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International firms sense opportunity in Indias stressed assets

Publication Date: 03 May 2018 - By Market Mogul By Market Mogul

Macro Environmental, Social & Governance FX ETF/Funds Multi Asset Asia ex-China

If one happened to visit India from 2015 onwards nbsp then one would have surely sensed the mood nbsp vis- agrave -vis the new Modi government. As happens with most popular leaders who get elected, reality sooner rather than later drowns the post-election euphoria. The aura of Narendra Modi, portrayed not just as a powerful prime minister but also as the CEO of his nation, as someone who will solve the myriad problems of India with a no-nonsense style of working, strict disciplinary approach, and ability to cut through India rsquo s notoriously byzantine bureaucracy has waned rapidly. Travelling in India, apart from Modi one might have also heard of other the other Modi, Nirav Modi, and of course Vijay Mallya, the ponytailed tycoon, currently a fugitive in India and who now resides in London. Both of them, Nirav Modi and Vijay Mallya, are poster boys of the biggest economic challenge facing India: accumulation of staggering levels of non-performing assets NPAs or bad loans. Indian banks are reeling under mounting NPAs either due to wilful defaults, as in the case with the two gentlemen mentioned above or due to a genuine economic downturn India went through in 2009-10. These challenges have been compounded by PM Modi rsquo s demonetisation policies and his sluggish implementation of a national sales tax. However, there is still opportunity in the midst of this uncertain situation. Opportunity Knocks Stressed assets have earned a bad reputation after the Lehman Brothers collapse and 2008 financial crisis that followed. In India, however, they offer an opportunity which early movers and risk takers can cash in on. The total value of stressed assets in India as of June 2017 is estimated at a whopping 154bn, or ₹10,00,000 crore. In the short to medium term, the value of stressed assets can go up as the full effect of the new Insolvency and Bankruptcy Code passed by the Indian parliament begins to be felt. Stringent rules issued by the Reserve Bank of India enforcing mandatory an asset nbsp quality review by public sector banks PSBs , which hold the bulk of stressed assets, along with tough provisioning standards for stressed assets are forcing banks to clean up their balance sheets. There is a catch, however. The PSBs in India are not in the position to write off all these stressed assets. They lack the necessary capital to absorb all the losses incurred by doing so. In fact, NPAs exceed the net worth of many banks according to McKinsey. nbsp Indian banks are still operating under Basel II capital reserve requirements, and things will get worse for them whenever they switch to Basel III conditions. These banks will have to sell off their bad assets. Here asset reconstruction companies ARCs and other institutional investors, mainly private equity PE firms, enter the scene. India has 24 active ARCs. These ARCs issue security receipts SRs to investors to fund their acquisition of stressed assets from the banks. The value of SRs depends on the value realised from turning around stressed asset. Under the new law, nbsp defaulting promoters are at the risk of losing their assets. The new code restricts these promoters from bidding for the stressed assets in an auction. This prevents promoters from bidding above the market price to gain control of their assets once again. Non-involvement of promoters in the bidding process has resulted in a more competitive acquisition price. nbsp With the nbsp global economy improving, and Indian government taking active steps to rejuvenate sectors which a lot of stressed assets operated in, ARCs have a much higher chance of realising profits from the assets. Long delays, though, in implementing many projects in these sectors have made net present value NPV of many of the assets negative and have also pushed down the internal nbsp rate of return IRR . Yet, despite clumsy action on economic reforms, the current government rsquo s initiatives to solve industry-specific problems have begun to show positive results. Recovery According to TN Ninan, Chairman of Business Standard, a highly rated Indian business newspaper, 2018-9 will be a year of recovery for India. As the Indian economy picks up, the returns on stressed assets will be handsome. nbsp Industrial production is up and inflation is within the target range set by monetary authorities. Exports have also started showing real growth and capital inflows are strong. nbsp As domestic and global demand picks up, fixed assets will reach optimal capacity utilisation. nbsp Consequently, prices for stressed assets will rise leading to handsome gains for investors who bought these assets at an earlier more attractive valuation. PE players are already gearing up to invest in these stressed assets. The streamlining of the insolvency process will give encouragement to more and more PE firms to invest in Indian stressed assets. PE funds nbsp also hope to include in their own ARCs to buy up assets and add them to their own balance sheets. A few PE firms have partnered with Indian firms. Apollo Global Management entered into an agreement with ICICI Ventures, and Bain Capital has done likewise with Piramal. Other big institutional players like Canadian Pension investor CDPQ are also eyeing these stressed assets. Meeting with Good Results Edelweiss ARC, the largest asset reconstruction company in India, is a success story which other players in the industry can emulate. Rasesh Shah, a banker turned entrepreneur and now the CEO of Edelweiss, has changed the perception entrepreneurs have toward ARCs. ARCs are viewed less as asset strippers and more as revival mechanisms. nbsp Edelweiss has started using its own funds, rather than relying solely on SRs. Edelweiss was also the first in the industry to back entrepreneurs with funds in order to turnaround their underperforming businesses. The success of Edelweiss rsquo s strategy is evident from the jump in its profits, from ₹340m in 2014-15 to ₹450m 2015-16, nbsp and to around ₹600m nbsp in 2016-17. nbsp Turning around distressed assets is a niche opportunity for nimble and skilled players but it is not without its risks. However, it does present an opportunity for those able to navigate the sector. But with India returning to the levels of economic growth seen before 2009, things are looking less and less stressful. This nbsp post first appeared on The Market Mogul.


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