Retail security receipts redemption rate for ARCs to rise 600 bps: Crisil Ratings

New Delhi, March 25: Asset reconstruction companies (ARCs) are poised for a significant boost in the redemption rate of security receipts (SRs) issued for stressed retail assets, with an estimated increase of around 600 basis points (bps) to 69-71 per cent in the upcoming fiscal year, according to an analysis of rated portfolios, according to the Crisil Ratings. By definition, ARCs are a financial institution that buys NPAs or bad assets from financial institutions and banks to clear up their balance sheets.

A recent assessment of a retail SR portfolio, consisting of approximately Rs 2,000 crore in stressed secured debt and Rs 17,000 crore in unsecured stressed debt, indicates that the anticipated rise will be driven primarily by robust recoveries from low-vintage accounts and strong settlement rates across both secured and unsecured asset classes.

Additionally, regulatory amendments in settlement guidelines are expected to play a crucial role in expediting recovery actions. The share of low-vintage borrowers--classified under the Special Mention Account (SMA) category--has risen from around 5 per cent in fiscal 2023 to nearly 25 percent in fiscal 2024. This shift has enabled ARCs to recover the full principal outstanding (POS) more efficiently, as these accounts offer better accessibility and require lower operational intensity for collections compared to deep-vintage borrowers.

The report added that the improved redemption rate will enhance cash flows for ARCs, ultimately strengthening investor confidence in the distressed asset recovery market.

The evolving regulatory landscape is also expected to provide further impetus to the overall efficiency of stressed asset resolution in India, as per the report.

Mohit Makhija, Senior Director, Crisil Ratings said, "The improvement in redemption rate will differ asset class wise. The cumulative redemption rate for secured loans is expected to improve by ~1,200 bps next fiscal, much higher than the ~700 bps for unsecured loans. Having said that, the recent trend of under-recoveries in the microfinance sub-segment would likely cap the improvement in redemption rates for the unsecured segment going forward."

The report adds that with improving asset coverage, settlement rates for secured loans have seen an uptick.

This is also reflected in our rated secured SR portfolio, where borrowers with 2x asset coverage have settled above POS, while in other instances, they were at 90 per cent of POS. For ARCs, settlements at above or near POS are the best-case outcomes as they result in faster redemption of SRs.

For unsecured loans other than microfinance, the intent of borrowers to improve their credit scores and maintain eligibility for fresh loans plays a crucial role in their willingness to settle outstanding debt, and that will continue to drive recoveries.

An analysis of 5 lakh accounts in our rated unsecured portfolio reveals the cumulative closure rate4 till fiscal 2024 in working-age borrowers5 was 7.3 per cent against just 4.7 per cent for other borrowers.

On the other hand, in the microfinance segment of rated SR portfolio, growth in cumulative redemption rate is likely to moderate to 700 bps from earlier expectations of 1400 bps for fiscal 2026 because of over-leveraged borrowers, the report added.