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In 2017, when the Insolvency and Bankruptcy Code (IBC) was passed, he was among many investors who saw a golden opportunity in the pile-up of sick companies and stressed assets that had clogged the banking system.

Till 2021, the 58-year-old investor from Mumbai stayed in the hunt for non-performing assets (NPAs) which he could buy at a cheap price, turn around with expertise and sell at a sizeable profit. He was even able to line up investment from marquee investors like the International Finance Corporation (IFC), the private investment arm of the World Bank.

Snails pace
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Snails pace

He recalls one company that was pushed to the IBC process in 2018 and that he was keen on—he spent eight months doing due diligence, and offered to buy it at a 70% discount. First, the banks refused his offer price. “Then, the promoter, who was politically connected, intervened through appeals to insolvency courts three-four times," he recalls.

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As the case went back and forth, the assets kept deteriorating. “At one point, the company’s expenses ballooned beyond a viable limit. I had to finally withdraw my bid after two years of pursuing the asset," he says. The company was finally sold at a 95% discount.

Frustrated, the investor is bowing out of the distressed assets business. In these five years, he hasn’t managed to close even five large deals—he has a portfolio of less than $700 million—with sub-par returns ranging from 13-16%, when he had expected returns over 20%.

He is not alone. Several distressed asset-focused funds, too, are reconsidering deals, thwarted by delays in the IBC process. Distressed-asset-focused funds typically acquire either equity or debt in troubled assets or NPAs at discounted prices, making a profit as they resolve the debts.

 

Illustration: Jayachandran
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Illustration: Jayachandran

In 2017, the IBC law had raised expectations all around. It promised swift resolution of bad or defaulted loans in the banking system within 180-270 days. The lure of high returns from stressed assets had attracted a bunch of global investors to India —for example, Apollo Global Management, Oaktree Capital Management, SC Lowy, Lone Star Funds, Blackstone and SSG Capital (now Ares SSG), among others. Many global funds set up offices in India; some raised India-focused funds.

But the reality has been sobering. One of the longest cases under India’s bankruptcy law, Essar Steel, took over two years (866 days) to be resolved. The debt-laden firm was finally acquired by billionaire Lakshmi Mittal’s ArcelorMittal.

Not surprisingly, financial investors are losing patience. Some of the global funds are moving away. That’s the bind US private equity giant Blackstone finds itself in. Blackstone was gung-ho in 2018, having picked up a 1,000 crore stake in one of India’s oldest asset reconstruction companies, International Asset Reconstruction Company (IARC).

But today it is struggling to close even one deal. It recently opted out of perhaps its only approved resolution plan under IBC—to acquire the debt-ridden toll road asset, Transstroy Tirupati Tiruthani Chennai Tollways Pvt. Ltd—citing government and regulatory hurdles. An insolvency court in its initial hearing has called for “punishment" to the Blackstone unit for going back on its commitment.

While two of its senior executives quit, Blackstone is also said to be on the lookout for buyers for IARC, which purchases non-performing loans or debt from lenders for a management fee and makes money on recovery of those loans. The fund did not respond to queries sent over emails or phone calls.

In 2020, Apollo shut down AION Capital— its joint venture with ICICI Venture —to focus on large buyouts in the credit space in India. Since it was founded in 2011, it closed around 13 deals—only two were distressed transactions. Recently, Mumbai-based distressed asset investor Eight Capital pulled out of its partnership with JC Flowers & Co, another US-based distressed investor, which closed a deal to buy Yes Bank’s 48,000 crore bad loans. Last year, Lone Star Funds shut down its India business after it managed to close just one deal in three years. The funds either declined to comment or did not respond to emails and calls from Mint.

The long wait

So, what’s ailing the IBC process? Simply put, multiple rounds of negotiations and litigation are leading to unviable delays. Once a stressed company’s case is admitted before an insolvency court, it is likely to take around six years for an investor to acquire it, according to MS Sahoo, former chairman of Insolvency and Bankruptcy Board of India (IBBI).

Sometimes, even starting the insolvency process takes a long time. A well-known stressed company, Visa Steel, which was to go under IBC in 2017, is still awaiting admission before the insolvency court. Admission of applications to start the corporate insolvency resolution process took an average 650 days in 2021-22, according to a recent discussion paper by the IBBI. The law says it should not take more than two weeks. Several such cases are mired in litigation as promoters game the judicial system through multiple appeals.

The reasons for delays are multiple: from inadequate number of judges, lakhs of companies filing for bankruptcy, and promoters resisting insolvency every step of the way through the process of appeal. “The value of the company keeps on reducing while the process lingers," Sahoo says.

The investor cited above also said that banks are unwilling to sell bad loans at major discounts even if it makes commercial sense to do so. On their part, bankers are afraid of the scrutiny of government agencies. “Today, if my loan of 1,000 crore is offered less than 100 crore, how can I sell the asset for that low price even if the market says so? Tomorrow the Central Vigilance Commission, CBI and Enforcement Directorate will question me. Sometimes, influential promoters also create hurdles if a banker is honest. I know of a former public sector undertaking (PSU) banker colleague who stood up to a promoter, and his retirement benefits were curtailed," says a PSU banker who did not want to be named. In November 2021, former State Bank of India chairman Pratip Chaudhuri was arrested by Rajasthan police in an alleged loan fraud case, long after his retirement, on the basis of a warrant issued by a Jaisalmer court. Chaudhuri was arrested for deciding to sell a hotel in debt to an asset reconstruction company, where he joined as a director later.

Low returns

As delays and litigation drag on, investors are bound to get impatient and look elsewhere. “For the credit funds, the focus has shifted to performing assets which give higher yields, not distressed opportunities," says Nikhil Shah, managing director at Alvarez & Marsal India, a turnaround and restructuring specialist.

“Investors with billions of dollars to deploy cannot wait in this uncertainty. Their return expectation is north of 20%. But they barely end up making 12-15%. I can make those returns by passive index investing in capital markets. Why will an investor work hard to acquire stressed assets?" says Rajeev Shah, managing director and chief executive officer at RBSA Advisors.

Besides the long delays under IBC, funds are also pressing the pause button amid a slowing economy, global geopolitical uncertainty and a hawkish interest rate regime.

According to Nirmal Gangwal, managing partner at Brescon & Allied Partners, several domestic businesses in financial trouble are avoiding funds as they have been able to raise capital from banks at one-third the cost.

Shrinking opportunities

Weighed down by mounting NPAs since 2012, India has had its own share of debt resolution mechanisms which have managed a recovery rate of under 20% of the debt value. The IBC has not done too badly—recoveries were at 47% at its peak in March 2020. It has dipped to approximately 31% as on June 2022.

Balance sheets are cleaner, and banks have also written off loans worth about 10 trillion in the last five financial years. While older bad loans continue to exist in the system, there are fewer takers for them.

“In steel, auto and financial industries, a lot of the assets have been resolved," said Ambrish Singh, managing director, loans and principal investments, at Nomura. Singh was formerly at the helm of Lone Star Funds in India.

From the foreign investors’ perspective, Singh believes, the IBC framework was unfair. “Foreign funds have a finite life. If, after spending time, money and effort on due diligence and bidding for the asset, they are left with unfair decisions by lenders and the courts, this will drive them away from the IBC."

Meanwhile, the ARC model has also been constrained by factors like irrecoverable NPAs being passed on to them, lack of debt aggregation, unavailability of additional funding and difficulty in raising funds. What has worked is the threat of being dragged to IBC—promoters fearful of losing control of their businesses are swifter in repaying lenders. Sahoo says, “I used to say the best use of IBC is not using it at all. That has come true."

Buying debt

While equity deals have slowed, a substantial amount of capital, upwards of $3.5-4 billion, has been invested in buying debt over the last 18 months, at least three industry executives said. (In debt deals, promoters do not cede control.) Domestic and foreign funds including Edelweiss Alternative Assets, Asia-focused PAG, Oaktree Capital, Varde Partners, Davidson Kempner Capital and Ares SSG Capital are among the active ones. Since April, around $750-800 million debt deals would have been closed in the distressed assets space, said a large homegrown stressed asset investor.

Moreover, several distressed debt asset managers including Oaktree, GoldenTree, Monarch Alternative Capital and Avenue Capital Group, anticipating a recession in the US, are now eyeing more developed markets in the West. Countries such as China and the UK are also expected to throw up opportunities in the distressed mergers and acquisition space. Many of these countries have evolved bankruptcy and insolvency laws.

To attract international capital, India needs to fix its bankruptcy system, bring in more legal certainty. “Such changes happen over longer periods of time. The US in the 1980s and 1990s, or Europe in the 2000s and after the financial crisis in 2008 saw the creation of functioning credit markets across loans, high-yield bonds, mezzanine debt, direct lending and distressed markets," said Sandeep Chandak, managing director at Värde Partners. Varde, along with Aditya Birla ARC, recently acquired the debt of KSK Mahanadi from State Bank of India for 1,622 crore, among India’s single largest cash buyouts of distressed debt.

This much is sure: India will continue to throw up opportunities as it grows. What it needs is a stronger legal system with adequate infrastructure and the right precedents. As banks prepare to increase loan shares, creating bigger opportunities in a growing economy, fresh stress is inevitable. The question is: Can the system get its act together in time?

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