Unclogging India

“Over the last two years we’ve seen a situation of volatility, virtually non-existent equity capital markets, and thus, we believe the capital raising environment has shifted to favour credit in India”, says Karthik Athreya, director at Clearwater Capital Partners.

His firm is one of several poised to take advantage of the opportunity as banks move to clean up their balance sheets and private lenders offer credit not available from the domestic banking system.

Leverage in corporate India is at its highest level since the late 1990s, according to Morgan Stanley, which places additional strain on a banking system which has seen distressed loan numbers reach a cyclical peak.

ICICI Venture and Apollo Global Management are raising a $500 million special situations fund in India, and Apollo senior partner Mintoo Bhandari told Private Debt Investor  last year that the firm was seeing a rich offering of opportunities to pick from as 5,000 of the 40,000 or so corporate loans in the country were not performing.

Stressed assets at Indian banks, including bad and restructured loans, rose from 4 percent of total loans in 2009 to 9 percent in March 2013. Around INR 2 trillion ($32.2 billion; €23.5 billion) in loans is now classified as bad loans and at least INR 4 trillion is being restructured. Total stressed assets are expected to reach 14 percent by March 2015, according to India Ratings and Research, the local unit of Fitch Ratings.


The RBI steps in

To encourage early restructuring or sale of these assets, the Reserve Bank of India (RBI) last month introduced a framework for more liberal regulatory treatment of asset sales. According to this, if a borrower’s interest or principal payments are overdue by more than 60 days, bankers must form a joint lenders’ forum for early resolution of stress.

The new rules, which come into effect from April 1, also allow for leveraged buyouts of stressed companies and encourage private equity firms to play an active role in the stressed assets market. “Appropriate incentive structures may be built so as to provide a greater role to private equity firms and other institutions in restructuring of troubled-company accounts. These institutions can be expected not only to bring additional funds for restructuring, but also bring in expertise for management of the business unit in question,” the RBI said in a statement.

“When banks start feeling pressure to offload NPAs from their books, private debt [activity] will increase because there will be a keenness among business owners to repay that debt and private debt players can also buy these NPAs from the bank,” says Ruchir Sinha, co-head of private equity and private debt at local law firm Nishith Desai.

The policy action encouraging banks to sell bodes well for GPs such as Kotak Investment Advisors, which is reported to be hoping to raise INR 38.5 billion for a fund that will buy NPLs held by Indian banks.

Kotak has bought up loans with its own capital in the past and generated returns north of 25 percent, a source close to the firm told Private Debt Investor. However, given the growing size of NPLs, the firm is now reaching out to foreign as well as local investors to address this opportunity through a fund structure.


A sectorial breakdown

Debt is inherent in sectors such as infrastructure and real estate where there is a frequent capital requirement and stabilized assets offer yield or self-liquidating returns. According to India Ratings, about 20 percent of infrastructure loans were restructured till the end of March 2013 and the proportion could increase to 30-40 percent over the next two years. However, the ratings agency expects credit losses to be contained as the long-term viability of most projects remains intact given the nationwide shortages of power, roads and quality urban infrastructure.

ArthVeda, the private equity arm of housing finance company Dewan Housing Finance, is among those looking to raise an infrastructure debt fund, offering institutional investors exposure to refinancing and distressed debt opportunities in this segment.

But India isn’t only ripe for distressed debt plays. Slowing economic growth and a decrease in bank lending has also created a scarcity of lender capital for companies looking to grow. India has always had high base rates of between 10-12 percent, so access to working capital, capital expenditure or any form of liquidity has always been fairly expensive, according to Clearwater’s Athreya. Investment grade, A or AA paper trades between 9-11 percent and anything below that rating will cost Indian companies 14-15 percent, so it is a high interest rate environment when compared to other markets across the globe.

In addition, companies that took on foreign currency borrowings have a heavier debt burden since the rupee sharply depreciated over the last year. Others seeking to refinance costly rupee loans with cheaper US dollar debt face restrictions limiting the use of external borrowing to capex alone. There are also tenor restrictions and only recognised lenders can participate.

As a result of the gap in lending, yields have risen in the last couple of years, so what used to cost corporates 15 percent is perhaps today at a 20 percent level, notes Athreya.

“So a post-tax, post hedged return of 12-13 percent for a senior secured debt is a pretty attractive one, which is possibly why smart money is already starting to move in this direction and participate in this opportunity,” he adds.