NON PERFORMING ASSETS

http://mrunal.org/2012/12/economy-sarfaesi-asset-reconstruction-company-arc-security-receipt-sr-qib-drt.html

What is NPA?

• Bank gives loan to a person.
• Person fails to make regular payments.
• Bank gives him notice to correct his behavior. But he doesn’t.
• Bank declares that loan as Non-Performing Asset (NPA) (=Bad Loan)
• Currently Indian banks have NPAs worth more than Rs. 1 lakh crores.

Debt Recovery tribunals?

• Prior to 90s, banks had very hard time recovering bad loans.
• Because often, borrowers (loan takers) would file frivolous cases in civil courts, then …taarikh pe taarikh, taarikh pe taarikh….. proceeding would go on for years.
• So 1993, Government established Debt Recovery Tribunals to deal with NPA matters.
• Now borrower cannot approach civil court, they’ve to goto special Debt Recovery Tribunal (DRT).
• This led to some relief, but then DRTs clogged down by truckload of cases. (Even now, more than 60,000 cases pending with DRTs)
• In 2002, Government came up with new Act, named “SARFAESI Act”.

What is the Sarfaesi Act?

• Securitisation
• and Reconstruction
• of Financial Assets
• and Enforcement of Security Interest Act, 2002,

Suppose, Mr.Paraajay has opened factory with Rs.100 crores. He financed this, via mixture of Debt + equity in following way. (make sure you understand debt vs Equity, if not click me)

	Holder	Rupees in Cr.
Equity (IPO->Shares)	Paraajay and his family	20
	Juntaa (public)	30
Debt (loans, Bonds)	Business loan from SBI	40
	Bonds	10
Total		100

• Initially the company runs well and good.
• But then Mr.Paraajay doesn’t revise his MBA books often, so he forgets the business concepts. His company starts making losses.
• He fails to pay loan EMIs for many months.
• SBI gives him notice to correct his behavior.
• Still, he doesn’t start paying money.
• SBI declares this Rs.40 crores loan NPA (Non-Performing Asset).
• Once a loan is declared as non-performing asset, SBI can take actions under SARFAESI act, to recover the loan money.

Bank have following powers under SARFAESI Act

1. Take possession of Mr.Paraajay’s assets without requiring court order. (Commericial or residential, fixed or moving assets.)
2. Auction / Sale them.
3. Change the administration/ Management of those assets.
4. If Mr.Paraajay had sold away the mortgaged asset to third party Mr.X, bank can order Mr.X to surrender that Asset.
5. If Mr.X owes money to Mr.Paraajay, he can be ordered to pay money.

• *ARCs explained after a few paragraphs.
• SARFAESI applies only to loans above Rs.10 lakhs.

• By the way SARFAESI applies only to those assets “mortgaged/secured” to get the loan.
• E.g. if Mr.Paraajay had taken business-loan, SBI would have asked him to sign away his factory/machinary/vehicles/land etc. specific items as mortgage.
• Hence SBI can attach only ^those assets.
• But SBI cannot take away Paraajay’s personal home-furniture, expensive wrist-watch or his son’s bicycle in the name of SARFAESI.
• Similarly, Agricultural land is exempted from SARFAESI attachment.

Appeal structure in SARFAESI ACt?

The borrower (loan taker) has following options:

• Get a stay order from Debt Recoverty tribunal (DRT) against the auction/sale of his properties. (He cannot file case in Civil courts.)
• Fight the case in DRT.
• If unhappy with DRT verdict, he can appeal to Debt Recovery Appellate Tribunal (DRAT).
• But before filing appeal with DRAT, he’ll have to deposit 50% of his pending loan money.

Bank: Power to Auction

• First SBI  contacts the experts, gets valuation of Mr.Paraajay’s assets.
• Expert says “those assets are worth Rs.50 crores according to present market value of land/ building/ machinary whatever.”
• Then SBI will give advertisement in newspapers “we are auctioning xyz land/machinary/building. Minimum bidding amount is Rs.50 crores. Whoever wishes to bid, send us application along with Rs.50,000 as deposit, and their class 10, 12 mark-sheets and school leaving certificates, duly attested by a Gazetted officer.”
• Problem: sometimes, bidders donot take interest in buying such properties, factories etc.
• To fix this problem, Amendment bill of 2011, makes a new provision: if noone else comes to bid in the auction, Bank itself can buy that property.

Here comes the new problem:

• Suppose SBI  attached a warehouse of Mr.Paraajay.
• If the land was in good urban area, SBI could open a new branch office there (or housing for its employees).
• But if plot/factory/house is in some remote area= useless for SBI’s personal business.
• Under the Banking regulation Act, a bank cannot keep such immovable property beyond 7 years, (max 12 years with RBI’s permission).
• So ultimately SBI will have to auction it to someone. What if they don’t get better price? Critiques of the bill say, this is not clarified in the bill.

What is ARC?

• Asset reconstruction company (ARC).
• They buy NPA (Bad loans) from Banks and try to extract maximum money out of it=profit.
• They’ve to register with Reserve Bank of India.

Examples:

1. ARCIL (India’s first and largest asset reconstruction company (ARC))
2. Reliance Asset Reconstruction Company Limited by Anil Ambani

• In our example, SBI has NPA worth Rs.40 crores.
• ARC will buy the NPA file from SBI at a lower rate say 35 crores. (well, SBI is making loss, yes, but something is better than nothing.)
• Besides, banks have hundreads of bad loan cases, they donot have time or manpower to pursue individual case, sometimes no bidders are interested in auction. All the filework and donkey labour, In such cases, it’s better for bank to transfer NPA to ARC.
• But that doesn’t mean ARC will give 35 crores to the SBI from its own pocket!
• Then how will the Asset reconstruction company (ARC) arrange for the money?= via Security Reciepts.

What are Security Reciepts (SR)?

• In above example, ARC needs Rs.35 crores to buy a Non performing asset from SBI.
• So ARC will issue “security reciepts (SR)” worth Rs.35 crores.
• Only Qualified Institutional buyers (QIB) can buy these security reciepts (SR).
• SR are not “bonds”, they donot carry fixed interest rate.
• ARC will promise to pay money on SR, when it gets money the bad loan.
• Although, ARC usually promise 9% profit on “security reciepts (SR)”.
• So, three possible situations:

1. Qualified institutional buyers (QIB) buy those security reciepts (SR). So Rs.35 cr cash goes from QIB -> ARC -> SBI.
2. SBI itself recieves SR worth Rs.35 crores for free. (that means ARC will gradually pay the money to SBI).
3. combination of both: QIBs buy SR worth 30 crores + SBI recieves free SR worth 5 crores.

What is Qualified Institutional Buyer (QIB)?

These people have the expertise and the financial muscle to evaluate and invest in the capital markets.

Examples: (click on each to read previous articles on them)

1. Scheduled Commericial Banks
2. Foreign Institutional Investor
3. Mutual Funds
4. Venture Capital Investors
5. Insurance Companies
6. Pension/ Providend Funds

Foreign investment in ARC

• ARC =buy bad loans from banks.
• ARC =arrange money from QIBs to buy bad loans from banks.
• Problem= Indian QIBs do not invest much in ARCs.
• Therefore ARC’s capacity to buy NPA= very low.
• And bank themselves don’t have enough expertize or manpower to dispose those NPAs quickly.
• Previously Foreign investors could invest only upto 49% in ARC=minority shareholder=cannot influence company decisions.
• Now, Government also increased foreign investment limit in ARCs. This would attract more investment in ARCs and help in quicker purchase and disposal of NPAs.

Foreign investment in ARC	%
Earlier	49%
Now (December-24-2012)	74%

Anyways, back to the topic, let’s recap:

1. SBI  had NPA. First solution: auction the property. Did not work out.
2. Second solution: sell it to ARC.

So, ARC purchased the NPA worth Rs.40 crores (at Rs.35 crores).

ARC’s aim= extract maximum money out of this investment. But how?

1. Auction the assets fully or partially. (sell the machinary now, rent the building and wait for land prices to go up for two years and then sell it.)
2. Sell the property in combination with other NPA properties of other defaulters. (similar to “buy one large pizza and get 20% discount on any medium sized pizzas”).
3. Restructure the EMIs of Mr.Paraajay. E.g. instead of 1 lakh per month, give us 75,000 per month.
4. Change the Management of that asset, appoint its own directors/officers.
5. Order Mr.Paraajay to outsource or lease his business to a another company.

^SARFAESI act empowers ARC to do such things. The amendment Bill adds a new power to the ARC.

ARC New Power: convert Debt into equity

Before reading further, Make sure you know the pros and cons of Debt Vs. Equity (else refer to Mrunal.org/ECONOMY)

The new Amendment in SARFAESI, empowers ARC to convert debt into equity.(fully or partially).

Share holding Before:

Shares	Rupees Cr.	%
Paraajay and his family	20	40%
Juntaa	30	60%
Total shares worth	50	100%

Share holding After

Shares	Rupees Cr.	Approx. %
Paraajay and his family	20	22%
Juntaa	30	33%
ARC	40*	44%
Total shares worth	90	100%

*that is the paper value of original debt (NPA loan of SBI to Mr.Parajaay), Otherwise ARC purchased it @Rs.35 crores.

Anyways, This leads to two situations:

1. If company starts making more profit in future, ARC will receive more share from that profit. (because more profit=more dividend to shareholders.)
2. If price of company’s shares go up in the sharemarket, ARC can sell those shares to third party and make decent profit.

Anti-arguments: Debt to Equity conversion

Critiques says this “debt to equity”provision will be abused. This provision is made to help bad corporates. How so? Well consider following:

Bank’s loss

• SBI gave Rs.40 crores loan to Mr.Parajaay
• He refuses to pay loan=bad loan/NPA.
• Then SBI sells this bad loan file to an ARC company @Rs.35 crores.
• Hence, SBI’s loss is 40-35=5 crores. (actually more than 5 crores, if we count the possible interest rate that he would have paid, if he had not defaulted. And loss figure will be different if he had paid a few installments earlier. Anyways, let’s keep the loss at 5 crore for the moment.)

ARC’s profit

• Now ARC owns the NPA assets. (their investment Rs 35 crores)
• Paraajay offers Rs.37 crores and ask ARC to sell the assets to his relative, friend or proxy.
• Hence, ARC’s profit is 37-35=Rs.2 crores.
• And yet Mr.Parajaay successfully saved Rs.3 crores (because originally he had to pay Rs.40 crores to SBI, but he walked away by paying just Rs.37 crores!)
• Few years back, CVC had held a meeting with Bank chairmans and CBI officers. They alleged ^this type of mischief going on, in many loan default cases.

Now under the new provision: if ARC converts its debt into equity (shares), then what will happen?

1. It is very unlikely that Parajaay’s company will start making huge profits (otherwise it wouldn’t be in bad loan problem in the first place!)
2. It is very unlikely that share-price of Parajaay’s company will go up in sharemarket. (because it has negative publicity due to NPA).

Hence it is very unlikely that ARC will make huge profit out of this “Equity”.

Then Mr.Parajaay can simply offer them a way out : “sell those shares to me, in my friend,relative,driver or peon’s name @Rs.37 crores.”

And ARC would agree, because 37-35=Rs.2 crores profit!

Side question

How would Mr.Parajaay arrange those Rs.37 crores?

Ans. If Mr.Parajaay is “totally awesome” then he wouldn’t give 37 crores from his own pocket. He’d just open another company, get new loan from second bank, issue IPOs to get money from juntaa. Then Iski topi uske sar pe.

^This is (one of the many) reasons why Mr.Ratan Tata said following thing:

• Overseas people go bankrupt or companies go bankrupt. Here they never do–they continue to be sick and still operate. Then they are operating to kill you with destructive competition (using predatory pricing etc.)
• (Airline business) is proliferated by many operators, some of them in financial trouble.
• I would hesitate to go into the (airline) sector today in the sense that the chances are that you would have a great deal of competition which would be unhealthy competition.

Bank Employee unions are also against the “Debt to Equity” clause of SARFAESI amendment. (When they had gone on strike to oppose Banking Amendment bill, they also cited this Debt-equity reason as well.)

Central Registry

• Previously, borrowers used to forged property documents and get loans from multiple banks by giving them duplicate property documents as security.
• So when borrower refuses to pay up loan, many banks would make claim for the same property!
• To fix this problem, Reserve Bank of India (RBI) setup Central Registry in 2011, under SARFAESI.
• This central registry has details of all properties against which loans have been taken.
• Any person or bank can inspect records of this registry to make sure the mortgaged property is genuine.
• Official name: Central Registry of Securitisation Asset Reconstruction and Security Interest of India (CERSAI)

Misc.Amendments

1. In public interest, Union Government can issue notification that xyz provision of SARFAESI act may not apply or may apply with modifications to a class or classes of banks or financial institutions.  Suppose many textile exporters have taken loans from banks but due to global recession they are not receiving payments and hence unable to repay loans. In that case, Government can order notification that“SARFAESI will apply to all loans except those given for textile-export business.”
2. Earlier a borrower could approach Debt Recovery tribunal (DRT) to get stay order against bank/ARC. New amendment says DRT cannot grant any stay order unless both parties (Borrower vs. lender bank) are heard. This will ensure the process of law is not misused by unscrupulous borrowers to get stay orders just to delay money-recovery.
3. Bill proposes to enable banks and financial institutions to enter into settlement or compromise with the borrower. It also seeks to empower the Debts Recovery Tribunal to pass an order acknowledging any such settlement or compromise.

Summary

• SARFAESI empowers banks and other financial institutions to attach secured assets of a loan defaulter and sale, auction or manage them without requiring court intervention.
• Parliament passed the amendment to SARFAESI Act and the debt recovery tribunal, in Winter session 2012.

Salient features of new amendment

Bank	can buy for the NPA property if there are no other bidders. multi-state co-operative banks can also take actions under SARFAESI.
Borrower	can’t get stay orders from DRT easily. Can make settlement / compromise with Bank/ARC.
Asset reconstruction companies (ARC)	can convert their debt into equity (fully or partially)
Government	can prohibit or modify SARFAESI’s applicability in public interest.

Apart from this amendment, Government has also increased foreign investment limit in ARCs from 49 to 74%.

Mock Questions

Q1. Which of the following are Qualified Institutional buyers (QIB)?

1. ICICI
2. LIC
3. EPFO
4. FII registered with SEBI

1. Only 2 and 3
2. Only 1 and 4
3. Only 2 and 4
4. All of them.

Q2. Which of the following is not correct about SARFAESI act?

1. It mandates the Rural regional banks to lend atleast 15% of their total loans to rural cottage industries.
2. It empowers banks to reduce their NPAs.
3. It empowers RBI to impose penalties on Bank responsible for NPAs.

1. Only 1 and 2
2. Only 2 and 3
3. Only 2
4. Only 1 and 3

Q3 Find Correct Statement

1. Foreign investment is prohibited in asset restructing companies.
2. To enjoy the priviledges under SARFAESI act, the Asset Reconstruction Companies have to get themselves registered with SEBI.

1. Only 1
2. Only 2
3. Both
4. None