“It is understandable that bankers want to get back to the business of lending and growing their balance sheets, but transferring NPA management to a specialized entity removes the moral suasion that bankers are currently feeling from the spotlight that has been put on the sector in the last few years," Khurana said.
While India’s NPL problem has created an opportunity for various distressed debt investors, Khurana said that it would be difficult for funds to buy out and turn around distressed companies without the help of promoters or strategic partners.
“That is evident in the bids that we’ve seen for the NCLT projects in the last 12-18 months. Whether it is bids for assets in the steel or in the cement industry, the majority of bids have been led by or backed by strategic players. This is true historically as well, where ARCs have a limited track record in turning out distressed companies. India-focused funds do not yet have the depth of operational expertise for turnaround given how recently the IBC was introduced," she said. At the same time, she also added that as the sector matures, and funds and restructuring specialists develop a track record of turning around distressed companies without the promoter at the helm, India could witness a situation where these investment funds acquire such assets by themselves, in line with the developed markets. Edited excerpts:
What are the factors to consider when investing in distressed assets in India? What opportunity does this present for global firms offering credit and financing businesses, as owners would like to retain their firms, and see long-standing debt issues resolved? How about NBFCs—do they now have a new market to explore funding opportunities for distressed small and medium enterprises?
India’s NPL problem has created an opportunity for various distressed debt investors and the key success factors for each investor varies. As bank lending has become more conservative, and for some sectors it has nearly dried up, it has created an opportunity for alternative investors including NBFCs, strategic investors and private equity players. Each type of investors has a different role depending on the level of funding requirement and distress in the company and the potential investors’ risk appetite. We are seeing a lot of NBFCs active in helping companies that are facing a shortage of credit. Often the need is for refinancing since usual bank channels may be closed to certain companies. NBFCs are able to offer various structured credit solutions to these borrowers. This is particularly relevant in certain sectors like real estate that have seen a squeeze on cash flows, and conglomerates that operate in sectors where growth has been muted.
In fact, there is a lot of credit available from NBFCs and they are facing a pressure on returns. Often the lending in these cases is secured and more short-term than equity investments, but there are some common risks that these potential structured credit providers have to consider. These include having comfort that there is no underlying fraud, that the funds that they are providing will be used more or less for the purpose for which they are being raised, and that there is nothing that will disrupt the operations of the company. Often since these companies have cash flow problems, a common concern is how employees and vendors are being treated to ensure there is no unforeseen disruption in operations. Creditors are also often concerned about the personal financial wherewithal of the promoters to understand whether they can continue to support their companies on a sustainable basis.
In all the cases described above, the promoter is still firmly in control of the operations. The situation is quite different when you consider the investment opportunities presented by large NPLs coming through the NCLT process in the last 12 months. In contrast to the above, these are buy out opportunities for prospective investors, where the promoter and majority of the previous management is ostensibly replaced.
But these opportunities are not suitable for all investors. Firstly, the cases that have come through RBI’s first two lists that target a total of 4.06 trillion of the NPLs all relate to large companies and are standalone investment opportunities that require large capital commitments.
Secondly, given that these are coming through the NCLT process, the timelines for decision making are usually very tight with limited time and data available for due diligence. So even experienced investors that have a track record of buyouts may not do these investments. This is the reason why the few success cases that we have seen recently has seen financial investors tie up with strategic investors. In these cases, the potential investors have operating teams in place much before the deal in signed, and preferably from the first day of the due diligence process itself. Lastly, it remains to be seen how these companies will be turned around without promoters that, in India typically, closely control key aspects of businesses, such as relationships with employees, suppliers, customers and regulators. This is not the case in developed markets like the US and UK which have a history of distressed debt restructuring, investment and turnaround. Finally, while the IBC is expected to create a good pipeline for distressed investments, it is meant to be a restructuring mechanism to ensure that labour and capital can be redistributed and further value can be created. It is not a mechanism to hold stakeholders accountable or impart justice related to distressed assets. It does not focus on the reasons behind the distress, whether there was fraud, who was responsible, the size of the so called ‘hole’ in the company and how exactly a new buyer may be able to hold a previous owner liable for criminal activities, if there were any. All these concepts remain to be tested and will be crucial to the success of distressed investing in India.
We are seeing a lot of PE firms—domestic and overseas funds—increasingly setting up shop independently, or as strategic partners, to invest in debt-laden firms. But so far, the lenders of debt-laden companies have given preference to strategic resolution applicants over financial entities. How do you see the situation going forward —will stressed assets funds continue to get secondary preference to strategic investors?
It is difficult for funds to buy out and turn around distressed companies without the help of promoters or strategic partners. That is evident in the bids that we’ve seen for the NCLT projects in the last 12-18 months. Whether it is bids for assets in the steel or in the cement industry, the majority of bids have been led by or backed by strategic players. This is true historically as well, where ARCs have a limited track record in turning out distressed companies. India-focused funds do not yet have the depth of operational expertise for turnaround given how recently the IBC was introduced. Before the IBC, restructuring could drag on for years in a legal and regulatory quagmire.
As the sector matures and funds and restructuring specialists develop a track record of turning around distressed companies without the promoter at the helm, we may see investment funds acquiring these assets by themselves.
Big picture—your views on the proposals of the Sunil Mehta Committee to resolve the bad loans mess. What are the gaps that need to be addressed here?
The proposal offers a potential solution to the banks so that they don’t have to focus on NPA management, but it does not address the fundamental reasons why India has such high level of NPAs (credit policies, priority sector lending, financial crimes, bank governance etc.) and why historically it has been difficult to resolve distressed assets - legal and regulatory challenges, large backlog of cases, ability of promoters to keep control of distressed companies). It also does not address where the accountability for the NPAs will rest.
It is understandable that bankers want to get back to the business of lending and growing their balance sheets, but transferring NPA management to a specialized entity removes the moral suasion that bankers are currently feeling from the spotlight that has been put on the sector in the last few years.
Do you think a lot of vulture funds and strategic buyers are waiting patiently instead of bidding for the distressed firms, to snap these assets at cheaper prices when the liquidation process begins? For several global funds, is this a once-in-a-lifetime opportunity to sift through the wreckage of India’s bad-loan debacle, and pick up assets on the cheap?
The opportunity is ripe but its success will depend on the overall state of the Indian economy in the next two to three years. The majority of NPAs are in sectors where market conditions are weak, such as steel, power, textiles, cement. In this environment, it is difficult for banks to find a varied set of buyers. This again is evident in the fact that a number of the NPAs coming through the NCLT process had too few bidders. Distressed asset investments need considerable handholding after the initial financial assistance.
The hard work in a distressed company begins after the capital infusion, change of management, and financial restructuring of operations. As transparency and accountability in the sector improves, the institutional framework of the IBC strengthens further, and the pipeline of distressed debt investment opportunities increases, we should see further interest in the sector from potential investors both domestically and globally.