Investment from large stressed asset funds has ramped up in response to policy, regulatory, legal and monetary changes.
The easing of regulatory forbearance practices by the Reserve Bank of India (RBI) in 2015 triggered an increase of reported gross non-performing assets (NPAs) from 4% in 2015 to over 8% (RBI report) in 2016. However, this increase was not met by a corresponding uplift in the percentage of NPA’s held by Asset Reconstruction Companies (ARCs). In response two key policies were enacted in 2016; the implementation of a single Insolvency and Bankruptcy Code and the opening of ARCs to foreign direct investment (FDI) of up to 100% of equity. The combined effect has seen an increase of applications and approvals for ARC licences from the RBI in Q3 and Q4 2016 including from Apollo, Bain Capital Credit, JC Flowers and Lonestar.
In the second half of 2016 (H2 2016), the RBI performed an asset quality review (AQR), which reported that Gross NPAs (as of March 2016) had risen to (INR)₹6 trillion ($90 billion). Of this, 90% was on state bank balance sheets (see Figure 1) and as a total the Gross NPAs represented 9.1% of total loans extended by banks in India; higher than any other major emerging market (excluding Russia), and higher than Korea at the peak of the East Asian Crisis.
Separately, in November 2016 the Government announced a demonetisation programme of 86% of the paper currency in circulation. Following this programme, and a period of low credit growth, the Government reported new NPA growth has spread from large companies to mid-size (micro, small and medium sized enterprises (MSMEs) through the Government’s Economic Survey 2016-17.
The Insolvency and Bankruptcy Code was introduced to consolidate and standardise the existing frameworks across India.
Prior to implementation, the average time to resolve an insolvency case in India was 4.5 years (compared to 1 year in the UK and 0.8 years in Singapore). Alongside this, India had the lowest recovery rate in the world (of c.20% of debt value).
The new law includes a specialised forum to oversee all insolvency proceedings, empowering all classes of creditors to trigger a resolution process and mandating an insolvency professional to take control of the corporate debtor. Once mandated, compulsory liquidation of the corporate debtors occurs if a resolution is not agreed within 180 days, with a transparent waterfall for payment of debt implemented in the event of liquidation.
By standardising and shortening recovery periods we expect greater certainty to feed through to both investor and seller price expectations.
Since the 2000’s India has followed a de-centralised ARC model to address banking NPAs. However, as of March 2016 ARCs manage 10% of the total NPAs in the Indian banking system.
To meet the increase in NPAs through 2015 and 2016, the price expectations of banks, and an increase in upfront capital requirement from 5 to 15% of asset value, ARCs faced funding difficulties. Regulatory changes by the RBI have allowed for 100% foreign equity ownership of ARCs to increase capital flows through ARCs to stressed assets on bank balance sheets.
2016 saw a range of US and Canada based stressed asset funds investing or co-investing in ARCs including Brookfield, Apollo Global, Bain Capital and JC Flowers.
The market is keenly watching how investors tackle the challenges of attracting funding and bridging buyer-seller price expectations in this new landscape. Recently, the Government’s Economic Survey 2016-2017 proposed a “bad bank”, the Public Sector Asset Rehabilitation Agency (PARA), to further ease these challenges.
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