India's 'dirty dozen' debtors lure big funds to bad loans

India’s highest-profile default this year and the government’s plan to inject capital into state-controlled lenders have thrust the nation’s bad debt into the spotlight. Some global debt funds increasingly like what they see.
 
The nation’s so-called dirty dozen—12 large debtors that have been ordered to go through the bankruptcy courts—are one focus for funds, including Bain Capital Credit and alternative investment firm Varde Partners. The government’s decision last month to inject Rs 2.11 lakh crore ($32.5 billion) of capital into state-controlled lenders over two years, as well as the country’s new insolvency code that took effect in 2016, will help open the market for soured loans, according to Hong Kong-based loan and bond trading firm SC Lowy.

 
Asia’s richest banker Uday Kotak concurs, saying India’s $207 billion pile of bad loans is a once in a lifetime opportunity. Oaktree Capital Group LLC, the world’s largest distressed debt investor, has said it is “quite enthusiastic.” While funds must grapple with the relatively untested new bankruptcy system, their rising interest could help lenders meet capital-reserve requirements, as slower economic growth erodes borrowers’ ability to repay loans.
 

“Opportunities in India are near the top of our list anywhere in the world,” said Jeff Robinson, managing director, head of the distressed and special situations group at Bain Capital Credit. “The 12 cases are going to be the bellwether. So far we’ve been happy with how the processes have moved along. How they conclude is too soon to tell.”

 
Robinson, who is based in Boston, has already been to India three times this year, and doesn’t expect the pace of trips to slow.
 
Varde is also looking at a number of situations and is involved in some of them—not just the ones targeted by the government but also some larger corporate restructuring cases, according to Ilfryn Carstairs, co-chief investment officer and Asia head at the firm.
 
The assets held by the dirty dozen — which includes Essar Steel India Ltd, Bhushan Steel Ltd and Bhushan Power & Steel Ltd—look attractive. “They are enormous companies, they have hard assets, and they are proper businesses,” he said.

 
Fresh failures outside the bankruptcy courts could also give funds more options. Reliance Communications Ltd, controlled by billionaire Anil Ambani, defaulted on dollar bonds last week in the highest-profile failure on international debt since the nation’s insolvency and bankruptcy code was passed in May 2016.
 
With the dirty dozen, the sale of assets by the bigger steel companies has attracted strong interest from strategic and financial buyers, according to Mihir Chandra, head analyst at SC Lowy. The firm has traded Reliance Communications’ loans and bonds and Jindal Steel & Power’s loans.
 
Investing in India’s bad debt, however, entails challenges. There are questions as to whether the companies can meet deadlines under the new bankruptcy code to resolve their debt, and get fair value for their assets.

 
“The insolvency process is an untested process,” said Chandra at SC Lowy.
 
Investors will also need to contend in some cases with business owners, including at some family-owned companies, who may try to avoid giving up control. If company founders see wrinkles in the legislation that will enable them to challenge the sale of assets, they will use it, according to David Kidd, partner at Linklaters LLP.
 
Robinson at Bain Capital Credit echoed that concern. “Some company owners have had a good run over many years, and how they react to the new system is going to be interesting,” he said.

 
India may tighten rules to prevent errant founders from misusing an 11-month-old bankruptcy law to regain control of delinquent companies that are being liquidated, according to a government official.
 
Despite the challenges, recent developments have boosted interest among debt funds. The recapitalisation of state banks could speed the resolution of loans and make the prices at which they clear in the market more acceptable, according to S Sriniwasan, managing director of Kotak Investment Advisors.
 
And despite its short track record, the new insolvency code, which forces lenders to take provisions on bad debt, is fuelling optimism. “These are positive steps that will improve the stability of the banking system and effectively serve to open up India’s distressed loan market,” said SC Lowy’s Chandra.