Founded by former Mittal Steel official Jai Saraf, the company returned shortly after the Insolvency and Bankruptcy Code (IBC) took effect in India.
Its second outing is already looking better than the first. Its initial successful attempt was in a bid for Uttam Value Steels and Uttam Galva Metallics, as part of a consortium. While the lenders picked the consortium as the preferred bidder, the matter is now in the National Company Law Tribunal (NCLT), the arbitrator of IBC cases.
Nithia Capital is among a number of players that are scoping to acquire debt and distressed assets, hoping to extract value from complex situations. There’s the Liberty Group from the UK, distressed funds like SSG, or private equity players such as Blackstone and Bain which are all actively courting distressed assets or companies destabilised by debt. In such deals, lenders agree to write down a substantial chunk of what they are owed, and investors make an offer for the value of the remaining debt plus the assets of the company.
This build-up of companies that are unable to service their debt has been ongoing since 2012. This has translated into a high share of defaulting loans, also known as non-performing assets (NPAs), on the books of banks. In March 2018, this peaked, at 11.75% of total lending, sparking concerns about the health of the banking system. The insolvency and bankruptcy process, which kicked off in 2016, had provided a safety valve, reducing the burden on lenders from businesses gone bad, and allowing good parts of a failing company to make a fresh start under new promoters.
Today, however, there is a reason to be concerned that even as the old cases are winding through the IBC process, a new set of companies are flirting with insolvency, thanks to the ongoing liquidity crunch sparked by the collapse of the Infrastructure Leasing & Financial Services (IL&FS) in September last year.
There are multiple signs of rising debt distress. The gross NPAs for the quarter ended June 30, 2019, halted the downward trend seen in all the four quarters of 2018-19, and inched up again. Last month, a report by Credit Suisse (CS) on debt in Indian companies pointed out that signs of a second wave of stressed loans can be seen in the new Inter-Creditor Agreements (ICA) being signed. An ICA is a process for resolving bad loan situations ahead of the formal insolvency process. The report noted that even though the gross NPA levels fell to 9.6% in the April-June 2019 quarter, from 11.75% in January-March quarter of 2018, if one adds the Rs 2.4 lakh crore worth of loans under ICA, for 16 debt-ridden companies, to the NPAs, the total stressed loans would exceed 12% of total lending. Out of the total debt in ICAs, 49% relate to financial sectors.
Ashish Gupta, MD and head of equity research at Credit Suisse, pioneered the tracking of debt situation of Indian companies in 2012. He uses the metric known as interest cover (earning before interest and tax, or EBIT, divided by interest payout obligations in a year). This means if a company’s operating profits are just sufficient to cover its interest obligations for that year, the figure would be 1. An interest cover less than 1 means a company has to find a way to fund the difference. A company with interest cover of less than 1.5 is typically watched closely for debt distress.
“A second wave is getting started because of the stress at the non-banking financial companies,” Gupta told ET Magazine.
The report adds that corporate stress is also high as the aggregate interest cover for listed Indian companies fell to 2.3 from 2.7 over the preceding year.
There are some silver linings, though. This time the debt build-up is being managed right as it unfolds. The IBC, even though it has slowed down, is acting as a major pressure valve. “With the IBC, the fear is gone to a large extent,” says Nithia’s Saraf. He adds that he hopes the ICA mechanism, too, will see banks taking a proactive role in accepting haircuts on their receivables.
An X-factor here is the big PSU (public sector undertakings, or state-owned) bank mergers announced by Finance Minister Nirmala Sitharaman on August 30, bringing down the total number of PSU banks from 27 to 12. The resultant banks, with greater heft, will be able to make faster and bolder decisions about debt resolution. But on the flip side, the period before and after the merger might see organisational flux, hampering decision-making.
A study of BSE 500 companies (excluding the banking and financial services sector), done by the ET Intelligence Group (ETIG), shows that the actual number of companies with interest cover below 1 has fallen over the last few years.
The number of such companies fell from 59 in 2013-14 to 39 in 2018-19. In terms of the sheer number of debt-heavy companies, that is a 33% drop. The number of companies with interest cover between 1 and 2 also showed a decline from 53 in 2013-14 to 37 in 2018-19.
There is some hope for further redemption in an environment where interest rates are going down. Elara Capital, in a report dated September 19, says it expected a sharp 50 bps cut in rates by the Reserve Bank of India in October. The report says: “We can expect interest expenses of highly leveraged corporates to drop meaningfully and shore up their net income as early as the third quarter of FY20. Our analysis suggests that a 100 bps reduction in interest rate will expand the NSE 500 (excluding financial sector) net income margin by 480 bps.”
Credit Suisse’s August report points out three clear areas of stress. The first being the continued corporate stress, it says that companies with interest cover of less than 1 had 42% of the debt, effectively putting 42% of outstanding debt under a cloud. Second, the huge amount of stressed debt being handled through the ICAs indicates that the market is viewing the IBC process as inadequate, almost certainly on account of speed. The third area of stress is the liquidity that used to be available through the shadow banking sector. The CS report says it is likely some debt restructuring may happen in the shadow banks, too, through the ICA route.
Learnings from the Battlefield
Much of the unfolding difficulties relates to NBFCs (non-banking financial companies) and started with the default by IL&FS in August 2018. The bad news was followed by news of stress at Zee, Dewan Housing Finance Corporation and the Anil Ambani-promoted Reliance Group. The exposure of the mutual funds industry, especially debt mutual funds (as opposed to those that invest in equity), to NBFCs, also came to the fore. By May 2019, the share of debt mutual funds to the total assets under management by the mutual funds industry fell to 29%, compared with 35% a year ago.
Apart from the banks, NBFCs also borrowed from the mutual funds industry, and redemption pressure from the mutual funds has compounded the woes of the NBFCs.
A former president of the Association of Mutual Funds, who asked not to be named, told ET Magazine that the mutual funds industry should have done a better job of explaining the difference between a bank fixed deposit and a debt mutual fund that invests in bonds and has marked-tomarket risks. “The fixed income teams at mutual funds would usually be 4-5 people strong. Compare that to the huge teams that banks are able to deploy to their fixed income assets,” he points out, admitting that the mutual funds industry made mistakes along the way, while scrambling to climb the assets-under-management league table.
Sundeep Sikka, CEO of Reliance Nippon Life Asset Management Ltd, says the mutual funds industry may finally take a good turn after the crisis. “Unfortunately due to various challenges in the economy, debt schemes have had some problems.
Whenever investors lose money, it does not look good for the MF industry. I am confident that learnings from recent events will help the industry in the future,” he adds.
Gupta and his team say this is an ideal situation for debt restructuring at NBFCs.
They hint at management change at some big NBFCs when they write: “In the recent finance bill, the RBI has been given powers to restructure/merge/de-merge NBFCs in the interest of financial stability.
We, therefore, expect that debt restructuring of some NBFCs may be accompanied with restructuring of the corporate entity.”
The role of the RBI as well as the government will become key as the nature of India’s NPA problem has undergone a change over the last one year. The stressed debt has suddenly grown again in absolute numbers and the financial sector itself has got troubled, moving the epicentre away from steel and power.