Funds chase stressed assets down the rabbit hole

Stressed asset funds are the flavour of the season. On Wednesday, State Bank of India (SBI) said that it has signed a memorandum of understanding with Brookfield Asset Management to purchase distressed assets. Brookfield will commit a little more than a billion dollars to the fund and SBI will contribute up to 5% of the total investments by the fund. Whether a bank, sitting on a large pile of stressed assets itself, should be a partner in a stressed asset fund is a separate question. But we will leave that aside assuming that there will be a Chinese wall between the operations of the bank and the fund.

Along with SBI, there are others who are trying to edge their way into this segment.

Edelweiss Financial Services, which runs an asset reconstruction company (ARC) as part of its portfolio, plans to launch a distressed asset fund with a corpus of $750 million to $1 billion. JM Financial Ltd, another company with an ARC, is also looking at raising a similar fund but with a smaller corpus of $300 million. In January, Ajay Piramal-led Piramal Group said it will be floating a $1 billion stressed asset fund in association with Nirmal Gangwal, founder of turnaround company Brescon Corporate Advisors Pvt. Ltd. In June, Piramal said he would bring in an international investor into this venture as well.

Others are already in the market. There is The Aion Fund, a joint venture between ICICI Venture and Apollo Global Management with about $825 million in committed capital. There’s KKR too, which through its global special situations fund and its domestic non-banking financial services company (NBFC), has been active in offering structured finance to stressed companies.

This is not an exhaustive list but you get the idea—there is a lot of money chasing stressed assets in the country now. The question is whether this money knows what it is going after? Or is it going down the proverbial rabbit hole?

There is no doubt that India needs to build an ecosystem that can help banks resolve stressed assets, which added up to 5.8 trillion at last count. We need well capitalised ARCs that can buy bad loans from banks and stressed asset funds that can invest in firms when promoters are not in a position to commit more equity. But promoters, bankers and investors need to be on the same page to get this ecosystem to function. That has not been the case so far, suggesting that these funds don’t know what they are getting into.

The first issue is an unrealistic expectation of returns. According to a senior public sector banker, a number of these funds are expecting returns in the range of 20-25% in rupee terms. Part of this is because they are building in about a 5% depreciation in the rupee against the dollar.

These kinds of returns can be delivered only if a) they buy into these assets at a significant discount and b) if the economy sees a strong revival, which allows for a turnaround in these assets.

Neither of those two conditions is being fulfilled at the current juncture. Banks and promoters have been reluctant to sell debt or equity at a significant haircut. The economy, while reviving, is still not firing on all cylinders.

There may also be a disconnect in the stage at which these funds invest. They may prefer to invest in companies that are facing early stages of stress but banks and promoters aren’t interested in selling such assets, at least not at a significant discount. What banks are eager to sell are assets that are already non-performing but funds are naturally cautious in such cases because they are not clear whether the assets can be revived and how quickly.

The banker quoted above, who didn’t want to be identified, also noted that since promoters are not willing to give up control, these funds will have to be comfortable working with them. All these issues will make it tough for large deals to close. You could, however, start to see these stressed asset funds invest in smaller firms. Such investments may not make for splashy headlines but will help in reviving smaller viable businesses where promoters are dealing with genuine stress brought on by factors outside their control.

Gangwal of Brescon has similar concerns. Funds are looking for high-yielding structures with full security, he said. For this, funds have to find businesses that have potential for growth; where banks are willing to take a haircut to make the capital structure more viable; and where promoters are willing to cede some control and work with outside investors. “Not many such scenarios exist,” said Gangwal. “The fact that these funds are coming into India is a good sign in terms of talk. We have to see whether this will convert into walk,” he added.

If you put the scepticism aside for a minute, you have to acknowledge that a lot of conversations are taking place. Banks are talking to stressed asset managers, stressed asset managers are talking to funds, fund managers are talking to investors, who are, in turn, talking to bankers, and so on. What we need now is for some of these conversations to end with a “we have a deal” as opposed to a “let’s talk again”.

Ira Dugal is deputy managing editor, Mint.