Edelweiss ARC Looks To Pivot To Retail Bad Loans

Edelweiss Asset Reconstruction Company Ltd., India's largest private stressed asset resolution firm, will pivot to retail and small business loans, as corporate assets under management dwindle over the next two years.

According to Chief Executive RK Bansal, the ARC has created a 50-member team focusing on purchasing and managing retail and small business loans. "There is space to grow in retail and SME pools still," Bansal told BloombergQuint in an interview.

The decision to pivot was taken three years ago, when Edelweiss ARC started building the retail bad loan management team, Bansal said.

Typically, private banks and non-bank lenders sell their retail and small business loans in a pool, which Edelweiss ARC can purchase on an all-cash basis for a 45-55% discount to the book value. If the company chooses to buy the pool of retail and small business loans under a 15:85 structure (cash-security receipts ratio), the discount is lower at 40%.

Edelweiss ARC could also do some structured transactions where banks and non-banks sell either fresh NPAs or loans which are close to the 90-day default mark at 30% discount. The likelihood of recovery is higher in these loans, according to Bansal.

Analysts said with the introduction of the National Asset Reconstruction Company Ltd., or India's bad bank, the opportunity in large corporate resolution has diminished for private ARCs. In the mid-corporate segments, ARCs have to compete with stressed asset funds.

"In the retail and MSME segments, however, ARCs have the opportunity to create niches. These segments need an operationally intensive set-up that other investor classes are unlikely to be interested in creating," Krishnan Sitharaman, senior director and deputy chief ratings officer at Crisil Ratings Ltd., said in a Sept. 13 note.

"Given the higher opex needed, volume will be key to profitability, so ARCs that invest will need to maintain sharp focus on this segment,” Sitharaman said.

Vintage Book To Bring Down AUM

Edelweiss ARC‘s attempt to build out a retail stressed assets business comes as assets under management of the company are set to fall.

By June 2022, about Rs 15,000 crore worth of bad loans out of the Rs 41,000-crore assets under management will complete the eight-year mark.

Typically, in a bad loan purchase, the ARC issues eight-year security receipts for a portion of the net asset value of the loan. While earlier transactions included 5% cash payment and 95% security receipts, the ratio was later set at 15:85 by the Reserve Bank of India to ensure more skin in the game for ARCs.

Once the eight-year period ends, banks need to write down these securities and fully provide against them, if not already done. For the ARCs, though, there is an option to continue recovery measures without writing them down for some time, Bansal said, adding that Edelweiss ARC will take a call later.

As the deadline nears, bankers are also mounting pressure on the ARC to show better recoveries. A senior public sector banker, speaking on the condition of anonymity, pointed out that companies such as Edelweiss ARC charge an annual management fee for the eight year period, ensuring that their initial investment is fully covered. However, banks eventually have to take a hit if there are no recoveries.

"This problem of ageing in the portfolio is something we have had to discuss with many bankers. We can see that historically loans sold under 5:95 regime were sold at an higher price, making recoveries difficult," Bansal said, adding that it was a mistake by banks and ARCs alike.

If this vintage portfolio is written down, Edelweiss ARC could see its assets under management reduce significantly.

Already, between March 2019 and March 2021, Edelweiss ARC has seen its outstanding unredeemed security receipts drop by 12.5%.

The rate of contraction for the industry has been slower at around 5%. According to Crisil, the overall assets under management for the ARC industry has dropped to Rs 1.07 lakh crore by March 2021 compared with Rs 1.13 lakh crore in March 2019.

However, it would continue to be the largest private ARC in the market, Bansal said, ahead of Asset Reconstruction Company of India Ltd. or Arcil’s Rs 11,000-crore book.

Future Growth Still Under A Cloud

Edelweiss ARC has also seen its bad loan acquisitions rate drop in FY20 and FY21, compared with pace at which loans resolved or written off. This also means that the book runs down faster than it grows.

According to information available from annual reports, the company acquired Rs 6,528 crore in loans between April 2019 and March 2021. In comparison, loans which were either resolved or written off stood at Rs 16,591 crore during this period.

The reduction in the book does not worry Bansal much per se.

"In FY22, we have already invested about Rs 600 crore cash to purchase bad loans worth nearly Rs 4,000 crore. The pace at which the book grows will depend on how many cash deals we do. The AUM grows faster when you structure your transaction under 15:85," he said.

This fall in business volumes is also reflecting in the way the company is being valued.

According to a person with direct knowledge of the matter, when Canadian pension fund CDPQ first decided to invest Rs 500 crore in Edelweiss ARC to pick up 20% stake through preference shares in October 2016, the investment valued the company three to four times higher than net worth.

In comparison, when the investment was closed last week, CDPQ converted the preference shares at a price of Rs 97.25 per share, close to the actual net worth of the company, this person said.

Does this lack of premium for CDPQ bother the Edelweiss Group, which holds about 60% stake in the ARC currently?

"We have full support of the Edelweiss group and they believe in the business," Bansal said.

Corrects earlier version that misstated preference shares as debentures.