The Insolvency and Bankruptcy Code has got cracking on the bad loans problem of the Indian banking system, but can it clean up the mess?
India: As the Insolvency and Bankruptcy Code (IBC) completes its second
anniversary, it is proving to be every bit the game changer it was hailed to
be. Some of the largest and most complex cases in the banking system are in the
process of being resolved, with the lenders expecting to make significant
recoveries, albeit with a haircut.
As
things stand, there is a clear visibility on the resolution of the Reserve Bank
of India’s (RBI) so-called dirty dozen, a group of 12 corporate defaulters,
which accounted for the single-largest share of non-performing assets,
amounting to ₹2.77 trillion.
In
May, debt-laden Bhushan Steel Ltd earned the distinction of being the first
successful resolution under the IBC, when it was acquired by Tata Steel. The
NCLT on Thursday approved the bid of AION Capital-JSW Steel to acquire Monnet
Ispat & Energy Ltd. Others such as Essar Steel, Monnet Ispat, Alok
Industries and Amtek Auto have also received significant buyer interest and are
likely to witness a change in ownership sometime soon. Outside the dirty dozen,
Binani Cement’s bankruptcy resolution process grabbed eyeballs, with binding
bids from several suitors. The highest bid exceeded Binani Cement’s total
outstanding debt. Although the decision on the final ownership of the company
is sub-judice, instances such as these prove beyond doubt that that for both
banks and defaulting promoters, status quo was no longer an option under IBC.
The journey so far
There had been several concerted efforts to resolve the bad loans
problem before the IBC became operational on 21 July 2016. However, resolution
mechanisms such as strategic debt restructuring (SDR) and sustainable
structuring of stressed assets (S4A), made little difference. Industry watchers
say the failure of these schemes stems primarily from the reluctance of
creditors (mainly public-sector banks or PSBs) to approve haircuts in
distressed asset deals, often a prerequisite for a resolution.
According
to industry experts, bankers were apprehensive and, in many cases rightfully
so, as they could have been held liable for selling the asset too cheap and be
accused of complicity and corruption. Introduction of the IBC has ensured that
buyers acquire cleaned-up assets without any hidden liability. Bankers are also
protected by the law to approve transactions for values considered optimum,
without any fear of being hauled up by regulatory agencies for alleged
corruption.
Besides, mindful of the impediments in successful
resolutions, the government and RBI have worked towards creating a level
playing field by effecting changes not only to the bankruptcy laws (amended in
2017 to prevent corporate defaulters from bidding for distressed assets), but
also to the entire ecosystem. One such measure was to raise the minimum upfront
payment by asset reconstruction companies (ARC) from 5% to 15%, which
discourages the use of ARC platforms by lenders for long-term warehousing of
bad loans without any resolution. The fear of errant promoters playing the
system to their advantage has also been addressed by a fair margin.
While
the insolvency regulations have stopped defaulting promoters from bidding for
any distressed asset, the involvement of multiple stakeholders in the
resolution process has ensured transparency and propriety, so much so that even
when decisions were challenged in court, it passed legal scrutiny. In the case
of Essar Steel, for instance, Numetal had to drop Rewant Ruia as a shareholder
as he was closely related to the promoters of the debt-laden steel major, to
remain eligible for the bid.
Investing in a perfect storm
With the dirty dozen potentially out of the way, the focus has
turned to the new cases. As per industry estimates, cases involving 150 firms,
each owing at least ₹2,000 crore, need to be resolved by August, else, they
will be referred to the National Company Law Tribunal (NCLT) for bankruptcy
proceedings. Industry watchers say there was a high probability that a large
number of these cases will finally end up in the NCLT.
While
some of these cases are expected to be resolved through a change in ownership,
many are expected to be liquidated. This, in turn, will bring in vulture funds
and strategic buyers, who have been patiently waiting on the sidelines, instead
of bidding for the distressed firms, to snap them up at cheaper prices when the
liquidation process begins. Such dealmakers include foreign and domestic
distressed asset funds, including Edelweiss, Blackstone, KKR, Piramal-Bain and
Aion Capital among the old guard, and newer entrants such as Varde Partners,
Blackrock group, Cerberus Capital and Oaktree Capital. Among existing funds,
many have already set up ARCs to acquire loans from lenders, which is part of
their overall distressed assets play in India.
The IBC is also proving to be a credible deterrent for
defaulting promoters, who run the risk of losing their assets. This, in turn,
has opened up opportunities for distressed and special situation funds, which
can refinance and close the funding gap between bank credit and internal cash
flows. Sample this: India Resurgent Fund (IRF), a joint venture between Bain
Capital Credit and Piramal Enterprises, recently bought out the entire debt of
Chennai-based Archean Chemical Industries from a consortium of PSBs. Further,
IRF had invested about ₹800 crore in the company, in a mix of debt and equity,
to help the company restructure its cash flows. The structured deal involves an
annual interest of 16% on debt, as well as on equity through a share of the
Ebitda on attaining certain milestones.
The road ahead
Recently, the government agreed to a five-pronged strategy
proposed by the Sunil Mehta Committee to resolve the bad loans mess. Project
Sashakt is aimed at retaining the value of the asset through operational
turnaround.
Under
the scheme, bad loans of up to ₹50 crore are required to be resolved within 90
days by the bank. For loans of ₹50-500 crore, banks will have to enter into an
inter-creditor agreement, authorizing the lead bank to implement a resolution
plan within 180 days, which includes appointing turnaround specialists. If the
lead bank does not complete the process in time, the asset would be referred to
the NCLT. For loans above ₹500 crore, the committee has recommended setting up
an independent asset management company (AMC), supported by institutional
funding or an alternative investment fund (AIF).
Industry
experts say that though the intent is right, there are still a few unanswered
questions. For e.g. Will the AMCs be truly independent or still be an off-balance
sheet subsidiary of the lenders? To
attract foreign and domestic institutional investors, the loans have to be
transferred/sold to the AMC at enticing prices. Moreover, the governance of the
AMC has to be pristine and investment decision-making framework has to be
clearly defined, so that there is alignment of interest between the
professional manager of the fund and the stakeholders, including investors and
lenders.
According
to experts, there are a few gaps that merit attention. Creditor classes need
separation; clubbing divergent interests into the same voting class is leading
to inefficiency and some malpractices. Next, there needs to be a strong focus
on much better collation and early dissemination of information. As yet, unduly
tedious procedures and unreasonable costs are limiting investor participation.
Also, creditors need to ensure resolution process rises above statutory minimum
thresholds towards achieving better outcomes.
Despite
the concerns, if the AMC model is successful, it will act as a market maker in
distressed asset deals. However, there should be some clarity on who will
manage the resolution process.
Unlike
in IBC, where the appointment of a resolution professional is a statutory
requirement, there has not been any word on who will manage the entire
resolution process of cases under Project Sashakt. Besides, the government must
find ways in the IBC mechanism to bail out smaller operational creditors from
acute distress when bigger firms fail to pay up.
IBC
is still a work in progress, but in all probability, it could prove to be the
key to solving India’s bad loans mess.
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