Recoveries by asset reconstruction companies (ARCs) across retail loans such as housing and MSME have slowed down since the launch of the one-time settlement (OTS) scheme in October last year, a domestic rating agency has said.

The ARCs have started following measured steps to ensure realisations, which has slowed down the pace of recovery, and the recovery timelines can get stretched by three to four quarters, India Ratings and Research said in a report.

Recoveries across retail loans, including housing and micro, small and medium enterprises (MSME), have seen a drag, proportioning 35% of the principal outstanding during June-December 2022 review cycle, the agency said. This was led by the protracted timelines of the settlement process, besides the pull down during the Covid-19 pandemic.

Though the agency has observed no major rating migration, it said it has seen the impact of the regulation in the upcoming surveillance cycles. 

The rating agency said a change in prescribed norms, which now require an independent advisory committee to examine all settlement of dues with borrowers including retail, SME and MSME loans, may be resulting in this slowdown in the recovery timelines. It also said that as per OTS, all the methods of recoveries shall have to be exhausted before a settlement process takes place.

Citing its discussions with ARCs, the rating agency said for retail loans backed security receipts (SRs), settlement or staggered payments were the most preferred method of recovery for ARCs in the past as it would increase the recovery amount and reduce the costs associated with repossession and foreclosure.

The agency, however, made it clear that the new rules will not impact the quantum of recovery, but there shall be a delay in the timelines to recovery by three to four quarters.

“In the Covid-19 times, ARCs faced a drag in recovery values and timelines, necessitating negative rating transitions as reflected in the June 2022 and December 2022 surveillance cycles. The ratio of downgrades to upgrades for the agency rated retail universe was 1.75x during the December 2022 review, compared with 1.5x during June 2022 review and 1.25x during the December 2021 review. With the operating environment returning to normalcy, downgrades were projected to slowdown in the upcoming quarters. However, the OTS guidelines could be one of the factors facilitating a drag in the ratings thereby momentarily increasing the downgrade to upgrade ratio,” the report said.

Although the recovery could slow down for ARCs in the near-medium term, the guidelines could benefit counterparties to SR transactions in the longer term amid the growing requirements of the financial sector. 

ARCs can tap their unused potential to resolve stressed assets, while the OTS process will also enhance the transparency and bring consistency in the settlement processes, the agency added.