In October, we discussed Indian Prime Minister, Narendra Modi’s, decision to hand over $32bn to recapitalise India’s state banks. The motivation was India’s slowing growth rate and the need to add one million Indians to the workforce every month. Crippled by massive bad debts, the state-owned banks were struggling to extend more credit to the economy. The announcement caused a surge in India’s Sensex equity index, led by the banks. India has the second highest bad debt ratio of the world’s largest economies – possibly third since China’s official figure is patently incorrect.
Enter Uday Kotak, Asia’s richest banker (net worth over $10 billion) and managing director of India’s Kotak Mahindra Bank.
Kotak is a self-made man. Turning down a job offer from a multinational, he set up a financial services conglomerate, beginning with bills discounting before adding stockbroking, investment banking, mutual funds and car finance. Kotak thinks he’s spotted a “once-in-a-lifetime opportunity” in Indian finance…so it probably bears considering. Nor is he alone as sovereign wealth funds and pension funds are also taking a close look.The opportunity is in India’s bad loans, as Bloomberg explains.
For India, it’s a $207 billion mess, a pile-up of bad loans years in the making that’s dragging on growth. For the nation’s wealthiest banker, it’s the kind of opportunity that very rarely presents itself.
What has billionaire Uday Kotak salivating is the government’s attempt to finally draw a line under delinquent loans, with recent steps to overhaul India’s bankruptcy laws and recapitalize state-owned banks. The moves are intended to lift a burden from the country’s banks and encourage them to accelerate lending, supporting economic growth.
Over the next year, the assets and debts of about 50 of India’s biggest defaulters may be sold off by court-appointed professionals, in a process in which banks are expected to take deep haircuts on their loans. The companies’ borrowings total an estimated 3 trillion rupees ($46 billion), close to one-third of total recognized bad loans in India’s banking system.
As the first tranche of bad debts comes up for sale, Kotak is focusing on the very steep discounts on offer from the bankruptcy process, especially in the steel sector.
“The whole insolvency and bankruptcy process is a once in a lifetime event,” said Kotak, the managing director of Kotak Mahindra Bank Ltd., in an interview. “Through this you could actually get assets that would give disproportionate returns for long periods of time.”
Funds controlled by Kotak Mahindra are looking at deals involving the assets and debts of some of the first 12 companies going through the bankruptcy courts, Kotak said. Industries including steel are of particular interest, according to the banker. Pricing of assets put up for sale should become clearer by the end of the first quarter, he said. Banks are likely to face losses of up to 60 percent on their loans to the companies headed for bankruptcy courts, according to Kotak.
Sovereign wealth funds from the Middle East and Southeast Asia, along with several global pension funds, have also expressed interest, Kotak said. He didn’t name the funds, but TPG, KKR & Co., Caisse de depot et placement du Quebec and Clearwater Capital Partners LLC are among overseas firms who have said they might invest in stressed Indian assets.
In Kotak’s parlance, the Modi government’s move to resolve the bad-debt crisis is a “watershed moment” for India. However, bankruptcy has long had a flexible meaning in the country. Progress is being made as Kotak told Bloomberg.
The insolvency and bankruptcy law put in place by Prime Minister Narendra Modi’s government shifts the balance in favor of the creditor from the borrower, creating greater accountability for the family owners of India’s major companies, Kotak said. “For the first time, founders fear losing control of the company if dues are not paid,” he said.
The sense among some Indian executives that they could walk away from their debts without facing consequences was a major factor limiting past efforts to bring delinquent loans in check. The government’s announcement last month that it will inject a record 2.1 trillion rupees into state-owned banks is another sea change, in that it should give the lenders sufficient capital to write off bad loans weighing down their balance sheets.
However, there’s a catch. There is the potential for owners of bankrupt businesses to make bids in order to regain control of their assets at knock-down prices. Kotak is concerned about how the bidding process will be structured, as Bloomberg notes.
Kotak expressed concern about the way that the founders of defaulting companies are free to put in bids to regain control of those same assets through the courts. “In the absence of a change in the law, the promoter is well within his rights to bid,” he noted.
As a result, creditors should put in place safeguards, such as forensic audits of any such bidders, to ensure they haven’t willfully defaulted on their loans, he said. “If it is so, then they should not be allowed to bid,” said Kotak. “If the issue is that underlying asset got into trouble because of extraneous circumstances, like the marketplace or government policy, and not because of any issues with the promoter, then it’s a different category.”
The federal government has set up a panel to review provisions of the 11-month old bankruptcy law including whether to bar defaulting founders from repurchasing assets, India’s Corporate Affairs Minister P.P. Chaudhary said in a phone interview on Monday. “The implementation of the law has to be reasonable, justified and not opposed to public policy,” Chaudhary said.
Kotak Mahindra’s bad debt ratio stood at 2.6% at the end of March 2017, a quarter of the level of the banking system as a whole…and far superior to some of the worst culprits.
Kotak described India’s attempts to clean up its bad debt problem as a “watershed moment” and he believes that the next few months are critical for the Indian economy.
“You have the Indian courts, policy making system and several other moving parts that have to move in tandem. At this stage I feel reasonably confident that the problems will get resolved. But always be aware of something being different,” he said.
This is India after all.