Asset Reconstruction Companies Feel The Heat As Covid Delays Recoveries

Ratings agency ICRA Ltd. on Thursday said a higher proportion of security receipts are being downgraded due to fallout of the Covid-19 pandemic. “The recovery for the ARCs are getting affected due to deferment or failure of auctions due to unsatisfactory bids or absence of any bidders, default or delay in payment as per the agreed settlement plan or agreed restructuring terms.”

It added that resolutions under the Insolvency and Bankruptcy Code have also sharply slowed, with only 16 resolutions in the the first quarter of the current financial year, compared to 35 in the previous quarter.

As a result, ICRA said it has observed higher downgrades across 37% of the trusts issuing security receipts compared to 21% ratings downgrades in the previous surveillance cycle in December 2019. Specifically, unresolved security receipts in older trusts acquired in FY15 or prior have seen a higher proportion of rating downgrades, it said.

The downgrade in the number of trusts does not correspond to the of security receipts seeing rating cuts. The of security receipts downgraded is not available with the ratings agency.

Operational Challenges

Representatives at ARCs said they are facing multiple challenges at present.

Since the National Company Law Tribunal is not functioning as normal, there has been an impact on recoveries, said the chief executive of a large ARC, speaking on condition of anonymity. Some ARCs could be facing recovery delays if bidders are not making payments or they want to renegotiate in cases where resolution plans are approved, said this person, adding that any new asset sales being undertaken may attract lower valuations.

Harihara Mishra, director at UV Asset Reconstruction Company, said recoveries have slowed since March as various recovery mechanisms, like the Debt Recovery Tribunal, SARFAESI and IBC came to a standstill or slowed significantly.

“Cash-flows from borrowers under ongoing settlement and restructuring packages across the sectors was also highly impacted, due to the severe contraction in the Indian economy. Going forward, the recovery outlook will be directly influenced by the pace of the economic revival,” he said.

Alok Dhir, managing partner, Dhir and Dhir Associates and sponsor, Alchemist ARC, says that as far as Covid-19 is concerned it has effected every sector of the economy. “With the downgrade ARCs will have to make provisions due to the downgrades in the rating as they have to adopt a lower weightage on the assets. Further, as the NAV for some ARCs reduces, the management fees will also come down as it is based on the lower end of the NAV,” he said.

Impact On Profitability?

In the near term, ARC profitability may come down due to higher provisions, but so long as the asset-quality does not deteriorate, these companies may be able to rebound since they hold on to assets for a long-time, said Abhishek Dafria, vice president and group head-structured finance at ICRA.

The eventual impact depends on how the of such properties falls in the post Covid-19 scenario, he said. There could be less buyers for buildings right now but two to three years later the ARCs may find the price they want, whereas assets like plant and machinery could depreciate quicker, Dafria said.

The ARC executive quoted above said overall profitability will not be impacted much as ARCs earn fee income, which can cushion the impact of a delay in recoveries to a large extent. It can take 6 to 12 months to get projects back on track and in a year’s time whatever valuation loss has taken place, due to Covid-19, can be reversed once operating assets restart, this person said.

On the flip side, the expected spike in stressed assets may present new business opportunities for ARCs. “The Kamath committee report identified 26 sectors that are going to need restructuring assistance from the banks due to the pandemic, so ARCs need to play an important role in reviving these distressed assets,” said Dhir.