Indian NPAs: Solvency strikes

By ordering the 12 largest distressed borrowers into insolvency proceedings last year, the Reserve Bank of India (RBI) kicked off the first major public test of the country’s new Insolvency and Bankruptcy Code (IBC). Regulators hoped to prove that the popular new law would succeed where the previous regime had failed in bringing India’s non-performing assets (NPAs), which were then reaching crisis levels, under control.

Today the RBI’s public stand seems to be paying off. Three of the so-called “dirty dozen” have been sold to strategic buyers and most of the rest are expected to exit insolvency by the end of the year. India’s banks have also started to push delinquent borrowers toward the newly-established National Company Law Tribunal (NCLT): more than 150 companies have been submitted for resolution by financial institutions so far, with another 100 expected by December.

“I think no other country in the world has introduced a code where you’ve had resolutions so quickly in a very short period of time,” says Vikram Utamsingh, a managing director with Alvarez & Marsal in Mumbai. “And the recovery for the banks is actually quite good. Before the insolvency code was passed, the banks’ recovery rate was in the range of 20%, and it’s now estimated that it could be 50% or more.”

Many investors have seen this moment building for some time, and a few foreign firms have spent the last few years laying the groundwork to catch the wave of NPAs when it finally crested. Now these early movers are ready to capture the flood of turnaround and restructuring opportunities expected over the next five years.

Popular policy

The IBC passed in 2016 amid a groundswell of public outrage at high-profile corporate collapses like Kingfisher Airlines, which ran up nearly INR65 billion ($897 million) in debt before it shut down in 2012. The flight of Kingfisher founder Vijay Mallya into exile in the UK in 2016 prompted further demands that the government impose some discipline on corporate barons, who were widely perceived as immune from consequences for their irresponsibility.

This public call for action dovetailed perfectly with the government’s growing concerns about the burden NPAs were putting on the banking system. By the end of 2015, gross NPAs across all financial institutions had grown to INR8.5 trillion, accounting for 4.9% of all loans in the banking system, and the banks were finding it increasingly difficult to issue new loans. The problem has only gotten worse since then. By last year gross NPAs had more than doubled to INR20.7 trillion, representing 10.5% of loans in the country.

India’s existing bankruptcy regime, the Board of Industrial and Financial Restructuring (BIFR), was widely blamed for the accumulation of bad debt. The strong protections for borrowers built into the system meant that bankruptcy proceedings could be stretched out for years.

“I used to call it Hotel California – you can check in, but you can’t check out,” says Ravi Chachra, a portfolio manager at distressed asset specialist Eight Capital Management. “And the courts had no teeth. They could come up with a suggestion on how to restructure a company, but the owners did not have to agree to it. As a result these companies would never be fixed.”

With debt capital urgently needed to finance a broad platform of infrastructure improvements, the two major parties – Prime Minister Narendra Modi’s BJP and the opposition Indian National Congress – both gave a majority vote to the IBC. The combination of bipartisan parliamentary support and a broad popular mandate meant that the new law had backing for its tough new measures aimed at debtors.

Even before the IBC, overseas investors had begun to see India’s NPAs as a compelling investment opportunity. By 2016 a number of global firms had set up partnerships with Indian distressed asset specialists: Apollo Global Management partnered with ICICI Bank to launch Aion Capital Partners, Brookfield Asset Management launched a distressed asset vehicle with the State Bank of India, and JC Flowers formed a JV with Ambit Holdings. Bain Capital Credit also joined the fray, partnering with Piramal Enterprises to launch the India Resurgent Fund (India RF), which is looking to raise $1 billion for its debut vehicle. 

“When we first kicked off the platform we expected that the opportunity set would be more around recapitalizing stranded and distressed assets and identifying promoters we could work with on an ongoing basis to do that,” says Barnaby Lyons, a managing director and Asia head of Bain Capital Credit. “The IBC has changed that landscape, making it possible to also buy those assets out of the bankruptcy process fully, buy debt as it goes into the process, or help resolve assets before they get that far.”

India RF has been an active player in the insolvency proceedings. The firm joined JSW to submit an offer earlier this year for Bhushan Steel, one of the dirty dozen, though they were outbid by the Tata Group. In addition, India RF is part of a consortium that is currently bidding against UltraTech Cement for Binani Cement.

Speed and certainty

Of the changes introduced by IBC to the bankruptcy regime, two are most frequently cited by investors. The first is the consolidation of India’s various restructuring boards into a single body, the NCLT, with a unified procedure for handling insolvent companies.

Of even greater importance is the strict time limit on resolution of proceedings. Once the NCLT has accepted a plea for insolvency, it appoints an insolvency resolution professional who must present a resolution plan within 180 days (though this can be extended by up to 90 days). If the tribunal does not receive a plan, liquidation proceedings begin automatically.

There are some exceptions to this time limit – for example, several of the companies that the RBI referred for insolvency proceedings last year still have not finished the process due to legal challenges. But rather than undermining the system, these delays are seen as an acceptable element of flexibility in an enforcement regime that has resulted in strong compliance overall.

“Because it’s timebound to nine months, the entire ecosystem works to achieve a resolution of the case, whether it’s the creditors, the advisors, the bidders, or the lawyers,” says Utamsingh. “There are some delays taking place because of court disputes, but even then, the cases are typically extended from nine months to 15 months – they don’t go from nine months to several years, as in earlier restructuring schemes.”

With the bankruptcy code fundamentally rewritten, many foreign investors see a rare opportunity to enter a market where all the local distressed asset specialists are, for the moment, on the same level as their overseas counterparts. As one investor put it, the rules are new for everyone: all players will have to work together to build up the new regime, and firms with experience in distressed asset investing have a lot to offer in building up the bank of experience. 

Foreign investors have also benefited from the government’s growing eagerness to attract overseas capital to help resolve India’s bad debt problem, which is seen as too big for domestic investors. This has led to the relaxing of some restrictions that previously hampered the ability of overseas firms to maneuver.

“A few years ago a foreign buyer might have been disadvantaged compared to a domestic buyer, because there was a lot more flexibility for domestic parties and optionality that wasn’t available to foreigners,” says Sarit Chopra, a managing director at Bain Capital Credit. “All that has now changed quite a lot – it’s still not entirely a level playing field, but today, for example, foreign buyers can own 100% of an asset reconstruction company whereas previously they would have needed a local partner.”

Local ties

Despite the easier environment for foreign firms, participants tend to agree that local partners are essential due to their industry connections. Personal contacts at all levels of the banking system can help identify opportunities that are about to emerge, while teaming up with an established player opens doors for a newcomer that might stay shut for years otherwise.

Firms that have already established their local operations see a vast range of opportunities, with all sizes and sectors represented. Some global firms are focused on the largest deals, which also tend to be the most visible. Others are more excited about the middle market, where the strengthened insolvency regime has made many promoters eager to avoid a process where they fear they will be disadvantaged.

“One of the interesting extensions of the opportunity is it doesn’t have to be fully distressed corporates,” says Ilfryn Carstairs, co-CIO at Värde Partners, which recently partnered with local investor Aditya Birla Capital to launch a distressed asset JV. “There are corporates that aren’t about to enter an insolvency process, but they see the writing on the wall – they have healthy assets in lots of parts of the corporate structure but one asset that is hard to finance. That is where you are seeing the demand for special sits loans, rescue lending or hybrid financing.”

With the distressed assets potentially coming to market in India set to dwarf even the largest investment vehicles, investors expect to have no difficulty deploying capital. The challenge will be identifying troubled companies with the best prospects for a reversal of fortune, where an investor can bring the greatest value.

“We’ve seen very interesting cases of vibrant businesses with good management that has been starved of working capital in a down cycle, and we have an opportunity to get a control position at a good valuation,” says Rahul Gupta, co-group CEO at Ambit Group. “We are not looking to sell the assets, we’re looking at turnaround stories, and so these are very interesting opportunities for us.”   

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• Topics
• South Asia
• Credit/Special Situations
• Buyouts
• Restructuring
• Regulation
• India
• Bain Capital Asia
• Varde Partners