Developing the Asian Markets for Non Performing Assets

Developing the Asian Markets for Non. Performing Assets – India’s 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 India’s Premier ARC - Arcil FAIR III – Session V

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

While the problem is not as intense… * Including exposure to bubble sectors FAIR III – Session V

…NPA “stock” merits a systemic response • 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 India’s Premier ARC - Arcil FAIR III – Session V

ARC – Indian model w ARCs in India are set up as a non-government vehicle n n n Minimal government participation in the ARC resolution process Market forces to consolidate and attractively package lender interests Create investors’ interest l Support from the banking system – an essential requirement FAIR III – Session V

ARC – Indian model w Fiscal Incentives to banking system n Tax set-offs on sale of asset to ARCs n Gains from buy-back of high yield government bonds to be used for set-off of losses from asset transfer to ARCs w 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) w Expeditious resolution of NPA “stock”- a priority w Indian NPA profile suggests n Recoveries from NPAs would be over a longer time -frame as against rapid realisation n Predominantly in industrial sector (Low exposure to “bubble” sectors – Real estate/ Capital Markets) w Banking landscape necessitates debt-aggregation n One borrower, many lenders (inter-creditor issues) n Different security classes and structures n Moral hazards related issues FAIR III – Session V

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

Structured along the DRA model Management & Resolution SRs Time line ARCIL Debt servicing Banks/FIs Sell asset Restructuring Acquisition Sell Down Sell debt Proceeds Investor Company t=0 t=5 t=1 Value capturing at resolution stage becomes critical for final exit FAIR III – Session V

Agenda NPAs in the Indian Banking System ARCs – Indian Context ARCs – Legal Framework India’s Premier ARC - Arcil FAIR III – Session V

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

Addressing “stock” and “flow” problem Regulator Agencies Resolution strategies Central Bank Self empowered CDR body Restructuring Regulatory Empowerment Debt Aggregation ARC Asset Sale Access to legal mechanisms Regulation Special Court Tribunal FAIR III – Session V

Legal Framework (1/2) w Act introduced two important new initiatives to bring about structural reforms to the Indian credit market n Setting up of Asset Reconstruction Company n Enforcement of securities without the intervention of the court w ARCs requirements n Registered with Central Bank n 15% capital adequacy n Arcil is the first ARC which has been granted license by the Central Bank FAIR III – Session V

Legal Framework (2/2) w ARCs empowered to take following measures for the purpose of asset reconstruction: n Take possession of secured assets n Sell or lease a part or whole of the business of the borrower n Change or take over of the management of the business of the borrower n Rescheduling the payment of debt payable by the borrower n Settlement of dues payable by the borrower FAIR III – Session V

Enforcement of Security Interest… et s ng nt se As i rm on N P rfo e 60 ay d tic no on ’c rs e 75 ito d % re cu se d e cr 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 India’s 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% 26. 5% 100. 0% Sponsors hold 40 % of NPAs of the system l Private sector character- 51% shareholding with private banks/ institutions l FAIR III – Session V

Building Blocks Approach Resolution Structure Investor FAIR III – Session V

Resolution strategy framework w Loan management strategy n Restructuring of loan based on transparent policy Maximise overall recovery value l Fair treatment to all stakeholder n Settlement w Asset management strategy – Asset restructuring n Sale of business/collateral n Preservation and enhancement of value of business/collateral l Orderly disposition through transparent process l FAIR III – Session V

Participation from Indian banking system a initial stage – key to value retention 25% 15% Return Expectations Rerating as normal debt T=0 T=1 NPA 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 Management quality High Low Settlement with Restructuring Existing promoters Strip sale of Sale of business/ Assets Induction of JV partner Low Industry viability High FAIR III – Session V

Building Blocks Approach Resolution 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 Cash realization Scheme Borrower wise 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 QIBs (Banks/FIs) Redemption of Original SRs Payment for subscription to fresh SRs Pooling of SRs Borrowers A, B Cash realization Master Trust / Scheme SRs Redemption of SRs Investors FAIR III – Session V

Building Blocks Approach Resolution Structure Investor FAIR III – Session V

Distressed debt investment opportunity CORPORATES Restructuring fund/private equity option Distressed Company MUL TIPL E OPTI ONS AVAI LAB Direct investor INVESTORS Partner with ARC Direct from Bank / ARC Asset Pool Securitization Fund level Large Portfolio Ideally suited for all classes of investors FAIR III – Session V

Geared to unlock value w Indian economy buoyant and future outlook is positive n Right time to tackle NPA problem n Maximize value and distribute it back to the system n Re-energize the financial sector n Unlock under utilized productive assets w A ‘Win-Win’ model - provides a medium-term structural banking sector solution FAIR III – Session V

Thank You FAIR III – Session V