Stressed asset investing: An alternative investment opportunity for HNIs

ARCs hold specialized expertise in asset valuation, negotiation, and legal procedures, crucial for navigating the complexities of a stressed asset landscape.
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In the ever-evolving landscape of finance, Asset Reconstruction Companies (ARCs) are now playing a pivotal role in revitalizing distressed loans, contributing to the health of the financial ecosystem. While positive regulatory changes have paved the way for strengthening ARCs and for a resolution of non-performing loans (NPLs), a crucial gap remains in securing capital and unlocking the potential of the sector as a sought-after asset class.

Historical Background

ARCs hold specialized expertise in asset valuation, negotiation, and legal procedures, crucial for navigating the complexities of a stressed asset landscape. Often perceived as a niche domain, the stressed assets market currently encompasses the acquisition and resolution of NPLs. The gross non-performing assets ratio in India in FY23 stood at 3.9% or Rs 5.72 trillion waiting to be revitalized.

ARCs in India were set up in 2003 with the support of public as well as private sector banks and institutions. Initially, ARCs had a limited capital base and were essentially asset management companies that acquired assets by issuing Pass-Through Certificates (PTCs) and managed a resolution of these assets. This facilitated resolution of NPLs but the risk associated with these assets continued to be held by selling banks. To ensure fair pricing for these loans, over the years, RBI has removed the provisioning benefits available to sellers resulting in sellers preferring to sell NPLs on a cash basis.

Given the cash sales, ARCs require significantly larger financial resources to acquire NPLs. The median net worth of the top 5 ARCs in India is Rs 1,500 crore. Given the risks associated with the underlying assets, it may not be prudent to allocate more than 15%-20% of net worth to a single asset. Therefore, the capital base of most ARCs is insufficient to buy the entire debt of even a mid-sized company.

Therefore, ARCs have been working with global funds to buy stressed assets. As these opportunities are high-yielding, most global funds present in India have made decent returns from these investments. Ideally, these opportunities should be equally available to domestic high-net-worth individuals (HNIs). However, the current regulatory framework does not permit investment by HNIs in security receipts issued by ARCs.

Opening the Doors: HNIs as catalysts for change

HNIs are currently excluded from engaging in direct investments in security receipts issued by ARCs due to their non-inclusion in the definition of Qualified Buyers (QBs) under the SARFAESI Act of 2002. The way forward is to permit HNIs to invest in these instruments. This would not only inject crucial capital but also help HNIs in the diversification of their investment portfolio, thereby reducing concentration risk. Reinforcing this approach is the Sudarshan Sen Committee’s recommendation, advocating for an expansion of investor participation in Security Receipts (SRs).

The phenomenal rise of Alternative Investment Funds (AIFs) in recent years is a testament to the power of HNI participation in alternative asset classes. By allowing HNIs access to investments in security receipts issued by ARCs, we can replicate this success in the stressed asset space. This, however, necessitates an amendment to the SARFAESI Act of 2002. Starting with Accredited HNIs can be a prudent initial step, allowing for a gradual and controlled opening-up of the sector to other investor categories.

A win-win proposition

For HNIs, it presents a chance to diversify their investment portfolios with a relatively secure, potentially high-yield asset class. Average returns on NPL deals are estimated at 20% per annum, which is equivalent to average returns generated by these investors from equity portfolios, and given the secured nature of these assets, the riskiness is lesser than equities. HNIs can also draw comfort from the fact that ARCs are regulated entities and are regularly audited by RBI, thereby reducing governance risks.

For ARCs, it translates into wider access to capital resulting in increased capacity to acquire NPLs and diversification of investor base. For the wider economy, it helps in creating an alternative asset class and opening the doors to private sector participation allowing deployment of taxpayer money towards productive uses rather than having a dedicated government-owned entity for the revitalization of stressed assets.

Opening the doors to HNI as an investor in security receipts issued by ARCs is not just an economic move; it’s a strategic one. It’s about unleashing the power of domestic private capital, fostering innovation, and accelerating the NPA resolution process. By embracing this change, we can unlock a brighter future for domestic debt markets, pave the way for creating a new asset class, and contribute to India’s continued economic growth.

(This article was originally published by Economic Times)