By Alekh Archana and T. Bijoy Idicheriah
MUMBAI - Kotak Special Situations Fund is set to close its first deal by investing 5 bln rupees in a steel company that was under corporate debt restructuring, Chief Executive Officer Eshwar Karra said.
The $1-bln fund, backed by Kotak Group, Abu Dhabi Investment Authority and Singapore's GIC, is also working on a 4-bln-rupee deal, where the debt of a chemical company will be refinanced.
"We should close these deals out by March," Karra, who formerly headed Kotak Group-promoted Phoenix ARC Pvt Ltd, told Cogencis in an interview.
The deployment in both cases will be through subscription to non-convertible debentures, as alternate investment funds like Kotak Special Situations Fund are not allowed to buy out loans directly from banks, Karra said.
"We have represented to RBI (Reserve Bank of India) and SEBI (Securities and Exchange Board of India) to allow special situation and distressed funds to purchase loans directly under the direct assignment route," he said.
The fund, which is not limited to investments in distressed assets, is seeing a lot of opportunity in structured credit space, Karra said.
While the fund is selectively bidding for assets under Insolvency and Bankruptcy Code, there are concerns around timelines, he said.
Following are edited excerpts of the interview:
Q. From managing assets through an asset reconstruction company to handling a $1-bln special situation fund, what are the key differences?
A. The ARC model requires very less capital commitment and more of skill and manpower commitment. However, we saw opportunities in the large-scale NPA and restructuring space, where more capital would be required, and we could be an asset manager for Global LPs (limited partners). Global sovereign and pension funds were keen to play an active role in this space and come into India.
We chose to partner ADIA (Abu Dhabi Investment Authority) and GIC for the fund. They, along with us, raised $1 bln and closed the fund in mid-2019. The fund has a wider mandate and looks at transactions from 250 crore (2.5 bln rupees) to 800-900 crore (8-9 bln rupees). We look at not only distress but also any special situations. We have structured credit and acquisition funding products, and also help promoters that want to buy back equity from PE funds. Right now, we see a lot of opportunity in this structured credit space.
Q. What is the final contribution of Kotak Group in the fund?
A. 17.5%.
Q. So you will not just look at distressed assets or situations?
A. These are not distressed at all. These are all performing credit where there may be need for correction.
The first deployment of the fund will be a 500 crore (5 bln rupees) transaction in the steel sector for a cash-strapped company that was under corporate debt restructuring. Under the restructuring, the company had issued OCRPS (optionally convertible redeemable preference shares), which needed to get paid out. If this payment is not done, the debt will be converted into equity, which will be a huge dilution for the promoters. The promoter has asked us to step in and pay the bankers, by taking funds from us through the NCD route.
We are doing one transaction that is a standard asset but revenue has not caught up at the anticipated pace due to capex. Given that background, the loans will have to be rescheduled. But, as per Indian regulations, any such rescheduling of a loan has to be downgraded as non-performing asset. So, we are stepping in to refinance the banks. This will be done through us subscribing to the non-convertible debentures of the company, and those funds will be used to repay bank loans. This company is in the chemicals space and the size of the transaction is around 400 crores (4 bln rupees).
We should close these deals out by March.
Q. Will you be keen on deals under the IBC route?
A. Under IBC, it will take about two-three years to get an asset. Only strategic investors can take a call of this nature, where the transaction is linked to business cycles. No funds have that kind of patience, as we have a seven-year horizon and then look to exit. Under IBC, unless there is visibility on the transaction happening immediately, there is no point in bidding. However, with recent developments on the legal front, we have started looking at opportunities on this platform as well, selectively.
Q. Are there more opportunities in the pre-IBC stage?
A. Yes, via structured credit. Under IBC, bankers feel they would lose control, and also worry about delayed timelines and value destruction. Most cases going to IBC are those in which banks have not been able to resolve through inter-creditor agreements. That has been a big let down. The RBI should make signing the inter-creditor agreement mandatory and not voluntary. If all lenders don't sign, I as an investor will not participate because there is a possibility of one lender taking the company to the National Company Law Tribunal.
Q. With inter-creditor agreements, why are resolutions of banks not playing out?
A. Valuation expectation of banks is far too high. But at least in some cases, they are prepared to approve schemes that are less than the liquidation value.
Q. Post IBC, there has been a lot of buzz around distressed and vulture funds taking over assets, but why have deals not happened?
A. Indian lenders don't seem to understand the construct of such funds. I think there is no disconnect with banks on the enterprise value, but lenders can't seem to agree on the break-up of their own payouts.
Banks are now valuing assets closer to what they should be because substantially, the legacy assets are provided for. Now the book value of these assets is less than the market value and it makes sense for banks as they can book profit, and reverse provisions. This is an ideal opportunity for funds like us to put in capital.
Q. Does allowing AIFs to take over loans make life easier for a fund like yours?
A. Yes, especially in the distressed space. Then I don't need to go to the ARC to buy the debt and face challenges related to capitalising the ARC. We have represented to RBI and SEBI to allow special situation and distressed funds to purchase loans directly under the direct assignment route.
Q. There are a lot of outstanding security receipts. Given the lower recovery rates of ARCs, what happens to those security receipts?
A. All that will come to roost. After seven years, banks have to provide fully. I think around 50% of 1 lakh crore (1 trln rupees) of SRs (security receipts) were priced on the 5:95 structure, before 15:85 was introduced in August 2015. That 50% will hit seven years this March. Banks will have to take that provisioning hit between now and March 2021.
In the next one-two years, you will see a substantial write-down of SRs because of non-recovery, which then brings us in the business again, as these written-down SRs are tradable. Once banks have provided, we can go and buy those SRs at steep discount, depending on their residual value as they have not been recovered for seven years.
Q. What is the internal rate of return that funds like you expect?
A. Roughly, IRR expectation is at around 20%.
End
US$1 = 71.55 rupees
Edited by Vandana Hingorani
