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PARA, PAMC, NAMC: Decoding The Alphabet Soup Of Stressed Asset Resolution Proposals

The three new proposals for a centralised solution to bad loans do not address the issue of capital or right-pricing of stressed assets

A scrabble board. (Source:&nbsp;<a href="https://www.flickr.com/photos/thebarrowboy/">thebarrowboy</a>/Flickr)
A scrabble board. (Source: thebarrowboy/Flickr)

There are now three proposals out there to find a new solution to the old problem of resolving close to Rs 7 lakh crore in bad loans on the books of Indian banks.

Just ahead of the Budget, the Economic Survey laid out a proposal to set up a Public Asset Reconstruction Agency (PARA), which would offer a centralised solution to the problem of bad loans. This was followed up by another set of options detailed by Viral Acharya, deputy governor of the Reserve Bank of India (RBI). He is in favour of setting up two asset management agencies - a Private Asset Management Agency (PAMC) and a National Asset Management Agency (NAMC).

The government is yet to give a go-ahead to any of these proposals. A senior government official told BloombergQuint that the Finance Ministry (government) is not convinced about the need to set up a new stressed asset resolution agency. Setting up such an agency, which would have both government and private sector involvement, would take its own time and delay the resolution process further. Ideally, the government would like to see the resolution process pick up through existing private sector asset reconstruction companies (ARCs) and stressed debt funds.

Chief economic adviser Arvind Subramanian and RBI deputy governor Acharya are, however, in favour of a more centralised solution.

Asset Management Agency vs Asset Reconstruction Agency

The first question worth answering in examining these three proposals is whether an asset reconstruction agency (PARA) is different from an asset management company (PAMC/NAMC).

The answer to that is - no, not really.

While there may be subtle differences in the legal structures, both will essentially perform the same function. They will take over stressed assets from banks and manage them till they can either be sold or restructured in a way that they become viable. Globally, the preference has been to set up sector specific asset management agencies. In Spain, SAREB (a national bad bank) was set up essentially to manage real estate assets that had gone bad. In Ireland, too, the NAMA (National Asset Management Agency) largely handled real estate stressed assets.

Acharya, in his proposals made as part of a speech last week, took a slightly different view. According to him, stressed assets could be split into two categories - those with near term viability and those which may be unviable in the short to medium term.

The first set (and this includes assets in sectors like metals and textiles) could be put into the PAMC, which would have no government involvement. Those that will take longer to review (and need some government handholding like power) could go into the NAMC, which would be a quasi government entity.

“At a conceptual level, moving these assets from existing lenders to a specialised platform makes sense but I’m not sure if a multi-agency asset management agency will work,” said Nikhil Shah, managing director for turnaround firm Alvarez & Marsal in India. The global precedent has been of setting up sector focused vehicles, he explained in a phone conversation with BloombergQuint.

The other questions that need to be answered are whether the transfer of assets would be voluntary or mandatory. It makes sense for it to be mandatory. Then you have to decide what value these assets will be moved at because the value ascribed by the banks may be very different from the real economic value. 
Nikhil Shah, Managing Director, Alvarez & Marsal India Ltd.

Nirmal Gangwal, founder of turnaround firm Brescon Corporate Advisors, adds the disagreement between banks and private ARCs on the valuation of stressed assets will remain a challenge under both the suggested models. As such, they may not be more successful than the existing set-up of private ARCs.

Gangwal told BloombergQuint that he believes that banks are best placed to resolve these stressed assets, given the right tools.

The problem should be resolved where it has originated. Banks are best placed to find a solution provided the government either gives them the capital needed or the regulator introduces provisions that allow them to amortise the hit over a longer period of time.
Nirmal Gangwal, Founder, Brescon Corporate Advisors
PARA, PAMC, NAMC: Decoding The Alphabet Soup Of Stressed Asset Resolution Proposals

Do Any Of These Models Resolve The Capital Problem?

Rating agencies also remain skeptical about each of these models as they do not appear to offer a solution to the need for government capital.

PARA, as suggested by Subramanian, would be a government led initiative although it may have private participation. The Economic Survey acknowledges that the capital requirement would be large. It suggests that the capital could either come from government issue of securities, the capital markets or from the RBI’s reserves.

PAMC, as suggested by Acharya, is proposed as a private vehicle along the lines of a private equity fund. “These companies would resemble a large private-equity fund run by a team of professional asset managers. Besides bringing in their own capital, they could raise financing from investors against equity stakes in individual assets or in the fund as a whole, i.e., in the portfolio of assets,” said Acharya.

The NAMC, which would hold tougher to resolve stressed assets, is envisaged as a ‘quasi-government’ entity which would require government capital to be committed. It could also raise government-backed debt, Acharya said.

“There has to be some government capital to backstop these plans. To expect private capital to come in in the absence of that seems ambitious,” Saswata Guha, Director - Financial Institutions, Fitch Ratings told BloombergQuint.

There are two pillars on which any stressed asset resolution plan has to be based. One, the right pricing. Two, the right amount of capital. On the capital front, it has to come substantially from the government. This is also because a large part of the stressed assets lie in the books of government owned banks.
Saswata Guha, Director - Financial Institutions, Fitch Ratings

In a note issued on February 23, Fitch Ratings said that while a ‘bad bank’ may speed up the resolution process, it would not reduce the capital commitment needed from the government. The rating agency estimates that the banking sector will need $90 billion in new capital by FY19 to meet Basel III requirements.

“This estimate is unlikely to be significantly reduced by the adoption of a bad-bank approach, and could even rise if banks are forced to crystallise more losses from stressed assets than we currently expect,” said Fitch.

PARA vs PAMC/NAMC

Gautam Chhugani, director and senior analyst for Indian financial institutions at Sanford C Bernstein, shared the view that government capital support is inevitable to kick start a  ‘bad bank’ like idea – whether by way of direct funding or by way of indirect guarantees.

The PARA idea floated by the Government or the Private Asset Management Company (PAMC) / National Asset Management Company (NAMC) idea floated by RBI – both of them at the end of day have to address the question – who will foot the ‘capital’ bill.
Gautam Chhugani, Director, Sanford C Bernstein

Chhugani added that evidence from different countries shows that the first and foremost hurdle is always the ‘transfer price’ at which bad assets will be transferred from banks to a centralised agency/special purpose vehicle.

“Banks are unwilling to take a large haircut; while private investors’ required return is much higher than banks’ own,” he said while adding that only an attractive ‘transfer price’ and ‘transparent resolution mechanism’ can crowd in private investors.

Devil Is In The Details

Alka Anbarasu, vice president - financial institutions group at Moody’s Investors Service told BloombergQuint over email that the structuring of any centralised solution (like PARA) would eventually determine whether the proposals are credit positive for banks.

According to Moody’s, some of the credit drivers include:

  • Proportion of assets that will be part of the ARC
  • Capitalisation profile of the ARC and sources of capital
  • Pricing/valuation of the stressed assets, haircuts required by the banks and impact on their profitability profiles
  • Payment mechanism to the banks
  • Final capitalisation profile of the public sector banks once the exercise is complete
Nevertheless, from a big picture perspective, we see the PARA as being a capital solution for the public sector banks – as ultimately the government will need to capitalise the entity upfront and some of the capital needs could shift from the public sector banks to the asset reconstruction agency.
Alka Anbarasu, Vice President - Financial Institutions Group, Moody’s Investors Service