_Making the non-performing assets perform

Rising NPAs in the banking system, which have crossed Rs. 10 lakh crore (more than 12% of the total loans given by the banking system), have become a constant cause of worry. The government tried to bring an end to the NPA issue by enforcing a new bankruptcy law in 2016. Even though the process has just started with some NPA accounts witnessing closure, the haircuts/losses which the creditors have had to bear in such cases has been large. It is a no brainer that 100% recovery from these accounts is not possible, however, the extent of haircuts/losses that a creditor has to bear can be reduced if they can unlock value from the non-core assets of the defaulting firm. To know more read the blog.

October 15, 2018

Introduction of the bankruptcy code

The Insolvency and Bankruptcy Code, 2016 (IBC) was introduced to create a single law for closure of insolvency and bankruptcy cases. Earlier bankruptcy acts, such as the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 (SARFAESI Act) and the Sick Industrial Companies Act (SICA Act), had failed to provide any meaningful exit or reprieve for creditors of failed companies. Hence, a strong law was required to provide a time-bound solution for the failed companies and help creditors get their dues.

The Code proposes two separate tribunals to oversee the process of insolvency resolution, for individuals and companies: (i) the National Company Law Tribunal (NCLT) for companies and Limited Liability Partnership firms; and (ii) the Debt Recovery Tribunal for individuals and partnerships.

In the initial stages, the companies under the ambit of various restructuring schemes were kept out of the purview of IBC till the moratorium period was on. After many years of anguish and futile attempts to save loss-making companies via various restructuring schemes (CDR, S4A, 5:25 scheme and Flexible Structuring of Existing Long-Term Project Loans), the Reserve Bank of India (RBI) recently announced scrapping most of the restructuring schemes and instructed the creditors of defaulting companies to admit the companies under IBC instead of restructuring the loans. On Feb 12, RBI withdrew all debt restructuring schemes and asked banks to classify all restructured loans as non-performing loans. The RBI also came out with strong guidelines and reduced the timeliness for classification of an account as Non-Performing Asset (NPA). These moves would lead to a greater number of companies being referred to NCLT in the next 2 years than those referred since the act came into existence.

Many failed companies have been referred to NCLT by their creditors. Some companies are facing liquidation. Many cases are getting entangled due to attempts by various parties involved to sabotage the process, while a few companies are finding new buyers via auctions. The government and the insolvency regulators have been very proactive in bringing out amendments to the law whenever there has been a hiccup. The Government and regulators are taking a continuous and serious effort is being undertaken to end the NPA mess. The code is constantly evolving and in case of India, due to the heterogeneity of the country it is very difficult to have a ‘one size fits all’ approach. It will take some time for the dust to settle, but this is an imperative move in the right direction.

Deriving value out of NPAs

Several cases of bankruptcy have been resolved under the IBC law. The most noteworthy resolution under this law till date is Bhushan Steel’s acquisition by Tata Steel. However, the haircuts that creditors had to take in the cases, which were resolved, have been significant.

One of the opportunities in the NPA mess is maximising the value from the non-core assets of bankrupt companies by separating them into an SPV and selling them separately from the main business. Many companies, which have been referred to NCLT, have prime assets located in the prime locations across the major cities of India. Some of these companies have high book value non-core assets (for e.g. company headquarters, company-owned assets, land, residences, retail assets, office buildings, regional/sales offices at prime locations) that may not be useful for the bidder, as the bidder would only be interested in the business and core assets (plant and machinery). The bidder would thus bid for companies as a whole, attributing majority value only based on the core assets and would get the non-core assets much below the fair value. This is because the bidders would be bidding for the company as a continuing entity and not sum of the parts. This may lead to lower realisations for banks and financial creditors as the value unlocking of non-core assets may not happen.

Currently, many of the Private Equity (PE) giants, Sovereign funds and Pension funds, are chasing too few office and retail assets. As per our latest report – Knight Frank’s ‘Realty Asset Monetisation 2018’, since 2011, around INR 57,300 crore (USD 8.4 billion) has been invested in office assets and INR 10,337 crore (USD 1.5 billion) in retail assets and the momentum is growing steadily. The only challenge to future growth in investments is the dearth of good quality assets in the sought-after business districts of the country.

Most of these investors are avoiding development risk and prefer acquiring mature or ready-to-move in assets. Hence, they are finding it increasingly difficult to find such assets in the top metros as majority of such assets have already been acquired by their competitors. Some of the mid and large size companies, which have been admitted to NCLT, own such assets and few of them also have large land holdings that were acquired at historical rates.

Knight Frank View

If the entire process of separation of non-core assets from the company and its subsequent sale can be completed within a stipulated time frame without any scope of future litigations, there would be huge amount of interest from real estate investors as well as from real estate developers for such assets.

A similar arrangement was done for a company under the erstwhile Scheme for Sustainable Structuring of Stressed Assets (S4A) scheme. Lodha Developers Pvt. Ltd (LDPL) had purchased 5 acres of prime land in Mumbai’s Jogeshwari suburb from Patel Engineering Ltd, which had agreed to reduce its debt by selling non-core assets under the S4A scheme¹.

The IBC has been proactively updated to resolve the pain points and ensure maximum gains for the creditors of a defaulting company. However, if there are no provisions in the current law to separate the non-core assets from the business and sell them separately, then an amendment should be made. The government through the NCLT must create an effective environment for successful transfer of non-core assets in a short period of time by establishing a single-window clearance system. Moreover, the laws for transfer of assets should be framed in such a way that it isolates the assets from any sort of dispute in the event of future litigations on the NCLT process.

This process of separation of non-core assets and selling it separately would lead to better value realisation of real estate assets of bankrupt companies and thus ensure smaller haircuts for creditors.

¹ Newspaper article in Mint on Nov 22, 2017