

Resolution strategies

Restructuring

Asset Sale
Access to legal mechanisms

Regulation

Special Court

Tribunal
FAIR III Session V

Legal Framework (1/2)

Act introduced two important new initiatives to bring about structural reforms to the Indian credit market Setting up of Asset Reconstruction Company Enforcement of securities without the intervention of the court ARCs requirements Registered with Central Bank 15% capital adequacy Arcil is the first ARC which has been granted license by the Central Bank
FAIR III Session V

Legal Framework (2/2)

ARCs empowered to take following measures for the purpose of asset reconstruction: Take possession of secured assets Sell or lease a part or whole of the business of the borrower Change or take over of the management of the business of the borrower Rescheduling the payment of debt payable by the borrower Settlement of dues payable by the borrower
FAIR III Session V

Enforcement of Security Interest

FAIR III Session V

without court intervention

No intervention of court

Overcoming cumbersome procedural delays

Expeditious recovery

FAIR III Session V

Agenda

NPAs in the Indian Banking System

ARCs Indian Context ARCs Legal Framework

Indias Premier ARC - Arcil
FAIR III Session V

Arcil brings together the complementary strengths of the three largest players in the Indian financial sector
Equity participation State Bank of India IDBI ICICI Bank Other private sponsor banks Total

Shareholding 24.5% 24.5% 24.5% 26.5% 100.0%

Sponsors hold 40 % of NPAs of the system Private sector character- 51% shareholding with private banks/ institutions
FAIR III Session V

Resolution

Building Blocks Approach

Structure

Investor

FAIR III Session V

Resolution strategy framework

Loan management strategy Restructuring of loan based on transparent policy Maximise overall recovery value Fair treatment to all stakeholder Settlement Asset management strategy Asset restructuring Sale of business/collateral Preservation and enhancement of value of business/collateral Orderly disposition through transparent process

FAIR III Session V

Participation from Indian banking system at initial stage key to value retention
25%

15% Return Expectations

Rerating
Rerating as normal debt

T=0
NPA

T=1
Implementation of resolution

Time
A performing asset

Banks can capture value by staying invested in the assets till the resolution stage

FAIR III Session V

Resolution strategy framework

High Management quality

Settlement with Existing promoters

Restructuring

Strip sale of
Assets

Sale of business/
Induction of JV partner

Low

Low

Industry viability

High

FAIR III Session V

Resolution

Building Blocks Approach

Structure

Investor

FAIR III Session V

Transaction structure - Asset Specific Trust

Banks/ FIs
Sale of loan assets Purchase Consideration

ARCs/ Trusts

Reconstruction thru Restructuring / Asset sale / M&A

Borrower

Scheme
Borrower wise

Cash realization

SRs

Redemption of SRs

QIBs
Payment for Subscription to SRs (Banks/FIs)

FAIR III Session V

Pooling and sale/ Securitisation at Subsequent Stage Exit for original investors

Scheme Borrower A

Scheme Borrower B Borrowers A,B

Cash realization

QIBs (Banks/FIs)

Redemption of Original SRs

Pooling of SRs

QIBs (Banks/FIs)

Master Trust / Scheme

Payment for subscription to fresh SRs
SRs

Redemption of SRs

Investors
FAIR III Session V

Resolution

Building Blocks Approach

Structure

Investor

FAIR III Session V

Distressed debt investment opportunity

CORPORATES INVESTORS

Direct investor

Restructuring fund/private equity option Distressed Company Partner with ARC Direct from Bank / ARC Asset Pool Large Portfolio

Securitization
Fund level

Ideally suited for all classes of investors

FAIR III Session V

Geared to unlock value

Indian economy buoyant and future outlook is positive Right time to tackle NPA problem Maximize value and distribute it back to the system Re-energize the financial sector Unlock under utilized productive assets A Win-Win model - provides a medium-term structural banking sector solution

FAIR III Session V

Thank You

FAIR III Session V