Mumbai: When the billionaire Ruia brothers sewed up a $13 billion (Rs86,700 crore) deal in October to sell a 98% stake in Essar Oil Ltd to Russia’s Rosneft PJSC and a consortium of Trafigura and United Capital Partners, the loudest roar of approval came from investors in India’s bad loan-laden banks.
Shares of banks with significant exposure to the Essar Group surged on the Monday, 17 October, following the weekend deal as investors bet that most of the proceeds from the all-cash transaction would go to repay Essar’s debt of Rs90,000 crore.
Essar Group director Prashant Ruia confirmed investor expectations, saying half the proceeds would go to repay lenders in the biggest debt-reduction exercise undertaken by an Indian conglomerate.
Some of the money will be used to restructure the debt of Essar Steel Ltd, settle some of the working capital debt and some will go to the founders, he added.
ICICI Bank Ltd chief executive officer Chanda Kochhar called the deal “a significant step in the process of deleveraging the balance sheets of Indian corporates”.
Indeed, on 22 October, barely a week after the deal was signed, the Press Trust of India reported that the top three lenders to the group—ICICI Bank, Axis Bank Ltd and Standard Chartered Plc—had got back an estimated $2.5 billion as part of the first payment for their exposure to the group.
The deal also confirmed that local lenders still have to depend on sale of assets by corporate debtors to achieve true resolution of soured loans.
“Indian banks have become very forceful in addressing the problem of bad loans,” wrote Sanjeev Prasad, M.B. Mahesh and Sunita Baldawa of Kotak Institutional Research in a 16 October note to clients. “Indian promoters may have little option but to sell profitable assets to reduce debt; this has been the case for the past two years,” the analysts wrote.
Indeed, the list of asset sales stretches long—from the divestment of cement assets by the Jaypee Group to Lanco Infratech Ltd’s sale of power plants (see graphic).
The Kotak analysts estimate that at least Rs1.84 trillion of assets (including the Essar deal) have been sold by promoters in the past three years to reduce debt.
A drop in the ocean
While that Rs1.84 trillion number sounds impressive, remember that is the enterprise value of these deals. Typically, only a fraction of the money is left in the hands of promoters, which they can use to inject fresh equity in stressed companies.
The Indian banking system was sitting on a toxic asset pile of Rs6.3 trillion at the end of June. Including restructured assets—loans whose tenure has been stretched, interest rates cut and so on—this was as high as Rs9.22 trillion, a Right to Information (RTI) application by Reuters found.
That means one out of every eight rupees lent by Indian banks has turned sour or had to be recast at more lenient terms. This has squeezed private investment demand (gross fixed capital formation fell 3.1% in April-June, for the second successive quarter) and bank lending to industry has slowed to a trickle. Reserve Bank of India (RBI) data show loan growth to industry fell 0.2% from a year ago in August, the first year-on-year contraction in at least eight years.
After finding the regulatory forbearance afforded by loan recasts weren’t working, RBI has tried a set of innovative solutions for the past three years, ranging from the strategic debt restructuring (SDR) initiative to the Scheme for Sustainable Structuring of Stressed Assets (S4A).
Under SDR, banks were allowed to convert a part of the debt in a company to majority equity, taking operational control. Banks would have to find a buyer in 18 months, during which the underlying debt would not attract any negative asset classification and thus, additional provisions.
Under S4A, banks can convert up to 50% of a company’s loans into equity or equity-like instruments. Under the scheme, banks face no specific timeline within which they have to exit the equity that they are holding.
But there haven’t been many takers for these schemes.
In such a scenario, asset sales by debtors seem to be the only way out for bankers to find a quick resolution for troubled loans.
“Asset sales do work better than any other form of turnaround because it means an instant injection of equity in the company and some form of operational restructuring of the company,” said a senior official at a large public sector bank, requesting anonymity.
“The promoters can then focus on the stressed firm and how to turn it around. However, the chances of sales are not always the same with all companies.”
In the case of Essar, the sale of the oil unit—which was profitable and earned the lion’s share of the group’s profits—will allow the promoters to focus on the steel business, which has Rs40,000 crore of debt and has been classified as a non-performing asset (NPA) by many of its creditors.
Prashant Ruia of Essar said the steel business will be the next “crown jewel of the group, just like Essar oil was”.
“By effecting the sale of a good asset, we will also be separating a good asset from a stressed promoter. This way, the asset can get the treatment it needs and the debt can also be reduced,” said a second public sector banker, also seeking anonymity.
One size doesn’t fit all
Selling assets is not easy, especially at times like this. For one, corporate India’s balance sheet as a whole is still highly leveraged. Second, despite what the new gross domestic product (GDP) numbers say, private investment activity is still slow.
Buyers of assets are still unsure if they want to take the extra burden on their balance sheets when cash flows are squeezed. Thus, in many cases, they end up disagreeing with sellers on valuations.
“It is important to make these sales happen at the right price, else the process becomes counterproductive,” said the second of the two public sector bankers quoted earlier.
The Essar deal was no fire sale because the group was in talks with as many as five overseas oil companies for the asset sale, according to Bloomberg. So, it shouldn’t come as a surprise that Rosneft was willing to pay a premium for these assets.
In many cases, the sale of assets just turns out to be a short-term fix. For instance, last year, Bhushan Steel Ltd approved the sale and leaseback of an oxygen and coke oven plant, which fetched it a total of Rs3,000 crore. But these were just enough to tide over some interest payments of the company and the Rs40,000 crore account is still an NPA for many banks.
“Asset sales are only one part of the whole stressed asset resolution process. You cannot solely depend on it to help you protect the whole account,” said Nirmal Gangwal, managing director, Brescon Corporate Advisors Ltd, a restructuring and turnaround advisory firm.
“Resolution through sale is also dependent on whether a company has a big enough asset that can be sold to deleverage (its balance sheet). Else, it will be only a short-term measure for a much bigger problem.”
If the asset is too small is some cases, it is too large in others. Even in the case of Bhushan Steel, lenders were looking at the option of carving out some parts of its business.
Is it the best option?
Then, there is the question of whether selling the family silver is the best option after all. In most cases, the assets that are being sold are the ones which are the most productive. When cash-generating assets are being sold off, there is a possibility that some of these heavily indebted companies might be worse off than earlier. Even in the best-case scenario, they need to figure out ways to restructure left-over businesses to generate cash flows.
For example, the Jaypee Group, which sold around Rs33,000 crore of assets in the past three years and transferred some land in lieu of debt, had to call for consultants to help ensure that the remaining assets generate enough cash to compensate. The power and cement assets it sold, especially the former, were some of the most profitable in the group.
To be sure, companies have no other option than to sell good assets, especially when there are few takers even for assets that are generating profits like power plants with purchase contracts sewn up and so on.
“We are seeing asset sales, but these are only of good assets in stressed companies. Companies are divesting good assets to pare down debt. This is good, but deals are not happening in the stressed companies themselves,” said Dinkar V., partner, restructuring at consulting firm EY.
“Issues leading to this include lender consensus regarding right-sizing of debt, unknown liabilities and litigations in the companies and reluctance to work with existing promoters,” he added.
Although there has been a spate of tie-ups in the stressed assets funds business, with at least $2 billion waiting in the sidelines to be deployed, there has not been much action. Bankers’ reluctance to offer debtors a discount, valuations squabbles and regulatory hurdles meant that the sales to stressed asset funds fell to Rs19,700 crore (book value of stressed assets) in fiscal 2016 compared with Rs40,000 crore the previous year, according to a July report from EY.
No end to stress
Sceptics also point to the fact that sales of good assets so far has not led to significant debt reduction in the banking system. September-quarter earnings of banks show that absolute amount of stressed assets is still rising.
One reason why sales are not leading to a big reduction in the toxic debt pile is that even the assets being sold are legally distinct even if they share the owners with the stressed assets.
In other words, it is the troubled company (which is a separate legal entity) and not the promoter that would have borrowed from banks. So, the promoter is under no obligation to inject equity into the troubled company.
To be sure, if the promoter has offered a personal guarantee or put up some of his personal assets as collateral, then it becomes easier for banks to ensure that proceeds from the sale of assets are used to retire some bad loans.
Still, as Kotak points out, Indian companies have limited options.
“While recovery and resolution of bad loans in several cases is still quite fluid, the growing number of transactions involving sale of assets by stressed companies to stronger Indian and foreign companies suggests that the eventual LGD (loss given default) figure may be contained within manageable limits,” Kotak analysts wrote. LGD is a measure of actual loss to banks at the time of default.