Brace for selective interest in stressed assets

We are now about two months short of completing a full year of working from home. One hadn’t imagined in March 2020 that the impact of Covid-19 would be so severe and influence the way we work. The downturn has put further stress on banks, which have been reeling under non-performing loan assets (NPAs) for many years now.

The recent forecast from the Reserve Bank of India projects a base-case scenario of NPAs at 13 per cent. With meaningful credit growth unlikely in the near future and weak capital adequacy ratios, banks — especially public-sector banks — are heavily dependent on their ability to recover from stressed assets. 

The suspension of the Insolvency and Bankruptcy Code (IBC) has now been extended till end-March 2021. To keep in line with the entrepreneurial spirit, the government did not want a procedural law to result in companies being dragged towards the IBC. When the initial relaxation of the IBC was announced, we had highlighted concerns around the same and the implications for it as a concept and for banks. The IBC recently completed five years and overall should be considered a success, because it changed the way promoters operated and shifted the pendulum in favour of the creditors.

However, the suspension of the IBC does devalue its relevance. Creating an artificial gap in the process will allow companies with a window to find options to give the IBC a complete miss. Further, international investors will also view this as intervention and their confidence in investing in and funding turnarounds could be dented. Lastly, banks have lost access to one critical mode of resolution which they had benefited from in the last five years.

Covid-19 has resulted in more companies needing distress funding. Accordingly, the supply of distress assets available across sectors has gone up multi-fold, creating a problem of plenty. Previously, investors had to choose from companies which had good assets, but a weak capital structure or fraud-related issues. But at present, there are companies with strong balance sheets and robust business potential facing distress due to liquidity issues. These businesses are more attractive, as the resolution and recovery times are faster.

There has been greater investor interest in such assets, especially from special situation funds. It is estimated that private equity funds injected close to $2 billion into distress assets in 2020, much more than their commitment in 2019. We expect this trend of investors cherry picking companies with short-term issues to continue, and believe that many companies which would have otherwise found takers, especially under the IBC, could now head toward liquidation. 

Large corporates with strong balance sheets and fund-raising ability were expected to participate actively in the distress-asset space. However, the impact of Covid has been so severe that it has forced most of these companies to conserve cash and create liquidity backup for the next 12-24 months. These large companies, while having aspirations to grow, are hesitant to commit or lock their capital in new opportunities given the uncertain business environment.

Despite the weak fundamentals, excess liquidity in the system has moved into equities. This has caused wide disparity, with promoters of distress companies expecting higher valuations while benchmarking themselves with the equity markets, while investors are unwilling to offer such premiums. With looming uncertainty, investors will be very selective, cautious and careful in allocating funds towards this asset class. All this means there will be ‘stressful times’ ahead for the distressed market.

The writer is Managing Director and Head of South Asia in the business intelligence and investigations practice of Kroll, a forensic firm. This column has been edited for space