Home / Opinion / Views /  The Adani imbroglio is unlikely to hit systemic stability

On 24 January, Hindenburg Research, a New York-based short-selling firm, dropped a bombshell by releasing “findings of research" that charged Gautam Adani, his kin and group companies with having indulged in market manipulation and accounting fraud. The impact was such that the stock prices of Adani Group companies tumbled and could attain some stability only late last week. Finance minister Nirmala Sitharaman had to reassure the Indian public of Life Insurance Corporation’s and State Bank of India’s manageably low exposures to the group. While unfounded allegations and assertions are flying around—made by Adani’s adversaries as well as supporters, with the former claiming a devastating blow to our capital markets and the latter playing it down completely—we should dispassionately dissect the impact of this report whose veracity needs to be tested by a trustworthy institutional investigation.

Exposure of Indian lenders: As per a recent CLSA report, around 40% of Adani Group’s total debt is owed to Indian banks (30% to public sector lenders and the rest to private banks), with foreign loans making up the rest. The share of Indian banks in total Adani debt has come down from 86% in 2016. In the absence of further data-bifurcation, it would be reasonable to presume that a majority of this is project finance lent to individual project companies as Adani is primarily an infrastructure developer.

To gauge the extent of project finance safety vis-a-vis Adani projects, we need an understanding of project finance sanctioning and administration processes in the country.

A bank issues a sanction letter to a project sponsor or company after examining in detail the project’s feasibility study, a detailed project report that offers comprehensive facts about the project, complete with a financial model spelling out its economics and documents to support projections of revenue flow, such as power-purchase agreements in case of electricity projects and concession deals for other infrastructure undertakings. After this, a loan is sanctioned only if the debt service coverage ratio is 1.15 to 1.50, and several financial and security documents are executed to secure the interests of lenders. The project’s immovable assets are mortgaged, movable assets and receivables hypothecated and a big portion of promoter equity in the project company is pledged to lenders. The latter assures lenders or their assignees substitution rights.

Among these arrangements, it’s pertinent to grasp how the project’s revenue is used to repay loans. Principal and interest payments are done as per an agreed amortization schedule prepared on the basis of the financial model. All proceeds of the project are credited to a trust and retention account, a kind of escrow account opened with the lender bank or lead lender in case of consortium finance. The project revenue thus received is disbursed through a ‘waterfall arrangement’, wherein payments are made in an agreed-upon hierarchy. Foremost, operational and management expenses, including statutory dues, are paid. Then, any fees payable to lenders, followed by loan interest, loan repayment and money for the debt-service reserve account. Many such waterfalls also provide for other reserves, like an inverter reserve for solar projects or similar maintenance reserves. After these obligations are met, equity-holders get to reap the fruits of their equity/quasi-equity investment in the form of dividends, coupon payments, etc. This makes the mechanism very effective in securing project finance. Unless there have been major time and cost overruns in the commissioning of a project, the waterfall device holds and its loans are efficiently serviced.

The Adani Group is generally known for timely execution of projects, which means that these ventures pose little default risk. Consequently, all projects with finance already tied up are unlikely to be hurt by the Hindenburg report. Infrastructure projects, in particular, are self-sustaining and ring-fenced. Notably, Adani project companies have no history of loan default. That is why Fitch Ratings ruled out any adverse impact on their bankability. Understandably, Adani’s follow-on public offer was mainly for generating growth capital for future projects, and the group will probably have to go slow on some of its plans.

Institutional and retail equity exposure: The short and medium-term impact will be enormous on public shareholders, given the price crash of the group’s securities. Share markets are also sentiment driven. Lockheed Martin and Eli Lilly were victims of disinformation recently. Just a tweet wiped off 22% of Meta’s market cap. Institutional investors have the wherewithal to conduct due diligence and take informed decisions on stocks, while retail investors do not. The general public holds only thin slices of Adani’s listed companies. However, considering the size of their respective floats, that also translates to a big number. While the finance minister’s words have helped restore relative market calm, a timely investigation of Adani by regulators would help secure stability as we go ahead.

On another note, irrespective of the Hindenburg report’s veracity, the way some Indians in positions of influence openly rejoiced at the crash of Adani stocks was repulsive. When Toshiba declared accounting impropriety, it saddened and worried the Japanese nation. There was no jubilation. As the truth eventually unravels, if the short-seller’s allegations are found to be true, we should be disappointed as citizens, not exultant. However, if false, this onslaught on a national industry champion should incense us.

Jagvir Singh is founding partner, Jupiter Law Partners.

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