MUMBAI: Private asset reconstruction companies (ARCs) will see their revenue mix continue to tilt towards recovery-linked income—away from primarily management fee-driven income—this fiscal and the next, as large assets have not coming to them since the IBC became operational in 2016.There are two reasons for this. One, healthy recoveries, with redemptions expected to continue outpacing acquisitions, coupled with lower management fees in the case of new acquisitions which are mostly retail assets. Two, a rising share of cash transactions, according to a report by Crisil Ratings.
Private ARCs saw security receipt (SRs) redemptions of Rs 26,900 crore last fiscal and Rs 14,500 crore in the first half of the current fiscal. However, new SR issuances declined more than a third to Rs 20,000 crore last fiscal from Rs 31,000 crore in fiscal 2024. In the first half of FY26 as well, SR issuances, declined much faster at Rs 9,600 crore, trailed redemptions.
With redemptions outpacing acquisitions, assets under management or outstanding SRs will decline a further 4-6% this fiscal and the next to Rs 1 trillion, which means, ceteris paribus, ARCs will earn management fees on a shrinking AUM base. Additionally, the average management fee rate itself has declined over the years.
According to Subha Sri Narayanan, a director with the agency, recoveries have improved in recent years due to several factors. One, lower vintage of assets has enabled higher and faster recoveries. Two, a higher share of retail assets that typically churn faster. And thirdly, more optimally priced cash transactions. Hence, SR redemptions have accelerated, and the continued strong recovery post SR redemptions has contributed to the increase in recovery-linked income.
The share of recovery-linked income, which is the income earned by ARCs from recoveries once all outstanding SRs are redeemed and any contractual payout to investors is done, rose to 44% last fiscal from sub-20% in fiscal 2022, driven by a favourable recovery environment and subdued acquisitions. This shift in revenue composition is also attributable to a rising share of cash transactions, preferred by ARCs with substantial investment capacity and the ability to attract investors.
Notably, the share of cash deals increased to 65% of debt acquired last fiscal from 40% in fiscal 2022. According to Aesha Maru, an associate director, in cash transactions, where the selling lender does not hold any SRs, there may not be a standard management fee structure. When an ARC invests entirely on its own, there is no management fee in any case, and income is entirely recovery-linked.
Even when a third-party investor is involved, many transactions are structured without a fixed management fee, or with a low fixed fee, and instead offer higher, albeit back-ended, benefits to ARCs upon achieving a pre-determined return for the investors, she said. The shift in revenue composition, partly driven by de-growth in AUM of ARCs, is also structural. Even when acquisitions pick up and ARCs enter a growth cycle, as opposed to a redemption cycle, management fees are unlikely to dominate revenue. Based on past recovery experiences, investors are likely to prefer recovery-linked, rather than fixed, payouts to ARCs.
The regulatory environment will also impact revenue of ARCs. For instance, the Reserve Bank’s proposed guidelines on the securitisation of stressed assets would allow ARCs to act as resolution managers, enabling them to build asset-light, fee-based revenue streams by leveraging their existing resolution infrastructure and expertise.