ISSUE 31 | MARCH 2016

PRIVATEDEBTINVESTOR.COM

INDIA FOCUS 2016
A MARKET BARELY TOUCHED

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INDIA
FOCUS
ANALYSIS

PRIVATE DEBT IN INDIA

Earning their
stripes
India’s entrepreneurs are sitting on one
of the world’s most enticing markets,
and if the banks won’t lend to them
then the private debt market is ready
to pounce, writes Siddarth Poddar

P

ity the typical Indian business
owner. Of the country’s 3,000
listed firms, the largest 10 percent hold 90 percent of listed corporate
debt, according to Goldman Sachs, leaving the others to share the rest.
With such low leverage – a result of a
banking sector systemically diverted from
its core function of providing credit to
business – it is not surprising that local
and foreign investors are jumping to
create a private debt market in India.
KKR is one of those betting big on
the debt space and the global investment
firm has a second dedicated vehicle in the
market. Closer to home, a host of domestic firms have raised capital for debt funds
across a range of strategies – including
Piramal, Religare, Motilal Oswal and Aion
Capital, a joint venture between Apollo
Global Management and ICICI Venture.

Pankaj Karna, managing director of
Maple Capital Advisors, an investment banking and advisory firm, says businesses are
gearing up as they put together capex and
growth plans to exploit an economy finally
settling down after years of turbulence.

Venkat Ramaswamy: private debt is a
significant alternative to private equity

16 Private Debt Investor | March 2016

A lot of this activity is in the mid-market, particularly in companies addressing
consumer needs, says Karna.
“In that area, corporates are looking to
either expand or consolidate their positions and that’s the biggest opportunity.
They expect the next two to three years
to be good, and they want to be ready to
capitalise on it,” he says.
The fact that India has an entrepreneurial community adds to the demand
for capital and private debt is a significant
alternative to private equity, says Venkat
Ramaswamy, executive director at Edelweiss Financial Services.
Edelweiss’s first private debt fund – a
2009 vintage – is almost fully harvested
and has provided a return of just over 20
percent in gross rupee terms. The firm
is currently investing out of Edelweiss
Special Opportunities Fund II.

INDIA FOCUS

INDIA IN NUMBERS

$40bn

Total bad assets, according to the
Reserve Bank of India

17%

Share of stressed assets with Indian public banking
sector, double the level in 2012

7.3% 7.9%
GDP growth rate in 2015

GDP growth rate for 2016,
according to the World Bank

$45bn

Capital that Indian banks will need to raise to
meet Basel III, according to Credit Suisse

3,000

50m

Number of listed firms

Number of SMEs in India, most of which
are family businesses

According to Ramaswamy, the biggest
advantage of private debt is that the company can postpone dilution and still raise
capital needed by the business. “Using
this kind of capital in the initial stages
as growth capital leads to postponement
and, therefore, reduction of dilution –
which is one of the primary motives of

Indian and Asian entrepreneurs,” he says.
One of the key reasons why investors
are backing the growth of private debt is
the failure by banks to meet demand for
capital.
According to Prashant Purker, managing director and chief executive of ICICI
Venture, “the commercial debt market is

a bit clogged and growth in credit off-take
is lower than desired levels”.
He says that in a few sectors, such as real
estate, the corporates require far more than
what can be supplied by the banks.
Considering the size of the Indian
economy, the local credit market is still
“very, very small”, adds Saleem Siddiqi,

BANKING SECTOR WOES
The intent from the Reserve Bank of India is very clear – foreign

Non-performing loans within the public sector banks stood at 17

investors are being invited in and domestic alternative lending

percent as of 30 September, according to the Reserve Bank of India,

encouraged. Much of this is because of the struggles of the Indian

and research by Credit Suisse suggests that the public lenders have

banking sector, which is heavily regulated with large chunks

continued to double down on loans to the most stressed sectors.

of balance sheets mandated for lending to government and
infrastructure projects.

With their balance sheets dedicated to financing government and

Large slices of public sector bank books were ploughed into

particularly the family-owned medium-sized businesses that make up

infrastructure financing when the times were good. Now lenders

the bulk of the country’s economic activity.

find themselves with rapidly increasing non-performing asset ratios,
particularly in their power and steel exposures.

infrastructure, banks effectively ignore most of corporate India –

But private credit providers aren’t complaining.

Ma rc h 2016 | Private Debt Investor 17

INDIA FOCUS

PRIVATE DEBT IN INDIA
DISTRESS SIGNALS
Outside of traditional corporate debt
investing, India is also seeing a flurry of
activity in special situations and distressed
investing. And with banks hitting 17 percent
non-performing loans and rising, it’s not hard
to see why.
“If you look at it only from an opportunity
standpoint, then distressed debt is a massive
opportunity,” says Shujaat Khan of Blue River
Capital, adding that “if you wanted to, you
could deploy an almost unlimited amount
of capital”. But the investment is naturally not
without its risks, he cautions.
In recent years, several Indian companies have
borrowed money from non-banking financial
companies. They have often pledged shares
in their businesses or personal assets in order
to stay within the banking system and not
default.
According to Khan, many of these corporates
are now adding more debt at an ever higher
cost of capital to sometimes refinance existing
loans, essentially deferring the problem
rather than addressing it. The lending is still
happening because lenders are theoretically
getting collateral as security cover, but the
problems are gradually compounding.
The primary challenge is securing good quality
collateral. Equity collateral is related to the
underlying company, so if the company does
not do well, or if a project is delayed, then the
value of the collateral also falls (as happened
during a broad decline in share prices last
year).
The message from investors is clear – for
the cautious, distressed debt is a hugely
promising opportunity; but for the hasty, it
could be a frustrating exercise.

managing partner at London-based
MUSST Investments, which plans to
launch a credit business this year with
backing from a US endowment. MUSST
will be working with Karna of Maple Capital and they plan to buy a defunct nonbanking financial company (NBFC) this
year to give them the necessary licences.
While the biggest 10 percent of Indian
companies account for most of the corporate debt, a large number are left
underserviced by banks that are “either
unwilling or unable” to finance them due
to their own constraints, says Siddiqi.
These banks are also taking longer to
finance companies, many of which are
unable to meet the eligibility criteria, says
Shujaat Khan, managing director at Blue
River Capital.
This financing void is being filled
by a steady creep in new debt financing structures and Purker expects more
firms and investors to launch initiatives
in this area. “Post-financial crisis, there
was a slowdown in this activity, as a lot of
the banks had to tighten what they were
doing. So NBFCs and funds are stepping
in to fulfil the unmet demand in recent
times,” he says.
There is also a supply side factor
in why private debt is becoming more
prominent. Institutional investors are
contemplating private debt strategies
on the back of disappointment with the
private equity industry. One debt investor
says that most private investment funds
in the country have been private equity
constructions, but over the last 10 years
or so “private equity has struggled to
deliver real returns and sometimes even
the prominent names have struggled to
even return capital”.
Where private equity has failed, private debt is moving in. India is expected
to be one of the few sources of growth
among the emerging markets, and private debt is becoming an effective way

18 Private Debt Investor | March 2016

“CORPORATES ARE
LOOKING TO EITHER
EXPAND OR CONSOLIDATE
THEIR POSITIONS AND
THAT’S THE BIGGEST
OPPORTUNITY. THEY
EXPECT THE NEXT TWO
TO THREE YEARS TO
BE GOOD, AND THEY
WANT TO BE READY TO
CAPITALISE ON IT”
Pankaj Karna

for investors to access the strong growth
anticipated in the country.
REWRITING THE RULEBOOK

The appetite is there and the corporate
demographics certainly match up. Yet,
lending in India is not without its challenges. One of the biggest issues is the
poor regulatory framework, with little
protection for lenders in the event of
bankruptcies.
So while there is an open field for
lending, alternative players face the same
problems that Indian banks have experienced, says Khan: “While the risk profile of businesses is lower [in traditional
lending], regulation is still to be had in
terms of if the promoter does default
and the business does go down. What is
your process for getting the money out?”
One of the challenges in India is the
mindset of business owners who will

INDIA FOCUS

NOTHING VENTURED…
Venture debt is another up and coming market. In the last five to 10 years, it has emerged as
a significant asset class in India, with more than $5 billion raised by venture capital-backed
businesses in 2015.
“The tenures are short for venture debt… it’s a pretty healthy market, and the underlying
dynamics are growth-oriented,” says Shujaat Khan of Blue River Capital.
According to Rahul Khanna, managing partner of Trifecta Capital, a venture debt firm that has
raised more than 200 crores rupees in commitments from Indian institutional investors as part of
a 500 crore rupee fundraise, venture capital-backed businesses also have debt financing needs
that are not serviced by traditional financial institutions.
Khanna says that equity financing is typically more expensive than debt: “While venture debt is
not a complete substitute for raising equity capital, a healthy mix of equity and debt financing
helps reduce the dilution impact on the founder and, more importantly, brings down the
blended cost of capital for the business.”
Moreover, as these small businesses scale, their needs include capex or acquisition financing,
Rahul Khanna: VC-backed businesses
have debt needs that are not serviced
by traditional institutions

agree to almost any terms just to get
the capital through the door, adds Khan.
This can be combined with assets that
are not as liquid as lenders would like,
particularly real estate which is often
used as collateral. The result is that if a
borrower goes into liquidation the workout can often be complex, making loan
and collateral structuring key to success.
However, the common view is that
the regulatory framework is improving.
Purker says “people now acknowledge
that regulation should be designed such
that borrowers have clear disincentives if
they do not meet commercial obligations
they have wilfully entered into”.
To that end, the latest regulations
have “clear guidelines for funds and
things like rupee borrowing from foreign
sources being allowed”, he adds.
One major legislative change
expected to boost alternative lending
is the new bankruptcy and insolvency
code currently making its way through
parliament. A committee was expected
to report on the bill as PDI went to

where debt is preferable but not available from traditional lenders. Lastly, he says, many
companies see venture debt as supplementary to an equity capital raise. As it is largely nondilutive, it extends the runway between two rounds of funding.

press, clearing the way for approval in
the budget session that has just opened.
The bill will allow creditors to take
control of the assets of bankrupt borrowers, as well as quicken the insolvency
and liquidation process. It is the passage
of this legislation, which has cross-party
support, that prompted Indian businessman Ajay Piramal to announce in January
that he would list a 6,000 crore rupee
($885 million; €820 million) fund to
invest in distressed loans.

“PEOPLE NOW
ACKNOWLEDGE THAT
REGULATION SHOULD BE
DESIGNED SUCH THAT
BORROWERS HAVE CLEAR
DISINCENTIVES IF THEY DO
NOT MEET COMMERCIAL
OBLIGATIONS THEY HAVE
WILFULLY ENTERED INTO”
Prashant Purker

Given the circumstances and the
opportunity on offer, Edelweiss’s Ramaswamy expects private debt funds to raise
anywhere between $1.5 billion and $2
billion per year for the next three years.
To put that in perspective, total corporate debt provided by funds so far stands
at around $1.5 billion, he says.
According to Karna, the biggest challenge now is to ensure that the structures mean the borrower has “skin in
the game”. The second is to back business owners with the right mindset and
a track record of engaging with lenders
positively, rather than just swallowing
attractive growth figures.
There’s more to it than just capital,
he adds. “I’ve seen that 90 percent of
the market is lending money and that is
where the story ends, but the onus has
to be on delivering value and not just
money. In short, I would say that managing relationships, mindsets and the right
structures are the key.”
So while challenges still abound, private
debt is here to stay. n

Ma rc h 2016 | Private Debt Investor 19