(An old post on NPAs, ARCs and other rackets)

Wockhardt Ltd is being pulled in to winding up (or winding down??) by the group of lenders who foolishly put money in to FCCB (Foreign Currency Convertible Bond) issued by the company. Whilst I have nothing for or against the company, the issue is a far bigger one. And our High Courts have promptly granted a ‘stay’ on the winding up order! Strange are the ways our legal system works.

The Indian banking system has long been taken for a ride by Indian businessmen who have siphoned off money from the banks. At some stage, either the banks write off the loans or there is a “one time settlement” (famously known at OTS) where the bankers sacrifice virtually all and get nothing in return. Often, I have seen that in OTS, there is a stipulation that the promoter bring in a large amount of money. Does anyone bother to find out how or where from the promoter is managing to bring this money? If he can bring it in now, why did he not do it earlier? Surely, it is the best indication that he cares a fig for the people who lend money to a company.

The Parel belt at Bombay is a stark reminder of the promoters’ chicanery and the pliant bankers. And now we have what is called as the “Asset Reconstruction Companies” (ARC) which give this a stamp of legitimacy and help the bank executive to evade scrutiny.

Let us see how the scam operates.

One basic requirement for banks to take control of a borrower is for 75 percent of the lenders (those who have lent against security only please) to sell their loans to an ARC. In turn, the ARC will try and find a buyer. That is how the system is supposed to work. In reality, what happens is different. A loan has to be sold at a low price by the bank to an ARC, for the deal to make sense. Here, grease can come in to play. Logically the banker would like to sell the loan at the best possible value to minimise his losses. However, the system is such that a single lender cannot influence anything unless 75% of the secured lenders act in concert. For this the ARC is essential. Under normal circumstances, a bankchairman would be scared to sell an asset far below book value. However, when the sale is to an ARC, it passes scrutiny! So, it is an easy matter to get a bank to sell a loan to an ARC. The borrower makes his round of the banks and makes sure that the banks sell the loans to the ARC at the lowest possible price.

Once the ARC gets hold of 75% of the loans to a company, it is virtually in control of the company. The ARC can dismember the company, strip assets or sell it off in one go to whomsoever it chooses.

So, the logical expectation is that once the ARC has got hold of the assets of a company, it would make efforts to sell it to the highest bidder through a public auction. In real life, it is sold back to the promoter at a price which will give a decent return to the ARC. The ARC’s board is happy. The promoter is happy because he has just escaped a huge liability. The original lenders have lost a pile, but who cares? Now, with the loans gone, the unit can suddenly become viable and the promoter rolls in money. Alternatively, the promoter, having got back his company for a song, can now sell off the real estate or develop it and make his money. The banking system (generally the PSU sector) has

lost many assets through this route and no one is wiser. Bank executives have made money, the ARC guys have made money, and the promoter has made money. The only loser is the taxpayer, who keeps bailing out the PSU banks time and again as the capital gets eroded due to regular write downs of loans which are not bad, but said to be bad. Recently, a co made a IPO. It was once a defunct co which went in to BIFR after defaulting in a big way. The original promoter bought it at a bargain price in collusion with someone else, including an ARC. The bankers lost money in a big way. The promoter had enough money to buy out the co from the ARC! No one asked him how .

No one seems to care that under typical OTS schemes, the promoter is asked to bring in substantial amounts of money as ‘his share’ in reviving the company. Does anyone bother to find out where the money comes in from? If he had this money in the first place, why did he not put it in to the company?

Why do companies that ‘come out’ through OTS not share their prosperity with the lenders who sacrificed so much? Why the bankers cannot write off the loans, but to the extent of write offs, take equity shares at par, for free? After all, they have sacrificed far more than the promoter. Also, when it comes to ARC’s, have we seen ads in mainline papers about entire company on the block? The only thing one sees are of houses / plots of lands that are seized and auctioned. Why cannot whole companies be auctioned? Surely it would get a far higher price.

And the bankers should take the lead in this. Not the bank chairmen, but the banking system, through a fiat. After all, when a bank sells a loan to an ARC, it does not get any money. It generally ends up with a ‘participation’ in the loan, in the form of an investment paper. It is rare that an ARC buys out an industrial loan by paying full cash. It would be best if the law mandates that the selling bank cannot invest in the assets it sells off. In fact, it should be a clean sale. Otherwise, the ARC’s are merely a facilitator (for a fee) to window dress the loan books of the banks. Today, there are multiple ARC’s. It should be easy for banks to put up their ‘loans for sale’ on a single website and the various ARC’s can then bid for it. This way, the banks get the best price for the loan.

Secondly, the banks should get something out of it in case the co revives and then does well. The best way would be for the banks to automatically get ten percent or so voting shares free and at par (which itself is a huge premium) or warrants that will enable them to buy shares at par. This will help the banking system in some way. Why should a defaulter get exonerated and then live to tell the tale? Surely, the lenders’ sacrifice is far greater than the promoters, in almost all Indian companies.

Of course, not everything that the ARC does is like the above. The above is just an example of how the ARC structure provides a ready conduit for the crooked promoters.

Going back to Wockhardt, it is time that the lenders taught a lesson. Let the co go in to liquidation or else, the remaining creditors who are so generous, can also first pay off the entire FCCB holders in full and then grant indulgence to the company. In many cases, the promoters are so smart that they leave nothing of value in the company. Real estate is often held in family companies and the listed company pays a fat deposit and a huge rental.

I would be glad to see the day when companies are genuinely ‘sold’ by the ARC’s. That is the best way to put back some integrity in to the banking system, which is now the handmaiden of businessmen and politicians.

R. Balakrishnan

March 23, 2011


2 thoughts on “NPAs- ARCs and other frauds

  1. Eye opener …!!
    Do you know by any means how much percent of ARC assets are resold back to promoters at tax payers cost ..? Just thought of finding if it is like bad apple in a basket or basket full of bad rotten apples ….


Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s