Credit investing

Distressed debt: Why India must make friends with the vultures

Sitting on a half a trillion dollars of non-performing assets, India’s desire to lift growth should be enough to allow foreign investors to fully tap the country’s distressed debt market. However, there are two major impediments to change.

India’s indigenous vulture population may have been driven to the brink of extinction over the past few decades, but a new variety has been circling the country in anticipation of rich pickings.

Over the past five years, the world’s distressed debt investors have increasingly viewed India as one of the most attractive opportunities there is. Its stock of non-performing assets has a face value of half a trillion dollars and there can be little doubt that a speedier resolution of stressed corporate and financial balance sheets would lift GDP growth and get credit moving again.

Foreign investors also have cheap capital aplenty after years of easing by central banks across the Western world. And as Phoenix Legal partner Aditya Bhargava told FinanceAsia, “They’re keen to deploy it.”

The problem, if it can be described as such, lies with the government. After spending decades trying to keep India Inc in local hands, it still maintains stringent foreign exchange controls to prevent capital flight and ensure that foreign inflows and outflows do not de-stabilize the economy.

It is understandably wary about solving one problem with foreign capital, only to create new less controllable ones further down the road. It has been making moves in the right direction, but is it getting close to fully embracing the capital, which foreign investors can offer?

Theron Alldis, an Indian expert at distressed asset trader, SC Lowy, certainly hopes so.

“The irony is that the strict regulations were put in place to protect Indian companies from foreign exchange fluctuations,” he commented. “The problem is that it’s now having the opposite effect; preventing them from accessing the financing they need."

First: the good news. Debt and bankruptcy resolution has been revolutionized since the government enacted the Insolvency and Bankruptcy Code (IBC) in 2016 based on the UK model. Where once it took four years to resolve cases, the government mandated a time period of less than a year.

The code represented one of the key initiatives of prime minister, Narendra Modi’s first government. Since then, there have been multiple directives to streamline things further.

In July 2019, for example, the Reserve Bank of India (RBI) issued a new directive providing a template for entities to recognize and report defaults. It also gave them a 30-day period to devise the broad terms of a resolution strategy followed by the signing of an inter-creditor agreement (ICA), which needed to be approved by 75% of lenders by value or 60% by number. The new rules also required clarity on whether legal proceedings would be initiated.

In the second half of last year, two key cases tested the IBC’s effectiveness and in one case, was found wanting. 

Last July, the National Company Law Appellate Tribunal (NCLAT) created a stomach churning moment for the debt reconstruction industry when it ruled that secured creditors (banks) and unsecured creditors (suppliers and vendors) should be treated equally in the bankruptcy of Essar Steel. The Supreme Court overturned the judgment in mid-November, prioritizing secured creditors and allowing the resolution plan that the ICA had agreed to proceed.

“That decision was hugely important,” Alldis commented. It particularly affected SC Lowy, which had purchased a portfolio of Essar Steel loans from Bank of Baroda at around 70% of face value earlier in the year.

The second case concerns the bankruptcy of non-banking financing company (NBFC) Dewan Housing Finance Corp (DHFC), which defaulted after delaying a commercial paper payment in June 2019. This is the first bankruptcy testing the code’s applicability to the financial sector.


Since Infrastructure Leasing & Financial Services (IL&FS) imploded in September 2018, the NBFC sector has been enduring a liquidity squeeze.

It is a big issue because the sector accounted for 25% of outstanding credit prior to ILF&S’s demise, according to HSBC calculations. And it had grown so big because traditional banks were not lending to the wider economy thanks to a debt overhang from an earlier lending binge.

Since August, the government has tried to credit flowing via 135bp in interest rate cuts. It has also enabled the most highly rated NBFCs to begin tapping the international bond markets for the first time helping to widen their funding sources.

However, analysts argue that the primary bond market is still largely shut to most NBFCs, signalling a poor credit transmission system. Credit Suisse also points out that weak M3 credit growth is holding the economy back.

For the 2019/20 Fiscal Year, the Indian government is forecasting 5% GDP growth, down from 6.81% the year before. This represents its lowest level in 11 years.

This coming fiscal year, supranational organisations like the World Bank and Asian Development are forecasting that GDP growth will stay flat in a 5% to 5.1% range. However, both forecasts were issued before India was faced with higher oil prices thanks to rising tensions in the Middle East.

Economists say the country’s balance sheet malaise has never been fully overcome and in certain sectors is getting worse. Typical is the view of HSBC chief India economist, Pranjul Bhandari and his team.

“For a time it was forgotten as India’s economy got a welcome boost from falling oil prices, a surge in shadow bank lending and a rise in public sector investment,” he commented.

This means that while the overall banking sector’s non-performing loan (NPL) ratios are now dropping from double-digit levels, there are still potential flashpoints as the weakest NBFCs continue struggling. HSBC research points out that the corporate sector’s debt-to-equity ratios are also still trending up, from the mid 30% level in 2004 to almost 80% at the end of 2019.

The credit rating agencies agree. In a mid-December report, Moody’s said that real estate companies and the NBFCs that lend to them are “under a lot of stress.”

Underlying it all is the classic asset-liability mismatch: financial institutions relying on short-term wholesale funding lend to projects with long-term repayment schedules.

However, where distressed asset investors are concerned, this combination of impaired assets with tentative signs of economic bottoming are the perfect breeding ground for good returns.

Local bankers say the return threshold for most of these funds lies around the 25% mark on a US dollar IRR basis, embracing four to five percentage points of hedging costs on rupee-denominated returns.


There are currently two factors holding the industry back. The first concerns India’s external commercial borrowing (ECB) guidelines.

Over the past year, the RBI has made it a lot easier for Indian borrowers to access foreign currency funding. But that is only if the credit is investment grade rated, or has a high non-investment grade rating.

This pretty much excludes the entire distressed asset universe. The issue lies with the government’s mandated pricing cap of 450bp over Libor, which equates to a yield around the 6% plus mark.

Both Phoenix’s Bhargava and SC Lowy’s Alldis thinks it makes sense to amend it. “We’d like to see the ECB cost of capital cap waived within resolution plans,” Bhargava commented. “This wouldn’t make any difference to potential court processes, but it would make it a lot easier to finance resolution plans once creditor groups approve them.”

Alldis adds that this rule change would not expose borrowers to foreign exchange risk given the government’s existing rules governing hedging 70% of exposure.

The second factor stymieing greater foreign involvement concerns rupee-denominated funding and direct asset purchases. Foreign distressed asset investors say the rules are not clear-cut, adding that in practise, local entities will only sell assets or loan portfolios to Asset Resolution Companies (ARCs).

Technically, foreign investors can buy ARCs, or apply for their own license. But many say the application process is slow and time consuming, compounded by the fact that the license granting criteria is extremely opaque.

Right now, the preferred option is co-investment alongside ARCs, or plough money into Alternative Investment Funds (AIFs). There are about 30 in India, but again, foreign players remain frustrated because only a handful have enough capital, or the commitment to invest.

The two leading ones are Edelweiss via its $1.34 billion Alternative Asset Advisors Fund (EISAF) II and Kotak, with its $1 billion Kotak Investment Advisors.

“It’s unfortunately a very cumbersome process and the requirement for co-investment creates bottlenecks,” Alldis explained. “We’d really love it if this was changed.”

The regulations also state that the ARCs have to subscribe to at least 15% of the security receipts (SRs), which are issued against NPLs. They have to maintain this ratio until redemption.

SC Lowy set up its Indian office in 2018 after starting to buy distressed assets one year earlier from its Hong Kong base.  Alldis says the country is now starting to attract the attention of more players from London and New York, building on existing regional interest from global funds based out of Hong Kong and Singapore.

Recent estimates suggest that, so far, about $5 billion has been raised and earmarked for India’s distressed asset sector.

One of the first foreign players to set up in India was Bain Capital, which established an India Resurgence Fund (IndiaRF) in association with Piramal Enterprises back in 2016 to invest in stressed assets. In December last year, the Canada Pension Plan Investment Board (CPPIB) invested $225 million into it, following a $100 million commitment from the IFC in 2018.

In 2017, KKR applied to set up its own ARC. Later that year, Blackstone invested in International ARC, building to a controlling interest.

Then in 2018, Varde entered into a 50/50 joint venture with Aditya Birla Capital's Asset Reconstruction Company (ARC), while Cerberus set up an office at the end of the same year.


One area where foreign investors feel they have more freedom lies in the NBFC sector because they can bid for portfolios of financial assets and then securitize them, something that is not possible with a manufacturing company.

Alldis says this sector and structured deals are where “the immediate opportunity lies.” Last year, SC Lowy securitized DHFC’s 360 West, although as Alldis points out this sadly was not enough to save the NBFC from going under.

In October, a KPMG audit concluded that loans were being diverted to promoters.  A lack of faith about the governance across the financial sector is a recurring theme.

Investors have also had issues about asset seizures. However, the government issued new clarifications in December, putting enhanced powers into the hands of creditor groups.

They now have control over the distribution of assets. Resolution plans are also now binding on all stakeholders including the central and state governments.

The government has also made it easier to put creditor committees in place by lowering the voting threshold to 50% of those present voting in favour.

And it has also cleared up concerns about the potential for lengthy court cases to eat into investors’ returns. The deadline to complete corporate insolvencies has been extended from 270 days to 330, but it now includes time spent in litigation.  

Foreign investors argue that many companies and distressed NBFCs would not need to liquidated or be forced into the bankruptcy courts in the first place if they had more freedom to provide them with rupee or dollar-denominated funding.

Yet while frustration prevails, the government has moved a considerable distance over the past few years. And while the pace is not fast enough for the hedge funds and distressed asset traders beating a path to its door, many are gaining valuable experience in tandem with AICs and ARCs. This should then able them to branch out on their own as the government liberalises further.

Alldis sums up the view of many when he says that, “India was very much flavour of the day until the NCLAT judgment regarding Essar. Since then, there’s more caution but the general sentiment is broadly positive.”

He concludes that, “there’s still a decent amount of liquidity chasing opportunities in India.”

¬ Haymarket Media Limited. All rights reserved.
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