For asset reconstruction companies (ARCs), the cumulative recovery rate of security receipts (SRs) is set to improve 500-700 basis points (bps) on-year to 55-60% next fiscal (see chart 1 in annexure). This will be driven by a bigger share of cash-based transactions¹, greater exposure to retail loans and faster recovery in recent acquisitions due to lower vintage and better-quality assets.

An analysis of the SRs rated by CRISIL Ratings, with underlying assets of ~Rs 30,000 crore (~25% of total such assets), indicates as much.

The share of cash-based transactions in the CRISIL Ratings SR portfolio increased from 36% in fiscal 2022 to 40% last fiscal, and this trend is likely to continue. The reduced capital requirement of ARCs - to 2.5%² of total SRs issued from 15% 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.

Says Sushant Sarode, Director, CRISIL Ratings, “Another reason for the increased recovery rate is that participation of ARCs in retail segment is likely to more than double³ to 15-18% 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.”

The past few years have also seen faster settlements and restructurings because of proactive monitoring by lenders as well as increased willingness of promoters to retain their businesses due to deterrence effect of IBC. 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.

For the CRISIL Ratings SR portfolio, the cumulative recovery rate in the first three years for trusts that originated in 2018 and 2020 has been higher, at 35-40%, compared with trusts that originated in 2015 (see Chart 2).

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.

Along with improving recoveries, likely consolidation due to the increase in minimum net owned fund (NOF) requirement to Rs 200 crore by the end of this fiscal, will also strengthen the ARC ecosystem. In fact, 2 of the 29 ARCs have already surrendered their licences to the Reserve Bank of India within a year of the NOF guideline.

Says Tanvi Fifadra, Team Leader, CRISIL Ratings, “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.”

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.

1 Cash transactions are deals where the original lenders are given full exit for their outstanding exposure with upfront payment. In contrast, in structured transactions, original lenders hold security receipts (SRs) of upto 85% of total SRs issued until redemption.
2 Based on the RBI guideline dated October 22, 2023, ARCs to invest in the SRs at a minimum of either 15% of the transferors’ investment in the SRs or 2.5% of the total SRs issued, whichever is higher.
3 The share of retail underlying assets in outstanding SRs is expected to increase to 15-18% by fiscal 2025 from 8% in fiscal 2022, driven by increased focus of banks and non-banking financial companies (NBFCs) on retail asset classes over the past four years.