ARC ecosystem likely to see consolidation due to higher minimum NOF requirement: Crisil Ratings
The asset reconstruction company (ARC) ecosystem is likely to see consolidation due to the higher minimum net owned fund (NOF) requirement of ₹200 crore, even as cumulative recovery rate of security receipts (SRs) for these companies is set to improve next fiscal, according to an analysis by Crisil Ratings.
The consolidation due to doubling of minimum NOF requirement will strengthen the ARC ecosystem, opined the agency. By March-end 2026, ARCs need to have minimum NOF of ₹300 crore.
In fact, two of the 29 ARCs have already surrendered their licences to the Reserve Bank of India within a year of the NOF guideline, opined the agency.
Tanvi Fifadra, team leader, Crisil Ratings, said, “Of the remaining 27 ARCs, 10 are below the required NOF threshold as per reported financials for fiscal 2023.
“Only a few will be able to raise funds and many small ARCs will find it difficult to reach the threshold by March 31, 2024, impacting continuity of their operations and triggering consolidation. Hence, we foresee big ARCs grabbing larger chunks of stressed assets,” she said.
Recovery rate of SRs
The cumulative recovery rate of security receipts (SRs) for ARCs is set to improve 500-700 basis points (bps) year-on-year to 55-60 per cent next fiscal, as per Crisil Ratings’ assessment.
The improvement in cumulative recovery rate of security receipts (SRs) for ARCs will be driven by a bigger share of cash-based transactions, greater exposure to retail loans and faster recovery in recent acquisitions due to lower vintage and better-quality assets.
An improving domestic economy and credit outlook for corporates after the pandemic, including upturn for some cyclical sectors, will also aid the recovery rate this fiscal and the next, the rating agency said.
The cumulative recovery rate (cumulative gross recoveries / cumulative SRs issued ) for Crisil Ratings’ portfolio for FY24 is 45-50 per cent (actual + projected).
An analysis of the SRs rated by Crisil Ratings, with underlying assets of about ₹30,000 crore (about 25 per cent of total such assets), indicates as much.
Cash-based transactions
The share of cash-based transactions in the Crisil Ratings SR portfolio increased from 36 per cent in fiscal 2022 to 40 per cent last fiscal, and this trend is likely to continue, per the rating agency’s assessment.
The agency reasoned that reduced capital requirement of ARCs — to 2.5 per cent (ARCs to invest in the SRs at a minimum of either 15 per cent of the transferors’ investment in the SRs or 2.5 per cent of the total SRs issued, whichever is higher) of total SRs issued from 15 per cent earlier — and preference of lenders for upfront cash are driving up cash-based transactions.
Upfront exit for lenders in cash-based transactions enhances the recovery rate, given lower SRs are issued compared with structured transactions, it added.
Sushant Sarode, Director, Crisil Ratings, said: “Another reason for the increased recovery rate is that participation of ARCs in retail segment is likely to more than double to 15-18 per cent next fiscal since fiscal 2022. This benefits as recovery for retail pools starts within a few months of acquisition, accelerating the cumulative recovery. In contrast, recovery for corporate assets depends on the resolution strategy and can stretch to 5-8 years.”
Amidst all this, ARCs will continue to align their business strategies with an increasing retail asset class mix and evolving opportunities in the Indian stressed assets market.
The agency noted that the past few years have also seen faster settlements and restructuring because of proactive monitoring by lenders as well as increased willingness of promoters to retain their businesses due to deterrence effect of IBC.
The expected rise in recoveries will benefit recovery risk ratings of SRs in the near term. For the Crisil Ratings portfolio, recovery risk ratings saw more upgrades than downgrades in the first nine months of fiscal 2024.