A widely held view is that little has been done by ARCs in the area of rehabilitating and turning around sick but potentially viable companies. It is rather difficult to contradict this view because the available information shows that successful turnarounds supported by ARCs have been few and far between.

When the SARFAESI (Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest) Act was introduced, the basic thinking of ARCs’ roles were reconstructing and rehabilitating companies, aggregating the debt and resolving the NPA problem.

But what happened thereafter (was that) ARCs were used not as reconstruction companies but as asset warehousing companies. Banks have used them largely to transfer assets at book value in order to minimize accounting and to have a larger period to write off. From these perspectives, ARCs have done their job.

It is pertinent to note that the poor performance of ARCs in resolving stressed loan situations in the past has played heavily on the minds of banks and has affected the industry in two ways: the overall deals between ARCs and banks have reduced considerably and more banks have started preferring cash sale to SRs. In view of this, the option of exit through the sale of stressed loans to ARCs has been underutilised.

During the early period of 2008 – 13 where reconstruction business was in infancy stage, the conversion of NPAs was slow. According to an ASSOCHAM report, the average recovery rate for ARCs in India is around 30% of the principal and the average time taken is between four to five years.

During 2013-14, because of multiple positive factors, the reconstruction business was booming as ARCs bought large quantity of bad assets from banks.

But after 2014, the performance of ARCs in settling the NPAs became below par. Especially in the recent periods, ARCs became underperformers in the context of the present rising tide of bad assets. This has caused steep rise in NPAs in the banking sector.

The declining asset reconstruction activity started from the second half of 2014, when the RBI raised certain norms for securitization business. RBI released a comprehensive ‘Framework for Revitalizing Distressed Assets in the Economy’. It suggested a corrective action plan to fight NPAs. Later, the RBI raised the cash payment to banks from 5% to 15%. Similarly, it removed special asset classification benefits to asset restructuring from April 1, 2015 to align with international norms. As a result of these, the asset reconstruction business witnessed a slow-down. Since 2015 onward, out of over 6,000 books that have been acquired, about 800 are in 5:95 and rest in 15:85 structure.

At present, there are 19 ARCs in India. But collectively, their capital base is also insufficient to tackle the country’s nearly Rs 8 lakh crores NPAs.

Cumulatively, ARCs acquired Rs 88,500 crores worth of assets and issued Rs 18,900 crores of SRs till FY 2013, but managed to redeem only Rs 10,100 crores worth of SRs. The high return for ARCs and low recovery of loans highlighted the difficulty of scaling up the ARC model. The sharp upward spike in transactions in the third phase invited greater RBI scrutiny and it raised the ARC investment requirement from 5 per cent to 15 per cent in August 2014. It also changed the method of calculation of the management fee: ARCs fees are now a percentage of the net asset value (NAV) at the lower end of the net value specified by the rating agency while earlier they were estimated as a percent of the outstanding value of SRs.

New investments norms have been enforced by the RBI to “ensure that distressed asset sales to ARCs genuinely transfer risks out of banks”. According to the RBI’s December 2014 Financial Stability Report the “rationale behind these regulatory changes was to incentivise realisation and thereby expedite the process of recoveries/restructuring as the net asset value (NAV) of SRs is calculated on the basis of the likely rate of recovery of stressed assets”.

The resolution of distressed assets is largely linked to the new bankruptcy code. But the biggest surprises are coming from the NCLT where legal challenges are becoming the order of the day. The operational creditors also have the power to drag a company to bankruptcy. "Once the company goes to NCLT, the stressed company is out of control of ARC or lenders," says an insolvency professional. There is also a huge risk of liquidation where the ARC won't make money - liquidation value is dirt cheap.

Given their capital constraints, smaller ARCs are content taking bets on micro, small and medium enterprises (MSMEs). The time taken for recovery is also lesser compared to that in bigger ticket loans. For example, for Reliance ARC, while the focus is more towards retail (60% of AUM) and SME (15%), its MSME exposure includes an auto component manufacturer, a steel player, a railway contractor and a liquor distributor.