Asset owners and fund managers are fast ramping up the amount of capital they commit to India’s soured-loan market as the government continues pushing for a cleanup of bank balance sheets – but a new ruling by the country's Supreme Court underlines the difficulties involved.
On Tuesday (April 2) Supreme Court dismissed the Reserve Bank of India’s (RBI) directive that banks should restructure bad loans within 180 days. This comes as the restructuring of Essar Steel, one of the country's biggest conglomerates, takes much longer than envisaged (nearly two years so far), highlighting flaws in the new bankruptcy law introduced in 2016 to speed up and add certainty to the debt-restructuring process.
The Supreme Court's move is a “double-edged sword for investors looking at the distressed asset class in India”, Jamie Tadelis, head of sales at Hong Kong-based boutique investment bank SC Lowy, told AsianInvestor.
Stressing that a detailed judgment is yet to be issued, Tadelis said: “On the one hand, [the Supreme Court ruling] disincentivises banks to clean up their non-performing loans (NPLs) and may, in fact, push banks to simply ‘amend and extend’ rather than declare such loans delinquent.”
“This would result in far less activity for secondary investors in the market,” he added.
On the other hand, Tadelis said, the ruling may provide banks with greater flexibility for out-of-court settlements with sponsors, particularly those that had not acted in bad faith. As such, the banks could choose to sell the loans or partner with investors with restructuring expertise to maximise value for creditors.
“It remains to be seen how this plays out,” he said.
LACK OF PRECEDENTS
Asset owners in Asia have increasingly invested in private loans and distressed debt funds as they seek to diversify and improve returns. And the relatively recent bankruptcy law introductions in India and China have offered hope of new opportunities in the world's second- and sixth-largest economies.
But the lack of precedent for debt restructurings has led to the slow progress on restructuring and loan sales and means institutional investors and the restructuring experts they use will need to be patient, at least in India's loan market.
“Admittedly timetables for resolutions have slipped in some of the larger situations like Essar Steel and Bhushan Power & Steel,” Tadelis said. “However, in exchange for such slippage, impactful case law is being created, which should pave an easier path for future cases.”
SC Lowy has bought loans from Indian banks, including Essar Steel loans at 50 to 70 cents on the dollar.
The lack of precedents for sales processes may have caused investors to execute less NPL restructurings than they would like, agreed David Lee, head of the special situations group at Hong Kong-based CLSA Capital Partners.
In addition, for certain sectors like power – which account for a large share of the NPL pool – there is a lack of clarity on the impact on a formal bankruptcy process on key contracts, Lee told AsianInvestor.
He also pointed to the challenge of getting, 15 or 20 bank syndicates to agree on a price for, or haircut on, the assets under the new bankruptcy process.
“Corralling all the banks to agree on a price for their debt is not an easy exercise, which is a problem the entire market is facing.”
Another downside of the new bankruptcy process, Lee noted, is likely to be lower than anticipated returns. Reducing the post-investment execution risk means the performance expectations on these deals should be lower than for a secondary and restructuring transaction funds in other markets.
Just over half (55%) of investors said they would seek an 11-15% return on Indian NPLs, while the rest targeted at least 16%, according to a survey published in March by law firm Ashurst (see graph below).
Ultimately, the lack of precedents for special situations reflects the difficulty of such investments across much of the region.
The Asian market is very different from that elsewhere in the world, “where you’ve got a long series of precedents and cases and well-trodden ways in which businesses are restructured and legal systems you can rely on for very predictable, timely outcomes”, said Brian Dillard, head of Asia credit at US alternative investment giant KKR.
“In Asia, these discussions become very complicated, very nuanced,” he told AsianInvestor. “You need to go negotiate with a series of local creditors, local banks and local constituencies to come up with a restructuring plan.
Hence the need for a large team on the ground: KKR, for instance, has 35 professionals in Mumbai across credit and special situations and private equity.
In addition to local staff, investors need a local partner for transacting bad debt.
To buy distressed non-performing assets in India, you need an asset reconstruction company, as they are the only entities that can hold Indian loans from the banking system, noted Haseeb Malik, head of Asia corporate and traded credit at US alternative investment firm Varde Partners.
“You can either build your own, as we’ve chosen to do with [local conglomerate] Aditya Birla as a joint venture, or you can rent it from others who already own these capabilities.”
Aditya Birla provides a strong local presence and history, banking relationships, sourcing ability and a platform, noted Malik, while Varde provides expertise around distress, fundamental analysis and global valuations and industries. Varde announced the JV in August last year and opened an office in India at the start of 2019.
It's early days still for the Indian private debt market but that, in part, is what makes it inviting for some in the field.
“It’s going to be slow and, at times, a frustrating process as this market is truly in its infancy, but if you’re a first mover in the process you have an edge, and that first-mover advantage is now,” Tadelis said.
“It took years and years of litigation to build case law, and subsequent amendments to the codes for the US and the UK bankruptcy regimes, to get to where they are today – regimes that continue to evolve,” he added. “India will need to undergo a similar process with its new code and tribunals. It’s foolish to think otherwise.”
This article has been updated to inlude the graph showing target returns for Chinese and Indian non-performing loans.
See the forthcoming Spring 2019 issue of AsianInvestor magazine for a feature on how and why the focus is rising on distressed debt and special situations investment in Asia.