Alpesh Mehta (Alpesh.Mehta@MotilalOswal.com); +91 22 3982 5415

Vallabh Kulkarni (Vallabh.Kulkarni@MotilalOswal.com); +91 22 3982 5430

Sector Update | 17 June 2015

Financials

Investors are advised to refer through disclosures made at the end of the Research Report.

Motilal Oswal research is available on www.motilaloswal.com/Institutional-Equities, Bloomberg, Thomson Reuters, Factset and S&P Capital.

Deep dive into ARC business Banks are ready, but resources at ARCs a key constraint

ARCs play a crucial role in the financial sector and help banks clean up stress loans. After a prolonged lull (2008-13), asset sales surged by >3x YoY in FY14—helped by RBI guideline of amortizing loss on sale to ARCs over an eight-quarter period.

Aggressive sales (higher MTM losses on security receipts in future) and ARCs’ agency model approach (focus on management fees rather than recoveries) led to tightening of guidelines by RBI in August 2014, which (amongst other things) increased ARCs’ minimum investment from 5% to 15%. This resulted in a sharp slowdown in asset sales; however, we recently saw large PSBs such as SBI and BOI selling NPAs at a steep discount to book value. Considering the changed dynamics, we expect more banks to become realistic about valuations/recoveries and steep discount sale to continue.

While enablers are in place, capital remains one of the key challenges for the ARC industry. Our detailed analysis factoring in available capitalization and borrowed funds suggests ~INR200b of SR issuances in FY16 (similar to FY15). Funding constraints are likely to result in higher bargaining power for ARCs. Our interactions with industry participants indicate a discount of ~40-60% for future transactions v/s at par to ~30% discount prior to guideline change in August 2014.

Banks adjusting to new reality; asset sale to drive stress loans lower: Post the sharp slowdown in stress asset sales, activity picked up in 1HCY15, with the key change being banks (led by SBI) willing to take higher losses. Our industry interactions suggest that the ARC industry has structurally moved from agency business (focus on fees for IRR) to fund-based business (focus on recoveries and realistic pricing for IRR). With the banks willing to sell higher NPAs at a significant discount, headline stress loans on balance sheet are likely to decline; however, credit costs will remain elevated due to amortization charges arising out of losses on sale.

Capital remains a key challenge for the ARC industry: Net worth of ARC industry is INR30b and capital employed is INR60b. While the industry can effectively have leverage of 6.7x+ (15% CAR, assuming entire as Tier I), uneven cash flows remain a key constraint for debt servicing. Other structural problems—(a) low-debt philosophy adopted by ARCIL (50% of industry net worth), (b) 49% sponsor shareholding cap, and (c) largely retail/SME/MSME-focused ARCs—have lowered capital availability for acquiring large/mid corporate loans. Our estimates suggest that a rupee invested in an ARC can help banks clean INR85 of stress loans (Exhibit 15).

Key enablers for growth: In FY16, banks (especially PSBs) are widely expected to use the extended RBI dispensation of amortization of losses on sale of assets to ARCs. Increasing the dispensation for banks beyond 31-Mar-16, removing the 49% cap on sponsor shareholding, strengthening the judicial system and sale of lower-vintage accounts at a reasonable price (better recovery incentives) are a few triggers for higher asset sales.

Please refer to our recent thematic on liability

profile of Indian Banks

94 100 95 92 85 88

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SRs Outstanding (INR b)

25% 27% 28% 30%39%

50%

1% 4% 6%10%

15%21%

80 70 60 50 40 30Sale consideration paid by ARC

IRR (earlier)IRR (now)

Impact of new guidelines - Business model no longer viable on just management fees

Source: MOSL

Source: MOSL

Stock of SRs have increased by 5x in last two years

Financials | Update

17 June 2015 2

ARC Industry - Highly concentrated amongst few players Top 3 players account for 75%+ of the industry AUM

Asset Reconstruction Companies (ARCs), which have been in existence for over a decade now, have witnessed strong growth over the last couple of years.

Our industry interactions suggest that the asset reconstruction industry has ~INR60b of resources (equity + debt) and ~INR550b of AUM outstanding (value at which assets are sold), as of FY15. Assets worth INR900b-1000b (gross basis) have been sold to the industry.

Based on AUM, top 3 players account of 75% of the ARC industry. ARCIL has ~50% of the industry’s net worth and ~20% of SRs outstanding.

Existence of a more than decade Asset Reconstruction Companies (ARCs) emerged post the SARFAESI Act, 2002 and have been in existence for over a decade now. ARCs are specialized companies that focus on resolution of NPAs (via recovery/restructuring/change in management) in the system. Our industry interactions suggest that 40%, 40% and 20% of the cases are resolved by one-time settlement, restructuring and enforcement via SARFAESI/DRT, respectively. From banks’ perspective, ARCs play an important role of freeing up capital and management bandwidth. Structure of the industry Fifteen 15 ARCs are currently functioning in India, out of which Two have majority ownership by public sector institutions Six have shareholding that is a mix of public and private sectors Remaining are fully owned by the private sector Exhibit 1: Top 3 ARCs account for ~75% of the system AUM (INR b)

ARC Major Sponsors AUM* Net worth (A)* Debt (B)* Resources

(A+B) Focus Area for NPA resolution

Edelweiss ARC Edelweiss (49%) 180 1.5 13.5 15.0 Corporate/SME

ARCIL

SBI (20.0%) IDBI (19.2%) ICICI Bank (13.3%) PNB (10.0 %) GIC (9.9%)

110 15.0 3.0 18.0 Mix of corporate and retail / SME portfolio

JM ARC JM Financial (49%) 90 4.3 10.8 15.0 Corporate

Phoenix ARC Kotak Group (49%) 28 2.7 0.0 2.7 Retail / SME

Reliance ARC

Reliance Capital (49%) Corporation Bank (11.5%) Indian Bank (11.5%) GIC of India (9%)

11 1.3 0.0 1.3 Retail / MSME

Others (10 ARCs)

131 5.3 2.8 8.0

Total

550 30.0 30.0 60.0

* Estimated figures based on management interactions; AUM on net BV basis Source: MOSL, Company

Sale of NPAs to ARCs helps in freeing up a bank’s

capital and management bandwidth to focus on core

activities

Edelweiss ARC has emerged as the largest ARC off late

Financials | Update

17 June 2015 3

ARCIL was the first ARC to be set up in India and has ~50% of the industry’s net worth. It has ~20% of SRs outstanding, out of which ~88% are large and mid corporate accounts while the balance is split between retail and SME accounts. It also has a strong retail setup with 17 branches across India.

Of the total AUM, ~80% market share is held by the top 5 players. Edelweiss ARC holds ~25% of the industry resources (5% of equity), and has ~40% share by AUM (as majority of the AUM acquisition was in the form 5:95 structure).

Exhibit 2: Top 3 players account for ~75% of industry SRs outstanding (INR550b)

Source: MOSL, Company

xxx

Exhibit 3: Top 3 players account for ~80% of industry capital employed (INR60b)

Source: MOSL, Company

On a thin capital: Huge AUM mobilization Our industry interactions suggest that the asset reconstruction industry has ~INR60b of resources (equity+debt) and ~INR550b of AUM outstanding (value at which assets are sold), as of FY15. Assets worth INR900b-1000b (gross basis) have been sold to the industry.

Exhibit 4: Quantum of assets sold by banks to ARCs (INR b)

Source: RBI, MOSL

Exhibit 5: Stock of SRs have increased by 5x+ in last two years

Source: RBI, CRISIL, MOSL

ARCs saw sharp increase in asset sales post Jan-14 as RBI allowed banks to amortize losses on sale to ARCs over 8 quarters. However, asset sales declined significantly post Aug-14 as the RBI increased the minimum investment of ARCs to 15% from 5% previously.

Edelweiss ARC 39%

ARCIL 20%

JM Financial

18%

Pheonix 5%

Others 18%

ARCIL 30%

Edelweiss ARC 25%

JM Financial

25%

Others 20%

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SRs Outstanding (INR b)

ARCIL has ~50% of the industry’s net worth and ~20% of SRs outstanding

ARC industry has INR60b of resources (equity +debt)

and INR550b of SRs outstanding

Financials | Update

17 June 2015 4

Exhibit 6: Post regulatory changes, assets offered-to-sold ratio decreased to 29% v/s 64-65% earlier

Source: ARCIL, ARC Association, MOSL

Changes in the August 2014 guidelines RBI mandated ARCs to increase their share of investments in SRs to 15% from

5%. Linking the computation of management fee with the net asset value (NAV) of

SRs rather than the outstanding SRs issued previously. Thus, any downgrade in rating for SR will directly impact the earning of ARCs.

Lowered the threshold level of enforcing SARFAESI Act to 60% share of overall debt value from 75%.

Shortening the period of valuation of SRs from one year to six months Banks must give at least two weeks’ time to conduct due diligence of accounts Reducing the time period for planning and reconstruction/realization of the

NPA to six months from 12 months. Membership in Joint Lending Forum (JLF)

418 342

595

119 64 80 270 218 175 18 8 22 208 157 58

65% 64%

29% 15% 13%

28%

77% 72%

33%

FY11 FY12 FY13 FY14 Upto Aug-14 Aug-14 to Mar-15

Assets offered for sale Assets sold Purchase consideration (SR issued) Assets sold / Assets offered

Proportion of assets offered to assets sold fell sharply

post guideline changes

Higher skin in the game for ARCs post guidelines

changes

Financials | Update

17 June 2015 5

Understanding the Business Model High operating and financial leverage | volatile revenue stream

How does the transaction happen for a sale to ARC? Banks sell assets either via an auction or though bilateral arrangements. Typically, PSBs sell via auction while private banks usually prefer the bilateral transaction route. Transactions can be in the form of only cash or cash and security receipts. Earlier, banks viewed ARCs as the last resort to recover dues and most of the written-off accounts were presented to them. However, this has changed and banks now view ARCs as partners in the recovery process.

Exhibit 7: Typical sale process in the form of cash and security receipts

Source: MOSL, ARCIL

In an auction process, initial details about the asset/pool of assets (including the

reserve price) are sent to ARCs. Once the ARCs confirm their initial interest in the transaction, banks display these assets (paper work, verifying the underlying assets, etc.)—which are accessible for 15 days—to the interested ARCs. The interested ARCs then put up a bid for the assets (consideration details, cash/SR proportion, etc). The concerned bank/consortium then decides the best bid and accordingly the assets are sold.

The bank then transfers the assets to a trust and receives cash and / SR consideration based on the deal structure. For instance, in a 15/85 structure, the trust issues 15% SRs to the ARC in cash (which in turn will be paid to the bank) and the balance in SRs; for e.g. in the gross loan value of INR100 sold to ARC at INR60, bank will receive INR9 (15% of INR60, which was funded by ARC in the trust) in cash and INR51 (balance) in the form of SRs.

Assuming that recovery happens in the fifth year, the trust expenses and management fees are paid first and then SRs are redeemed. In case of excess recovery, usually ~20% of the upside is shared by the ARC (note: upside arrangement varies from transaction to transaction).

Typically, PSBs sell via auction while private banks

usually prefer bilateral transaction route

Banks are giving additional incentives to ARCs for early

resolution of cases

Financials | Update

17 June 2015 6

Incrementally, banks are giving additional incentives to ARCs for early resolution of cases, which in turn increases the IRR for ARCs.

QIB investors—like financial institutions (FI), NBFCs, mutual funds, foreign institutional investors (FII), foreign portfolio investment (FPI), insurance companies, banks and alternative investment fund (AIF)—can participate in ARC sale transaction. The investor’s share of cash investment is put in the trust against which SRs are issued.

However, banks and ARCs have been the key investors in security receipts. Foreign investor participation has been limited since FIIs/FPIs have been allowed to invest in SRs since the last budget only. Also, the track record of recovery/restructuring of large-scale transactions has been limited. As per CRISIL, recovery ratio till Dec 2013 stood at 36% (recovery/principal debt).

How do ARCs make money? There are two major sources of income for an ARC: (1) Management/trusteeship fee, which could be 1-3% of the net asset value each year; (2) redemption of SRs, which depends on the quantum of recoveries. Further, banks have incrementally started giving incentives for the early resolution of accounts. The chart below illustrates the expenses and flow of charges on income received by the trust. Exhibit 8: Distribution of repayments/recoveries made by the trust

Note: # Upside sharing depends on the arrangement between banks and ARC; *Higher expenses are largely for Retail and small value loans; corporate loan-related expenses are 2-5% of NBV

Source: MOSL, Reliance ARC

Management fees and redemption of SRs are generally back-ended, i.e., post

recoveries (which could take 3-8 years). Hence, an ARC’s income varies greatly. The major expense for an ARC is employee costs and interest expenses

(depending on the amount of leverage). A few of the large ARCs in India employ 40-100 people. Hence, the business has significant operating leverage.

Foreign interest remains low due to limited track

record. As per CRISIL, recovery ratio till Dec 2013

stood at 36%

Two major sources of income for an ARC are

annual management fees (1-3% of NAV) and redemption of SRs

Management fees and redemption of SRs are normally back-ended

Financials | Update

17 June 2015 7

Benefits for a bank to enter into an ARC transaction Balance sheet clean-up | Focus on core activities

One of the main advantages for banks is a lower GNPA/restructured number as the assets are offloaded from bank’s balance sheet and transferred to an ARC trust. However, considering the high sale transactions, investors will start looking at stress loans (including SRs) on the balance sheet.

Assuming an ARC paid a consideration equal to net book value; banks would get some relief on provisioning if the asset is likely to get downgraded further. However, this benefit has reduced under the 15/85 structure as ARCs have lowered the consideration offered as IRR for ARCs have come down meaningfully.

In case a bank sells an asset below net book value, RBI allows banks to amortize losses over eight quarters. This is beneficial especially in accounts where recovery is likely to be long drawn (lower) and provision requirements likely to increase further. This benefit is available to banks for the sale transactions up to 4QFY16.

Selling assets to ARC frees the senior management’s time and effort on recovery, and helps it to focus on core functions of business growth/profitability and revival / recovery.

Once the ARC aggregates 60% debt, it can enforce SARFAESI and thereby pace up the resolution; arriving at a consensus is a major hurdle for banks.

In a portfolio sale approach, banks get an opportunity to dispose of older-vintage NPAs along with lesser-vintage NPAs (thereby reducing the level of stress on the balance sheet). Typically, high-vintage accounts are written off and banks have been unable to recover the money. Any recovery will add to profits and, in turn, capitalization.

Other benefits: a) Reputational risks associated with aggressive recovery mechanism, (b) release of blocked capital with lowering of RWAs and (c) no long legal battles.

Exhibit 9: Banks would prefer to sell assets with 3-4 years vintage as provisioning impact is limited NPA Vintage (years) (INR) 1 2 3 4 > 4 Gross loan amount (secured) 100.0 100.0 100.0 100.0 100.0 Provisioning Required 15% 25% 40% 40% 100% Provisions 15.0 25.0 40.0 40.0 100.0 Net book value 85.0 75.0 60.0 60.0 0.0 Assuming loan is sold at INR 50 50.0 50.0 50.0 50.0 50.0 Profit / (loss) on sale -35.0 -25.0 -10.0 -10.0 50.0

Source: MOSL

Lower share of stress loans on balance sheet

Provisioning benefits will partially take care of low

capitalization and ROE concerns

Focus on core business and freeing up of top

management bandwidth

Financials | Update

17 June 2015 8

Agency model IRR’s down sharply under new regime Industry structurally moving from agency business to fund-based business

Let’s take a simple example where an asset is sold to an ARC for INR100 under the 5/95 structure and management fee is 1.5%. Assuming that there is no recovery in five years, the ARC would lose its INR5 investment. However, this is more than adequately compensated by management fee income for five years (i.e., INR7.5). In this case, the IRR for an ARC would be ~15% (under the old structure and without any tax and expenses adjustment). (See exhibit 10)

Considering the high IRR (with no skin in the game), several ARCs bid aggressively during the Sep-13 to Aug-14 period with the focus on agency business model (AUM building and at least earning management fees).

With increased share of ARCs in transaction (15%) and linking the calculation of management fee with NAV of the SRs (v/s outstanding SRs issued previously), IRR has come down sharply. For the same transaction mentioned above (assuming no markdown on SRs), IRR has fallen to -24%. (See exhibit 10)

Exhibit 10: Easy money—not anymore; focus back on actual reconstruction/recovery (INR) 5/95 15/85

without

recoveries with

recoveries without

recoveries with

recoveries Sale consideration 80 80 80 80 Cash investment by ARC -4 -4 -12 -12 Management fee Year 1 1.2 1.2 1.2 1.2 Year 2 1.2 1.2 1.1 1.1 Year 3 1.2 1.2 1.0 1.0 Year 4 1.2 1.2 0.9 0.9 Year 5 1.2 3.7 0.8 8.3 IRR 15% 25% -24% 1%

Source: MOSL

Exhibit 11: Earlier, management fees could cover risk of lower or no recoveries for ARCs and help banks to defer upfront hit of provisioning Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Total Loan Value 100 Provisions held 20 Net BV 80 Sale Consideration 80 SRs issued to ARC 4.0 4.0 4.0 4.0 4.0 4.0

SRs issued to Bank 76.0 76.0 76.0 76.0 76.0 76.0

Realizable Value 50 MTM losses on SRs 0.0 6.0 12.0 18.0 24.0 30.0

Profit Loss Impact ARCs (net of expenses) mgmt fees: 1.5% -4.0 1.2 1.2 1.2 1.2 3.7 4.5 IRR for ARC 25% Bank (write-down on SRs) 0.0 -5.7 -5.7 -5.7 -5.7 -5.7 -28.5 Impact on Bank P&L (write-downs + fees) 0.0 -5.7 -5.7 -5.7 -5.7 -11.7 -34.5

Source: MOSL

Increase in cash investment by ARCs has resulted in

lower bid prices and higher management fees

Assuming recovery of INR 50 (62.5% of NBV)

Sale consideration = net book value reflected ARCs

willingness to pay higher price to earn higher

management fees

Financials | Update

17 June 2015 9

Exhibit 12: However, under the new structure, the economics change completely for an ARC Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Total Loan Value 100 Provisions held 20 Net BV 80 Sale Consideration 80 SRs issued to ARC 12.0 12.0 12.0 12.0 12.0 12.0

SRs issued to Bank 68.0 68.0 68.0 68.0 68.0 68.0

Realizable Value 50 MTM losses on SRs 0.0 6.0 12.0 18.0 24.0 30.0

Profit Loss Impact ARCs (net of expenses) mgmt fees: 1.5% -12.0 1.2 1.1 1.0 0.9 8.3 0.6 IRR for ARC 1% Bank (write-down on SRs) 0.0 -5.1 -5.1 -5.1 -5.1 -5.1 -25.5 Impact on Bank P&L (write-downs + fees) 0.0 -5.1 -5.1 -5.1 -5.1 -10.9 -30.6

Note: We assume that value of SRs goes down gradually toward realizable value and the entire recovery happens in the 5th year. Source: MOSL

Exhibit 13: Business model no longer viable on management fees

Source: MOSL

Note: In the above chart, we assume gross loan value of INR100, net book value of INR80, realizable value of INR50, management fees of 1.5% constant under both 5/95 and 15/85 structures. We assume a 20% upside for the ARC on excess recovery under both the scenarios.

The above chart clearly illustrates that the ARC would no longer be willing to pay

higher considerations (especially net book value). Also, fees charged would have to increase as the revised guidelines link management fees to net asset value rather than outstanding SRs.

The IRR for an ARC under the above scenario increases significantly if sale consideration is lower than 60% of realizable value. In the above chart, IRR is ~21% (under the 15/85 structure) when sale consideration is INR30; i.e., 60% of realizable value of INR50.

SBI’s recent transaction is an example of how banks would need to accept a lower sales consideration and thereby take an amortization hit over eight quarters.

Our interactions with several ARCs highlight the reduced price competition and increased incentives to ARCs for faster recoveries.

25% 27% 28% 30% 39%

50%

1% 4% 6% 10%

15% 21%

80 70 60 50 40 30

Sale consideration paid by ARC in INR

IRR (earlier) IRR (now)

Under similar conditions, the new guidelines increase

ARC investments and reduce management fees

IRR down sharply if ARC business is based on the

agency concept

20% 30% 40% 50% 60% 70%

Discount to BV (%)

Financials | Update

17 June 2015 10

Impact of new guidelines at the system level Long term positive; near term remains challenged

The rationale behind the changes was to incentivize and expedite the recovery/restructuring process. The revised guidelines ensure that ARCs focus on redeeming the SRs rather than just base their business model on earning the management fees. In our view, ARC business has structurally moved from agency business to fund-based business.

The new guidelines increase the capital requirements for ARCs. Hence, the number of transactions declined sharply in 2HCY14 as banks took time to adjust to the revised bid prices being offered.

From a long-term perspective, we believe the industry (post the new guidelines) is moving in the right direction where proportion of cash increases and assets are priced closer to their true value. Favorable regulations such as lowering the threshold level of enforcing SARFAESI and membership to JLF, coupled with more experience in resolution of NPAs are likely to result in speedy recovery/restructuring.

In 4QFY15, SBI Group sold assets at a significant discount to net book value. We expect this trend to continue in FY16 as the stressed loan position at banks remains challenged and the asset reconstruction industry remains capital constrained. Also, RBI dispensation to allow banks to amortize any loss from sale to ARCs over two years should enable banks to sell lesser-vintage accounts that would likely have higher chances of resolution/restructuring.

Challenges faced by ARCs for the growth ahead In the near term, we expect few large ARCs to moderate their growth levels and

rejig their business models as earnings come under pressure due to change in fee structure and income on bulk of the capital deployed remains back-ended (will take 3-5 years before meaningful recovery is seen).

Some large ARCs may take on more leverage or infuse additional capital; however, raising equity could be a challenge—given the regulatory cap of 49% sponsor shareholding and low foreign investor appetite due to limited track record. Overall financial leverage for the industry is low (approx. 1:1); however, given the nature of business where income stream is lumpy, servicing debt could be an issue.

Participation from QIBs may remain limited unless banks sell assets at significant discount to net book value. The is because initial payout in an SR is adjusted toward recovery of principal and only then any proceeds can be diverted toward any fixed coupon payments (differential SRs like class A/class B) and capital gains. This creates a challenge for the investor as his upside is limited unless the bank offers the asset at significant discount (an ARC still earns management fees, unlike a QIB investor).

Under the new guidelines, ARCs need to buy out the SMA2 account on their own book and cannot transfer it to a trust. SARFESI is only applicable to NPA account and the trust cannot declare an account as NPA. This creates a major roadblock for banks to sell incremental stress assets. Recently, HDFC Bank classified a large

In our view, asset reconstruction business has

structurally moved from agency business to fund-

based business

Industry moving in the right direction - proportion of

cash is higher and assets are priced closer to true value

Large ARCs to moderate growth levels and rejig their business models as earnings

come under pressure

Sponsor shareholding capped at 49%

Participation from QIBs may remain limited unless assets

are sold at significant discounts

Technicalities involved in acquiring SMA2 account

Financials | Update

17 June 2015 11

steel company as an NPA before it was sold to an ARC at a ~40% discount to net book value.

As per RBI guidelines, banks are required to sell NPA at a reserve price, which should generally be not lesser than net asset value based on the estimated net realization from the account. This leaves very less margin of safety for ARCs.

The ARCs are only allowed to convert a part or entire debt into, up to 26% of total equity. Such conversion can potentially provide significant upside to the ARC in case of all-cash acquisition. However, upside tends to be nullified since the SARFESI Act requires the restoration of management to the defaulter after turnaround by ARC.

Financials | Update

17 June 2015 12

Key growth enablers for asset reconstruction business Removal of sponsor shareholding cap could bring additional resources

Highly efficient judicial system: Recovery suits must be disposed of within statutory timelines and any delay should attract strict penalty. Indian Bankruptcy Act and additions of new DRTs should help in strengthening the recovery process.

Removing the 49% cap on sponsor shareholding will allow large private ARCs to raise equity capital and sustain the growth momentum seen in FY14-1HFY15.

Loss on sale to ARCs should be written off over a 2-3 year period (currently two years for sale up to Mar-16). This will allow more banks to clean up their books. Also, proportion of cash transactions may increase as the industry has moved from agency business to fund-based business under the 15/85 structure and usually the IRRs are higher for ARCs in cash transactions. This will also be beneficial for banks as it will immediately free up capital.

ARCs should be allowed to hold majority shares post conversion of debt to equity and to invoke pledged shares.

Exhibit 14: Industry can lever up to 85x ...

Source: MOSL

The above example highlights that if an ARC invests INR100 of equity, it could leverage up to 6.7x based on regulatory requirement of 15% CAR (assuming the entire is Tier I capital). Assuming its share of 15% in a 15/85 structure transaction, the ARC can acquire INR5130 worth of assets (net basis). On a gross basis, it would result into ~85x leverage (assuming the sale happened at 60% of net book value).

Removal of sponsor shareholding cap one of the

key enablers of growth for ARC industry

Every rupee invested via Tier I capital, can help clean

INR85 worth of loans from banking system

Financials | Update

17 June 2015 13

Exhibit 15: Sensitivity table: Gross Leverage based on various discount to BV and debt/equity levels Discount to Gross BV

Leverage 20 40 60 80

1.0 17 22 33 67

3.0 33 44 67 133

5.0 50 67 100 200

6.7 64 85 128 257

Source: MOSL

Exhibit 16: Our detailed analysis factoring in available capitalization and borrowed funds, suggests ~INR200b of SR issuances in FY16 (similar to FY15).

Source: MOSL

We expect 10% increase in industry’s net worth and

leverage of 2x in FY16

Financials | Update

17 June 2015 14

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