Source :live mint : Aveek Datta, aveek.d@livemint.com: Mar 28 2011. 1:00 AM IST
The regulator has told Arcil, India’s largest ARC, to
refrain from such conversion till further notice.
India’s banking regulator has prohibited asset reconstruction companies (ARCs) from converting part of the stressed loans they buy from banks into equity, three people with direct knowledge of the development said.
It is common practice for some ARCs to convert a small portion of so-called non-performing assets (NPAs) acquired from banks into equity. This equity can be sold in the market when the affected company turns around.
A few months ago, the Reserve Bank of India (RBI) had written to the Asset Reconstruction Co. of India Ltd (Arcil), India’s largest ARC, asking it to furnish details of such conversions of debt into equity.
The regulator has told Arcil to refrain from such conversions till further notice, a person familiar with the matter said. He did not want to be identified since the regulator’s note is not in the public domain.
S. Khasnobis, Arcil’s managing director and chief executive officer, confirmed that Arcil was not currently in a position to convert any debt into equity in assets it was trying to revive.
“The assets that we acquire from banks suffer from very high debt levels. We write off this debt to improve the valuation of the company. A portion of the debt is converted into equity, which can be sold in the market to recover a part of the debt forgone,” Khasnobis said explaining the need for ARCs to take equity participation in distressed assets.
Khasnobis termed conversion of debt into equity as a financial restructuring mechanism that could improve recovery from assets gone bad.
Arcil holds stakes in the range of 8.5-10% in several companies whose debt it has bought from banks. Though the letter was addressed to Arcil, the directive is applicable to other companies as well.
An email sent to RBI on Friday did not elicit any response.
There are 13 ARCs operational in India. The oldest among them, Arcil, began operations in 2003 and continues to be the market leader.
ARCs buy stressed assets from banks that want to get them off their balance sheets at a discount and make money by turning them around.
Till March 2010, ARCs had made investments of around Rs.2,000 crore in buying stressed assets. Typically, they buy stressed loans at 15-20% of their face value.
The heads of two other ARCs also confirmed that RBI has asked them not to take stakes in assets they are reviving.
Birendra Kumar, managing director and chief executive officer ofInternational Asset Reconstruction Co. Pvt. Ltd, said though the new contracts his company is signing to acquire assets include a provision for converting a portion of the debt into equity at a later stage, the provision would be subject to RBI’s approval.
“We are discussing the matter with them (RBI),” Kumar said.
Another person familiar with the development said in the absence of the possibility of such a conversion, some ARCs may prefer stripping assets and selling them or negotiating directly with the borrowers for a settlement. He, too, did not want to be named.
P.H. Ravikumar, managing director and chief executive of Invent Assets Securitisation and Reconstruction Pvt. Ltd, agreed that the bar on converting debt into equity could make it difficult for ARCs to revive distressed assets by infusing more capital.
Though ARCs could not pinpoint the exact reason behind RBI’s move, they said it might be to address concerns of the promoters of such distressed companies losing ownership to them.
Khasnobis stated Arcil’s intention wasn’t to take ownership of the company and conversion of debt to equity would just help them recover a part of the debt that they were forgoing.
“Otherwise, the benefit of the debt restructuring is captured only in the hands of the owners of the company, without any benefit to the debt holders who have taken losses,” Khasnobis said.
According to some other companies in the sector, however, prohibition on conversion of debt into equity would not have much impact on the way ARCs go about their business.
Ramesh Venkat, director of Reliance Asset Reconstruction Co. Ltd, a part of Anil Ambani-owned Reliance Capital Ltd, said there weren’t too many instances where an ARC would need to convert debt into equity.
Unless a distressed asset is being liquidated, an ARC could participate in the upside of a potential revival through other means, Venkat said.
“Infusion of capital by way of debt can sometimes serve as a motivation for a company to return to financial health quickly, as debt extended by ARCs is more expensive than bank debt,” Venkat said. “As for the ARC, they can charge a performance-linked success fee to participate in the upside.”
He added that in many cases, there was often a need for equity infusion into a company being rehabilitated, but that mostly came from sources such as private equity funds focused on distressed assets.
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