Developing the Asian Markets for Non-Performing Assets – India’s Experience

Developing the Asian Markets for Non-Performing Assets – India’s Experience November 11, 2003 Presented By: Mr. S. Khasnobis

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

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

While the problem is not as intense… * Including exposure to bubble sectors

…NPA “stock” merits a systemic response • Gross NPA levels on the rise • NPA holding cost = 25% of the net profit of the banking system

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

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

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 ResolutionAgency Focus on Asset Management & Resolution Risk & Rewards retained by the banking system

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

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

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

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

Addressing “stock” and “flow” problem Regulatory Empowerment RegulatorCentral Bank Self empowered body Debt Aggregation AgenciesCDR ARC Resolution strategies Restructuring Asset Sale Access to legal mechanisms Regulation Tribunal Special Court

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

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

Non Performing Asset 60 day notice 75 % secured creditors’consent Enforcement of Security Interest…

…without court intervention No intervention of court Overcoming cumbersome procedural delays Expeditious recovery

Equity participation Shareholding State Bank of India 24.5% IDBI 24.5% ICICI Bank 24.5% Other private sponsor banks 26.5% Total 100.0% Arcil brings together the complementary strengths of the three largest players in the Indian financial sector • Sponsors hold 40 % of NPAs of the system • Private sector character- 51% shareholding with private banks/ institutions

Resolution Building Blocks Structure Approach Investor

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

Participation from Indian banking system at initial stage – key to value retention 25% 15% Rerating Rerating as normal debt Banks can capture value by staying invested in the assets till the resolution stage

Resolution strategy framework Settlement with Existing promoters Restructuring High Management quality Strip sale of Assets Sale of business/ Induction of JV partner Low Low Industry viability High

Borrower Purchase Consideration Reconstruction thru’ Restructuring / Asset sale / M&A Cash realization SRs Redemption of SRs QIBs (Banks/FIs) Payment for Subscription to SRs Transaction structure - Asset Specific Trust Banks/ FIs Sale of loan assets ARCs/ Trusts Scheme Borrower wise

Scheme Borrower A Scheme Borrower B QIBs (Banks/FIs) QIBs (Banks/FIs) Pooling and sale/ Securitisation at Subsequent Stage – Exit for original investors Borrowers A,B Pooling of SRs Redemption of Original SRs Cash realization Master Trust / Scheme Payment for subscription to fresh SRs Redemption of SRs SRs Investors

Distressed debt investment opportunity CORPORATES INVESTORS MULTIPLE OPTIONS AVAILABLE Restructuring fund/private equity option Distressed Company Direct investor Partner with ARC Direct from Bank / ARC Securitization Asset Pool Fund level Large Portfolio Ideally suited for all classes of investors

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

Thank You

Developing the Asian Markets for Non-Performing Assets – India’s Experience