Indian Stressed Assets Opportunity

India is the worlds fastest growing economy, worlds largest democracy and the fifth largest economy, blessed with abundant natural resources, diversified & young human resource, India is a LAND of OPPORTUNITY.

This LAND of OPPORTUNITY witnessed a huge capex cycle beginning from 2005 and peaking in 2012, this capex cycle which was unbridled, unmonitored and to some extent bordered on euphoria and speculation, little wonder that the Indian banking system started getting saddled with defaults & NPAs  beginning 2013, which as of date is a mind boggling Rs 10Lakh Crores.

The gravity of the situation can be gauged from the fact that the officialy declared Rs 10 Lakh Crores of NPA is almost 50% of the total market capitalisation of all Indian Banks and more than the entire market capitalization of all the PSU banks put together. As of March 2018, the NPA Ratio was a threatening 10.8% of the total advances of the Indian Banking system, thereby India’s present NPA problem rank among the worlds worst.

If we add to this Rs 10 Lakh Crore of NPA the amount of NPAs and Stress in the NBFC sector and also add the NPAs /Stressed assets with ARCs and the assets lying locked up in 1000s of companies languishing in winding up proceedings before the HC and in BIFR or pending Liquidation with various adjudicators we could be easily glaring at an approximate figure of more than Rs 16Lakh Crores.

There is clearly blood in the Indian Financial world and herein lies the opportunity, a screaming opportunity to pick up great assets at huge discounts. Majority of these assets are world class manufacturing facilities, infrastructure projects, power projects, land banks, stalled realestate projects, service industries and of course corporates seeking bridge funding desperately.

This humungous figure of NPA and the fact that great assets are available at minimum of 40%-50% discount to fair value , when seen in the backdrop of the inherent strength & potential of the Indian Economy presents an opportunity of lifetime – certainly not to be missed.

Overview and development of Indian Insolvency laws

The first effective legislation to address the Industrial sickness in India was the SICA (Sick Industrial Companies Act) 1985, under this legislation BIFR (Board of Industrial and Finance Reconstruction) was set up as an apex board to spearhead the handling of  industrial sickness issue, including reviving and rehabilitating potentially sick industries.

To give more impetus to the financial institutions to recover their debts, it was felt that special tribunals be set up to deal with the cases of debt recovery. Therefore, in 1993 RDDBFI Act (Recovery of Debts Due to Banks and Financial Institution) was promulgated, wherein specialised Debt Recovery Tribunals (DRT) and Debt Recovery Apellate Tribunals (DRAT) were established to fast track the debt recovery process.

All these legislations were still inadequate as the there was no timeline to cases before the DRT and BIFR was used by unscruplous promoters as a sheild against recovery proceedings. Thereby SARFAESI Act 2002 (Securtisation and Reconstruction of Financial Assets and Enforcement of Security Interest) was promulgated wherein for the first time ever the secured creditor was given power and muscle to not only take over the physical possession of the asset but also to dispose off the same without permission from the courts. The SARFAESI Act also laid the foundation of ARCs (Asset Reconstruction Companies) to help the banks in Securitisation of Debt and Asset Reconstruction.

All the actions of DRT and BIFR were however thwarted by the promoters by taking final refuge by getting filed/filing winding up petitions in High Courts under the Companies Act of 1956. The Companies Act was thereby amended in 2013 to give more impetus to the process of winding up and resolution (section 230) in fact one can see the genesis of the present IBC code in the winding up sections of the Companies Act of 2013. However, this winding up process was still slow, uncertain and open to manipulations, the receiver of the assets so appointed by the courts were found wanting in the professional skills needed of the assignment.

To plug the loopholes, the SARFAESI Act and RDDBFI were further amended in 2016, however even after having updated legislations in place, the NPA problem refused to get solved, one of the major reason was a difficult attitude of the promoter (owner) and therefore there was a need to shift the prevailing structure of “Debtor in control” to “Creditor in control”. Another problem was the dithereing and reluctance by the bankers to accept and initiate pragmatic steps to solve the stressed situation due to their fear of departmental inquiry and vigilance being unleashed on them.

 Insolvency & Bankruptcy Code –The Game Changer

Need was felt therefore to enact a comprehensive stress asset resolution legislation which can provide a visible & feasible resolution achieveable in a definite time frame. Therefore the present day Insolvency and Bankruptcy Code, 2016 (IBC) was promulgated.

Insolvency & Bankruptcy Code (IBC) is a game changer, has the blueprint to execute a practical and reasonable resolution of the NPA is a timebound fashion. It is one of the best piece of legislation to happen to India, the path breaking reforms ushered by the code in the Insolvency resolution domain helped India improve its ranking in the “ease of doing business substantially”.

The spirit of the code is to find a RESOLUTION to the stressed situation, the clear objective is to save & salvage the viable business through the mechanism of RESOLUTION PLAN and to LIQUIDATE the un-viable business so that the assets imprisoned in that un-viable business could be set free to be used more productively elsewhere.

As of April 2019, about 1700 corporates have been admitted for insolvency proceedings, 88 of them have been resolved and NPAs worth more than 1Lakh crore have been resolved.

• The code ushers in the CREDITOR in control regime , bringing an end to the earlier DEBTOR in control era
• Promoter of the company is dispensed with and management is transfered to a competent registered INSOLVENCY RESOLUTION PROFESSIONALS (IRP) AND ENTITIES (IPE), appointed by the debtors
• Objective is to hammer out a RESOLUTION PLAN ie a feasible & implementable scheme of things to revive the assets , keeping in mind interest of all the stake holders and the effected parties
• Stressed Situation to be resolved within a maximum period of 270days called the CIRP (Corporate Insolvency Resolution Process) period.
• This is a departure from the earlier era wherein auction / liquidation/winding up was the first and last resort and took a lifetime to be completed
• DEFAULTING PROMOTERS and connected/related persons/entities have been banned from submitting the resolution plan and buying back the Assets at a hair cut u/s 29A of the code.
• Insolvency and bankruptcy board of India (IBBI), the nodal agency for controlling the fight against NPA is formed , it has created a pool of about 2300 Insolvency Professionals to tackle the stressed situation as of date.
• The mechanism of Resolution Plan approved by NCLT provides a much needed immunity and indemnification to the prospective investor from the uncertainities normally associated with the Stressed Assets, thereby giving him the much needed confidence to bid for the stressed asset aggresively

Needless to IBC provides a platform to buy an asset which is litigation free, clearly transferable, all liablities whatsoever crystallised in a realistic payment terms with the investor totally indemnified by the tribunal. Therefore, a safe mechanism to invest in discounted stressed assets has finally evolved in India.

CIRP & Liquidation under IBC

The Insolvency resolution mechanism rests on the twin pillar of CORPORATE INSOLVENCY RESOLUTION PROCESS (CIRP) and LIQUIDATION.

Outgoing promoter is not allowed to participate in either of the process

IBC- An evolving legislation

US was the first country to adopt the Insolvency law in 1978 followed by Japan, even these countries took 8-10 years to stabilize the Insolvecy law and establish Insolvency resolution as an Industry and essential part of business planning and growth. Kudos to the Indian spirit of adaptability and flexibility, IBC is evolving by the day.

GOI, IBBI and NCLT/NCLAT are very proactive in identifying and accepting the loopholes and shortcomings of the code and have been very prompt in coming up with remedial/corrective ordinances from time to time.

In the next 3-6 months we can expect:-

• Comprehensive rules and guidelines for the LIQUIDATION Process under the code. Strict (and reduced) timeline, extended payment time and more importantly a chance to the Corporate debtor to submit a scheme of Settlement & Compromise u/s 230 of the Companies Act 2016 (upholding the spirit of rescuing the viable business at all cost)
• Group Insolvency Guidelines- Often it is seen that resolution of a single company from a particular business group is not possible till a holistic resolution of entire group in toto is not done. Case in the point- Videocon Grp, Educomp, Ramswarup
• Insolvency resolution of individuals & Partnership firms- Individual and Partnership firms insolvency resolution would be a great step in solving the stress at micro level.This will also help solve the nagging problem of Personal Gurantee of the promoters coming in the way of resolution of the main corporate business
• Cross Border Insolvency – Guidelines to be announced
• Information Utilities- An important pillar and tool to make the entire insolvency resolution process efficent, important guidelines to be issued so as to attract players from private sector to set-up and promote them
• Funding to run the business a a going concern- Guidelines to enable a corporate undergoing CIRP to raise funds from open market to enable it to function as a going concern
• Improving the quality of RPs, so that a pool of sector specific resolution experts (individuals and Ies) be created, so that the CIRP and Stressed situation is handled by the most suitable and competent sector specific resolution team

The list goes on and on, in nutshell, IBC has done all it can to establish Stressed Assets as an Alternate Investment class and now the ball is in the court of the investors, its upto them to make the most out of this historic and once-in-lifetime opportunity that India presents to the world

What is Stressed Assets?

Any business (in the form of a Corporate, AOP, LLP ) which is unable to service the cost of borrowed capital employed or has defaulted in repayment of the borrowed capital employed is said to be Stressed Business and the Assets imprisoned in such a stressed business is known as Stressed Assets (land , building , P&M, Inventory, Intellectual property, share holding, book debts, arbitration awards etc). For purpose of simplicity we shall in this report address both of them as Stressed Assets

If we see closely, all we havw been taking about so far has been about the assets which fail are technically classified as NPAs (Non Performing Assets) by the banks. However, the Stressed Assets universe does not only mean NPAs, actually stressed assets should mean :-

Stressed Assets = NPAs + Restructured Loans + Written Off Assets

Therefore Stressed Assets includes assets which are:-

1. Functioning at a low potential – Already an NPA
2. Could become an NPA – Restructured Assets
3. Assets which are dead but can be resusticated– Written off Assets

Reasons for an asset to get stressed

An asset which is stressed does not mean that it is totally unviable in future as well or that it cannot be revived at all, fact is that the business which owns the asset is stressed, and once the stress of the business is resolved, the asset becomes healthy again.

Therefore to revive the Stressed Asset we must know the fundamental reasons for a business to get stressed. Some of the reasons for an asset to get stressed:-

1. Financial troubles

• High cost of debt
• Cash Flow mismanagement
• Untimely/late disbursal of bank finance
• Capex Overrun/ High Gestation period
• Diversion/Siphoning off of Funds

2.Management/Ownership Issues

• Technical Incompetency of the Key Management
• Succession Issues in top management/owners
• Untimely/unforeseen exit of a key investor

3. Technical/Technological Issues

• Failure to upgrade technologically
• Present technolgy getting obsolete

4. .Marketing and Sales Issues

• Product gets obsolete
• Unforseen Structural disruption in the market
• Price war by a new entrant

5. Supply Chain Disruption

• Key Supplier closes down/backs off
• Trade embargo from/off a raw material importing country
• Law and Order issues in key raw material supplying geography

6. Change in Govt Policies

• Increase in Taxation
• Withdrawl of financial concessions
• Shrinkage in Govt spending

7. International Factors

• Price war in Export market
• Threat from Import and dumping
• Currency fluctuations
• Geopolitical reasons

Challenges in Resolution of Stressed Assets

Normally it is perceived that the prime reason for balloning NPAs of financial institutions is the in-sincerity & bad intent of the promoter and corrupt loan sanction/disbursal/settlement mechanism of the financial institutions, however that is always not the case.

Despite best efforts from the banks and insolvency professionals the main difficulties in resolution/monetization process of stressed assets are:-

1. The asset-liablity mismatch is so huge that even if the promoters dispose off the entire assare in-sincere in settling the dues and on the contrary their effort is always to maximize their gain from the settlement, thereby not only delaying the settlement and disposal of the asset but also sometimes destroying the marketability of the asset.
2. Promoters normally are not able to understand the practical modus-operandi of disposing the assets, they tend to be prejudiced and conceited.
3. Difference in valuation between lenders and the promoters, thereby delaying the sale of the asset and thus destroying the intrinsic value of the asset as well.
4. Whenever an asset gets sick there are always certain legal uncertainties attached to it, the asset therefore is always seeked at a deep discount due to these legal uncertainties, thereby creating a huge mismatch between expectaion – need –offer of the asset. It is however always difficult to quantify the discount applicable on the same.
5. The asset has encumbrances like Labour attached to it, and this makes it untouchable, the promoter is unable to settle with the labour sometimes due to his ego and sometimes due to lack of funds.
6. Gaps in our legal system & lapses in enforcement mechanism leads to a prolonged battle in the courts, thereby destroying the value of the underlying assets. Sometimes a sincere promoter is also victimised by the rigid course of law
7. Fear of inquiry and prosecution by the bank officials desists them from taking practical decisions and haircuts, thereby delaying the resolution.

Challenges in acquiring a stressed asset

Stress asset is a complex asset, it has many unpredictible dimensions to it and before one acquires it, it is important to first understand the extent of stress and chances/percentage of salvage possible, the timeframe in which the asset could be nourished back and the quantum/quality of funds, expertise and time needed to be injected into it.

Thereby the major challenges an Individual or an Institution faces in acquiring a stressed asset are:-

1. Lack of Understanding of the Stressed Asset – It is actually not possible for an individual HNI investor (howsoever professional investor he may be) to spend time and energy in studying and understanding a sick asset (causes of sickness and its remedy), a sick asset could be understood only by a team of professionals having diverse expertise and experience, both technical, legal and financial. However, sadly, the universe of such professional teams specialised in stressed assets is very limited and even difficult is to locate a combination wherein such a team is backed by funds from investors.
2. High Risk associated with Stressed Assets– Due to various legal complications and encumberances, stressed asset is preceived as a risky investment.Main risk is in getting a legally valid complete ownership in a definite timeframe.
3. Huge scale of Investment needed in acquring a stressed asset of a feasible scale. To acquire a stressed asset that can possibly justify the effort that goes into resolving a stressed situation the investment needed is mostly out of reach of individual HNIs/Family offices. Moreover there is no institutional mechanism in place whereby the investor can raise finance to takeover a stressed asset.
4. Difficulties in creating tax efficient and regualtory compliance structures for investing into a Stressed asset
5. Sometimes an Investor does not want to be openly seen as being interested in an asset due to various social, political and personal reason. The PE funds are restricted in investing into stressed assets due to their founding charter

Therefore need of the hour is to develop this combination of a professional stressed assets rejuvenation/management team backed up by funding from investors.

Acquisition, Resolution, Salvage – Now Made Easy

• Turnaround of business – when business can be turned around by
• restructuring of debt/ replacement of high interest debt by equity
• management buyout/replacement
• infusing technical skills
• infusing managerial skill
• expanding scale of business or improving the productline

• Bridge funding – where only bridge finance is enough to turnaround the business , as the bridge finance gives the much needed break to the promoter to put his house in order, to sell non-core assets and to streamline his operations etc.
• Disposal of Non Core Assets – Sometimes the asset could be nourished back by disposing off some non-core assets so that the financial health of the asset is restored
• Asset Stripping and Sale of Tangible assets- where the asset/business cannot be turned around, there is no way but to dispose the same by way of (a) Auction (b) Private Treaty
• Resolution Proceedings of CIRP of IBC under NCLT
• Most of the times banks and the unsecured creditors are unwilling to take a haircut, Resolution proceedings at NCLT gives a window whereby banks, creditors, borrower all have to take a hair cut in their expectations and chances of a resolution emerges
• Sometimes , certain Govt/Statutory concessions can infuse new life into the dead asset, this is now possible under the Resolution process

With the IBC and its process of CIRP and LIQUIDATION , it is now much easiness in :-

• BUYING BUSINESS AT DEEP DISCOUNT ON DEFERED PAYMENT BASIS
• BUYING ASSETS CLEAN OF ALL LIABLITIES
• BUYING ASSETS CLEAN OF ALL UNCERTAINITIES
• BUYING ASSETS UNDER A FAST TRACK JUDICIAL PROCESS THEREBY ELIMINATING ALL POSSIBLE FUTURE LITIGATIONS
• VARIETY OF ASSETS FROM VARIOUS BUSINESS DOMAINS
• ALL TICKET SIZES AND ALL GEOGRAPHIES

Therefore , now Acquiring, Resolving and making profit out of a Stressed Asset is indeed possible!!

Investment Themes in Stressed Assets Universe

Stressed assets universe is very wide, however for the purpose of investing, the universe can be divided into four broad categories

High Potential Low Performing assets

Actually buying a High Potential Low Performing Asset and turning it around is the romance of Stressed Assets Investing.

Therefore our first aim would be to identify an asset/business which though is NPA, is still alive and generating some revenue, where it is still doing production & sales (obviously much below its capacity) thereby its brand-value, workforce, logistics, customer base, supply chain , marketing network, systems & SOP are still intact and the plant and machinery are in running/working condition. Such stressed business could be rejuvenated on the strength of capital infusion, managerial and technical talent infusion.

Similarly there are assets which are not stressed at all, but are due to a particular reason low performing as of now and could turn NPA any day. The idea is to identify the reason for underperformance, then buy the asset, tackle and remove the reason for underperformance by application of financial and technical skills thereby resulting in huge value unlocking.

Thereby it makes all the sense to buy High Potential Low performing assets, turn them around and enjoy cash flow or exit fully/partially at higher valuation.These assets are the ones wherein time line of resolution is the minimum, wherein the certainity of exit with good returns is the highest. It won’t be a bad idea to partner with a domain expert/entrepreneur to buy such stressed business (instead of relying on the expertise of the inhouse team).

FINANCING STRESSED ASSETS REVIVAL

• FINANCING THE CORPORATE INSOLVENCY PROCESS UNDER IBC – Loan to the corporate debtor to keep it going as a running concern, it is given aa super charge on the assetss- superceding the first charge of the secured creditors and given the highest priority in repayment after the asset has been resolved/disposed of.
• FUNDING OF ONE TIME SETTLEMENT (OTS) – Helping a genuine promoter salvage a promising business
• AGGREGATING DEBT OF BANKS – Aggregating bank debts is another way of controlling the asset
• FINANCING THE RESOLUTION PLAN – Resolution Plans submitted for revival may be funded with a mixture of Debt & Equity

FINANCING ACQUISITION UNDER LIQUIDATION- There is virtually no funding available to buy assets through liquidation process of IBC. A huge opportunity

P&M and Financial Assets of company under liquidation

When the Resolution process has failed and Liquidation is underway, huge investment oppprtunity is thrown up to invest in fabulous assets at very deep discounts.

REAL ESTATE CENTRIC STRESSED ASSETS

For majority of the NPAs that clog the banking and financial system, the Real Estate associated with it carries the maximum monetisable value. Thereby the maxim “that for a stressed asset its associated realestate is only and the final saviour”. Therefore in order to revive a stressed asset we must assess and evaluate the value & utility of the realestate associated with it. The asset wherein the associated realestate is its most important & strategic component is called the REAL ESTATE CENTRIC STRESSED ASSETS.

Such Real estate centric stressed assets could be further classified as :-

• Housing- With RERA get going there will be huge Stress in Group Housing segment
• Industrial – Sick Industrial units having huge realestate assets (land parcels)
• Logistics – Warehouses, Logictics Park
• Tourism – Hotels, Resorts , Niche entertainment hubs
• Retail / Commercial – Malls, Quality Office space, IT Parks
• Education – Educational Institutes
• Healthcare- Hospitals

Some of the situtations unique to the realestate centric stressed assets are:-

• Sometimes land parcel is not sold because of its landuse, the stress could be addressed by getting the landuse changes
• Sometimes a land parcel is not sold due to inadequate infrastructure, the stress could be addressed and value unlocked by providing/getting developed the required infrastructure to it
• Sometimes under-construction real estate gets stressed due to problems (not associated with the project) with the promoter/builder (siphoning).
• Under-Construction realestate may also get stressed due to high cost of finance/paucity of funds/cost overruns/unforeseen negative cashflow/mis-management
• Cash yeilding Real estate projects (malls, hotels, hospitals) may get stressed due to a high gestation period which is an inherent character of this business
• Battle for supremacy of RERA and IBC will throw up interesting situations

Industrial Real Estate- An opportunity amidst debacle

It has been noticed that the large sick industrial assets of corporates is actually an “A” class realty asset, these corporates are inadvertanly sitting on a prime realty (which was not prime when it was acquired by them for industrial purpose but in these years and decades that industrial real-eatate has become prime), mostly they are now located in middle of the city as the urban limits of cities have expanded in all these years to engulf the once offbeat location of the asset and making it a prime realty as of date.

Therefore by a creative usage/land-usage change of the sick industrial real estate, we can surely unlock huge value.

All in all it is evident that a distressed asset is always available and sold at a discount which may vary from “Hefty” to “Steep” and just by taking the asset out of distress (ie by settling the encumbrances, labour or changing the land use) there is a huge re-bound in the valuation, this is precisely what investing in Realestate Centric Stressed Asset is all about

Stressed Sectors- Indian Context

At any given point of time in the Indian economy some sectors (atleast two) are always in distress, with time they may come out of distress but then some new sectors will get distressed.

Besides the above, there are Hotels, Hospitals, Pharma Units, Electrical Goods, Auto Components units too available through the IBC/NCLT process.

Stressed Assets – An Alternate Investment Class

Stressed Assets are also an ASSET –WHICH ARE AVAILABLE BELOW IT’S INTRINSIC FAIR VALUE DUE TO SOME INTRINSIC DISABILITY OR ENCUMBERANCE

This unique characterstic of Stressed Assets make them a DISTINCT INVESTMENT CLASS. While Return on Investments(ROI) in case of other asset classes (like Gold, Debt, Equities, Commodities,Currency) are dependent on the appreciation ie GROWTH which is dependent on many external economic factors beyond control, however in case of Stressed Asset the ROI gets generated the moment the Intrinsic disability or the encumbrance is removed. As this Intrinsic disability or the encumbrance is removed the valuation of the asset reverts to “normal” and this “normal” is much above the invested price. Therefore ROI in a Stressed Asset investment is generated just by changing the status, the ownership, by just executing simple logical actions.

The foremost objective for an investor to invest in stressed assets should be to generate an ROI > 20% PA, there is no other asset class which can visibly give such high ROI on a sustained basis.

Stressed Assets as an Investment class is capable of giving ROI>20%PA on a sustainable basis because of the perenial nature of the pipelines deals and opportunties to invest into and a clear visible exit route, thus “Stressed Asset Investment” is the bold , new and an evergreen investment class.

COMPARISON WITH OTHER TIME TESTED INVESTMENT CLASSES

Co-Investing – The best Investment Vehicle

The biggest challenge/hurdles for a standalone stressed asset investor to invest in Stressed assets are:-

• Huge investment needed to acquire a potentially profitable stressed asset
• Understanding the complexities of a stressed asset
• Lack of thorough diligence of the asset
• The risk involved in investing into a stressed asset in early stages is very high
• There is no clear timebound exit route or exit strategy
• Lack of understanding of the technical issues important for scripting a turnaround
• Lack of understanding of the geography and local pecularities where the asset is located
• Lack of continous flow of potentially profitable deals and investment opportunities
• The skill set and expertise to acquire, resolve and exit a stressed asset needs a constant enhancement and upgradation

For a Stressed asset fund to succed the managing team must be having a mind of an entrepreneur, it must have the instincts to spot a turnaround opportunity, must have the skills to develope a resolution/turnaround plan, must have an expertise to identify risks and develope risk mitigation plans, must have ability to execute its plans with punctuality and precision, must have patience and  last but not the least the team must be grounded with a sense of responsibility towards money which is riding on its shoulders.

Keeping all the above concerns in mind, one can very well deduce that all these are very well addressed and taken care of by Investing in a pool or in partnership with an AIF (Alternate Investment Fund) or an ARC (Asset Reconstruction Company) or to put it in a bettter word CO-INVESTING.

Proposed Return & Exit Strategy

Stressed Assets has a low gestation period to generate ROI. The exit period can be as short as 3 months, however an optimum period to exit a reasonably sizeable asset should be about 30 months.

Stressed Assets- Driver of Future M&A

It also makes a strong economic sense to invest in a stressed asset that could be turned around rather then invest in a green field venture. The simple reason being that a stressed business has already seen the worse, the mistakes committed during the irrational exuberance period of a project are behind it. Therefore with time, money, patience and expertise it is far more paying and secure to nurse a stressed asset back to health than to start a green field project with its attached uncertainities.

• Therefore, it can be deduced that for a corporate or a new business in expansion mode, it would be more prudent of them to buy/acquire a stressed asset that fulfills the need rather than acquire something new and fresh.
• The price at which the relevant Stressed asset is available shall be atleast a benchmark aganinst which the acquisition cost of new asset would be compared
• It is only the Resolution process of IBC which provides a unique opportunity to any corporate to buy out its own competitior – that too in staggered payments

Hence, Stressed Assets Investment is not only a screaming opportunity not to be missed but also is the future friver of corporate M&A and surely an integral part of the lexicon of corporates and investors alike.

Welcome to the World of Stressed Assets!!