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How KKR’s credit risks came crashing down

The credit unit’s then CEO Sanjay Nayar (now KKR India’s chairman) saw big potential in structured corporate loans, which tend to offer higher interest rates than traditional bank loans but come with fewer creditor protections. (Photo: Mint)Premium
The credit unit’s then CEO Sanjay Nayar (now KKR India’s chairman) saw big potential in structured corporate loans, which tend to offer higher interest rates than traditional bank loans but come with fewer creditor protections. (Photo: Mint)

  • A global investment behemoth’s sprint from boom to bust is a cautionary tale about India’s shadow-lending sector.
  • With a growing number of foreign money managers looking for opportunities to sift through the wreckage of India’s debt markets, the story behind KKR’s troubled bet illustrates what can go wrong

MUMBAI : Few asset managers have enjoyed more success in the riskier corners of credit than KKR & Co. But after a decade-long attempt to wring big returns from India, the Wall Street titan has become a cautionary tale for investors in one of the world’s most tantalizing emerging markets.

Rocked by the shadow-banking crisis that began rippling through India’s financial system two-and-a-half years ago, KKR’s local credit unit lost 15.2 billion ($207 million) in the final nine months of 2019, wiping out nearly 40% of its capital. While the unit posted a small profit last year as RBI pumped record amounts of cash into the covid-battered economy, KKR is now in the process of merging the business with a competitor.

It’s a steep fall from grace for a venture that extended about $800 million of loans at its peak and at one point seemed poised to deliver a windfall to KKR in the form of an initial public offering. By late 2019, just before the pandemic, KKR had determined that more than half the loans at the unit—called KKR India Financial Services Ltd—were at risk of default.

With a growing number of international money managers now looking for opportunities to sift through the wreckage of India’s debt markets, the story behind KKR’s troubled bet illustrates what can go wrong. Interviews with a dozen people familiar with the firm’s Indian operations, most of whom asked not to be identified discussing private information, point to missteps that include questionable underwriting assumptions and a decision to accelerate lending in the lead-up to the 2018 IL&FS crisis.

“They wrote large checks in rapid succession to balance sheets that didn’t have the size or capability to repay," said Amit Goenka, managing director of Nisus Finance Services Co and a two-decade veteran in India’s credit markets.

In a response to questions, KKR said its India credit unit enjoys a strong liquidity position and will keep looking for ways to expand. “When we saw what was happening in the market, we rallied around our business—locally and globally—and created a task force that has been proactive in managing the portfolio and performance of the business," KKR said.

The India credit unit recorded a pre-tax profit of about $9.7 million in 2020, according to one person familiar with the matter.

High-profile bets

While KKR was among the most high-profile casualties of the 2018 crisis, it was far from the worst hit. Four of India’s largest non-bank financiers have defaulted on their debt, while Franklin Templeton shocked market participants in April 2020 by freezing withdrawals from six Indian debt funds and telling investors it would wind them down.

When viewed in the context of KKR’s global business—the firm oversees $234 billion worldwide, including about $75 billion in credit investments—the losses suffered by the India unit are modest. They’ve also had little discernible impact on KKR’s stock price, which gained 39% last year and hit a record high this month.

Still, India credit was supposed to be a bright spot. KKR was one of the first big international investors to enter the market in 2009, committing $100 million to launch the business. Like the rest of KKR’s India operations, the credit unit was overseen by Sanjay Nayar, a Citigroup Inc. veteran who had been handpicked by KKR co-founder Henry Kravis a year earlier.

Nayar saw big potential in structured corporate loans, which tend to offer higher interest rates than traditional bank loans but come with fewer creditor protections. He set up the unit as a non-bank finance company, rather than as an investment fund. Among other things, that enabled KKR to amplify its lending power by taking on leverage.

Early additions to the portfolio included Analjit Singh’s Max Group and Avantha Group, the paper-pulp to power plant empire led by Gautam Thapar. Rupee-denominated loans to the companies yielded about 12%, and they performed well as India emerged from the global financial crisis relatively unscathed, two people with direct knowledge of the loans said.

Coffee Day Resorts was another high-profile bet. KKR took a stake in the chain, founded by India’s “coffee king" V.G. Siddhartha, through its private-equity business in 2010 and extended loans via the credit unit in 2012. KKR usually avoided lending to companies in its private-equity portfolio to prevent an over-concentration of risk, but Nayar persuaded his bosses in New York to make an exception, according to one person involved in the deal.

By 2013, KKR’s India credit team was riding high. The Teacher Retirement System of Texas, one of America’s largest institutional investors, had agreed to take a $100 million stake in the unit, while KKR had also raised about 425 crore for a separate India-focused credit fund.

KKR began exploring the possibility of taking the India credit unit public in 2015, four people familiar with the discussions said. The feedback from IPO bankers was that KKR’s loan portfolio was still too small to attract strong investor demand, so Nayar and his team decided to ramp up lending.

The red flags

As they doled out credit at a quickening pace, some underwriting decisions were questioned by members of KKR’s global credit group who had been co-investing with the India unit, two people familiar with the matter said.

One of the bets that raised red flags was Resonance Eduventures Ltd, a training school for India’s top engineering college. KKR’s credit funds typically demanded collateral from borrowers in the form of physical assets, but the loans to Resonance were backed only by founder R.K. Verma’s shares in the unlisted company. That left KKR lower in the creditor pecking order if Resonance had trouble repaying its debt. KKR’s bargaining power in the event of default was also limited because Verma was seen as integral to the company’s value. The loans went ahead despite the global team’s concerns.

Enthused by the India credit unit’s fast growth, Abu Dhabi Investment Authority, one of the emirate’s sovereign wealth funds, bought a stake in the firm for $100 million in 2017. With local debt markets booming, the time for an IPO seemed ripe.

Everything changed in August 2018. A surprise default by IL&FS, one of India’s largest non-bank financiers, exposed the shaky economic underpinnings of a credit expansion that had propelled the nation’s shadow banking assets to a record $393 billion. Many Indian companies that had become reliant on short-term loans suddenly lost access to funding. KKR and peers that had extended credit to these borrowers were exposed.

Nayar initially saw the chaos as an opportunity, telling Bloomberg in an October 2018 interview that he was looking to buy portfolios from struggling shadow lenders. But by the end of that year, KKR’s global investment committee had taken a more active role in the business, rejecting Nayar’s requests to extend more credit and make acquisitions, two people familiar with the matter said.

Brian Dillard, a KKR managing director tasked in late 2018 with overseeing the firm’s credit operations across Asia, told colleagues he was worried that the India unit would become a drag on the firm’s regional ambitions, two people said. Investors in KKR’s separate India credit fund were becoming more circumspect too, in part because of the turbulence in Indian markets. In early 2019, after KKR’s initial fund had reached its maturity, they turned down the firm’s invitation to invest in a new one, two people familiar with the matter said.

Meanwhile, the credit unit’s loan book was deteriorating. Sintex-BAPL Ltd, an auto-parts manufacturer, stopped repayments in June 2019, a little more than a year after KKR made its original loan. Avantha Group was also falling behind on repayments, two people familiar with the matter said. Several other borrowers, including Resonance, were showing signs of stress.

KKR eventually wrote off the value of the Sintex and Resonance loans. The latter has been mentioned on internal KKR calls as a textbook case of how not to structure deals, two people familiar with the matter said. Sintex and Resonance didn’t respond to requests for comment.

Things had also gone badly wrong at another big KKR investment—Coffee Day. In July 2019, Siddhartha, the coffee chain’s founder, was found dead in a river in an apparent suicide. A letter purportedly written and signed by him and sent to Coffee Day’s senior management mentioned “tremendous pressure" from lenders and one of the company’s private-equity investors that he didn’t name. Coffee Day’s board, which included Nayar, ordered a probe into allegations that Siddhartha had embezzled money.

The following month, senior KKR managers in New York took an even more hands-on role at the India credit unit, according to two people familiar with the matter. The firm formed a task force to look into each of the unit’s 33 outstanding loans, concluding by October that as many as 18 of them risked slipping into default.

Around the same time, KKR India Financial Services had its long-term credit rating cut to AA, the third-highest investment grade, from AA+ by Crisil, the local unit of S&P Global Ratings. Borrowers of more than half of its 5,900 crore in loans weren’t fully complying with the original terms of their debt agreements, Crisil said.

B.V. Krishnan, the CEO of KKR’s India credit unit, left the same month. He was replaced by Kapil Singhal, a Goldman Sachs Group Inc. veteran.

Working with Dillard, Singhal started looking for opportunities to sell KKR’s loans or the entire unit. Several of the country’s non-bank lenders balked at a deal on valuation concerns, three people familiar with the matter said.

With worries about another rating downgrade by Crisil mounting, KKR pledged to make a further $150 million available to the India credit unit in January 2020. It said in a statement at the time that the move would bolster the unit’s position in India’s credit markets, though the money has yet to be drawn down.

By July, Coffee Day’s probe into Siddhartha’s death had concluded. The entrepreneur had siphoned off $360 million so he could buy back shares held by private-equity investors, repay loans and keep up with interest payments on other borrowings, Coffee Day alleged, citing the findings of an investigation led by a retired senior official from India’s federal law enforcement agency. The investigation didn’t find any fault with lenders or private-equity investors. Police in Karnataka, the Indian state where Siddhartha died, said the cause was suicide but declined to comment further.

The endgame

The following week, InCred Financial Services Ltd, a local consumer lender backed by former Deutsche Bank co-CEO Anshu Jain, said it had signed an agreement to merge with KKR’s credit unit in an all-stock deal, without specifying terms. KKR will get a roughly 20% stake in the merged entity while the other two investors in the credit unit—Texas Teacher and Abu Dhabi Investment Authority—will also hold minority positions after the transaction is complete, according to three people familiar with the matter.

The company will operate under the InCred name, the people said, adding that terms of the deal have yet to be finalized and could change.

“While we are unable to comment on any specific transaction, it is accurate that we have and will continue to explore new ways to invest in and expand the business," KKR said. Texas Teacher and ADIA declined to comment.

In the months since the merger agreement was announced, India has been pummelled by covid-19 along with much of the rest of the world. Yet, at the same time, local credit markets have proven remarkably resilient thanks to central bank stimulus. One gauge of Indian debt risk—the spread on the highest-rated corporate bonds over government notes—spiked to a six-year high in May but has since fallen close to the lowest level since at least 2002. International money managers, including Apollo Global Management Inc and Blackstone Group Inc, have been scaling up their India lending businesses.

“KKR squandered the coveted first-mover advantage," said Arun Kejriwal, director at KRIS, an investment advisory firm in Mumbai. “We will see whether they have learned lessons."

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