Mark to Market value of Security Receipts

South Indian bank in its presentation for q2fy18 said that


PAT* was driven down on account of the exceptional provision on MTM valuation of Security Receipts received on the sale of assets to ARC.


Nature of Security Receipt is - Instead of taking an upfront cash payment, banks were willing to accept delayed payment in the form of SRs. ARCs made a down payment of a minimum 5 per cent of the agreed value and the balance 95 per cent was redeemed against the SR, when the amount was finally recovered.

Source - Sale of bad loans to ARCs hit for second year running

My Question

What is the nature of Security Receipt that the bank has to take provision even after selling to to ARC?

Usually a bank will sell an NPA to an ARC and be paid partly in cash and the rest in security reciepts. The security reciepts are paid off as the NPA is resolved. If the actual collection (or expected) is less than the security reciepts, then the bank has to take a charge
for example (with simplification)
lets say the Asset value = 100
NPA = 70 (after taking provision)
Sell Asset at 70 to ARC and get 20 as cash and balance as SR
After one year, if the expectation is that the asset will get resolved only for 30, then the bank has to take a charge of 40

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I guess this is an important question on an area which is revolving fast with new facets:

  1. NPA: when a person fail to pay loan to bank , the bank declares the asset (loan given to bank) as Non Performing Asset (NPA).

  2. Earlier DRT or Debt recovery tribunal were used to deal with NPA matters which was superseded by SARFAESI Act meaning securitisation and reconstruction of financial assets and enforcement of security interest. SARFAESI empowers to take action to recover the loan money.

  3. Under the act bank can take possession of assets, auction/sale them, change management of assets, even a third party where asset is mortgaged can be asked to pay.

  4. Banks cannot keep immovable properties more than 7 (extended up to 12 with board resolution, approval from RBI).

  5. ARC or asset reconstruction company buys loans from banks and try to make profit from distressed asset. Always ARC will buy a NPA lower than bank valuation. Say HDFC Bank reports a NPA as 100 Cr, ARC will buy at 90 Cr.

  6. ARC administer the asset and pursue individual case till closure. This helps bank in outsourcing non core competency.In reality a special purpose vehicle is created for distressed asset.

  7. When ARC pays bank it does not pay out of pocket. It pays via security receipts. Say in above case ARC requires 90 Cr to buy NPA. It will issue 90 Cr Security receipts to bank. Security receipts are financial instrument (but not fixed interest carrying like bond) purchased by QIB-qualified institutional buyers.

  8. Now twist- ARC can convert the debt to equity. Meaning say the defaulter has 50 debt 50 equity in his own account. ARC will make equity to 100 and hold 50% shares in defaulter balance sheet. If the defaulter makes profit ARC goes there in as shareholder who will share profit.

Mathematical equation:

HDFC Bank- asset value 100 Cr, NPA provided- 100% say to 100 Cr

HDFC Bank sell to ARC for 90 Cr. So immediate loss of 10 Cr.

ARC buys at 90 Cr, defaulter offers 95 Cr and ask ARC to sell assets. ARC is a subject matter expert in asset reconstruction, supposed to wield influence better than bank or defaulter.

Defaulter saves 5 Crores, instead of paying 100 Cr to bank he managed to get away by 95 Cr.
But if debts are converted to equity the story changes as business turn around takes time, due to NPA the share price of defaulter are unlikely to go up.

Mark to market for security receipts

Mark to market is reflecting the value of asset to current financial situation. Say I have shares purchased as 100 and market value is 80. Despite shares not sold, assets are marked to market value i.e. 80 on balance sheet date. As that is a fair value assessment on that date.

Security receipt as per SAFAESI means a receipt or security issued by securitisation company or reconstruction company to any QIB pursuant to a scheme evidencing the purchase of acquisition by holder.

SR’s are backed by impaired assets, they are not debt instruments. The cash flow from underlying assets can not be predicted in terms of value. Rated below investment grade.

The SR rated every year to assess their recovery potential, if downgraded further bank has to reduce the value of securities receipts to reflect current financial fair value assessment. This is nothing but mark to market.

So, if you have a severe downgrade coming from SR, the MTM accounting will have a higher value. This is a normal process of debt securitisation accounting!

Apologies for covering entire loop, it may help others. I used to have a transaction mapping file for debt securitisation- special purpose vehicle to redemption and MTM. Let me check, or else I can write it later as well.



Sorry, I missed one part of your question although the gist I guess is covered in my reply.

What is the nature of Security Receipt that the bank has to take provision even after selling to to ARC?

As I mentioned above SR is a financial instrument lower than investment grade issued against an asset which is impaired. The nature of risk is always high, but discussions are going around to list the SR in secondary market. That will improve liquidity not safety. SEBI argues these are type of infrastructure companies, RBI says sick guys, issued a circular cash flows can not be predicted. Let us wait for more clarity, RBI possibly will provide inputs soon as this was a contentious issue announced in union budget.

dear Suvendu sir,
two doubt on this.
A. How is this related to the AAA, BB kinda ratings by Care , Crisil etc.
B. How to read these ratings when such rating agencies upgrade or downgrade a company’s rating. esp the bonds these companies raise? does it have a long/short term effect on the volumes?


AAA, BB is the rating provided by rating agencies based on criteria that are developed by them, vetted and accepted by regulatory authorities.

The ratings can be provided on a portfolio of assets or even single asset.

Ratings can tell you quality of asset as most of questions address financial and strategic risk.

I suggest you can further read on rating agencies methodology, it’s a big subject. :grinning:

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Once Security Receipt is issued by ARC to bank. How is Security Receipt reflected in the financials of Bank (Profit & Loss and Balance sheet)?

Thanks for taking out time to answer.