5 minute read 25 Nov 2021
Private credit in India

How private credit is evolving in India

Authors
Dinkar Venkatasubramanian

EY India Partner and National Leader – Turnaround and Restructuring Services

Interim manager, restructuring advisor and insolvency professional. Actively involved in implementing the new insolvency regime in India.

Bharat Gupta

EY India Turnaround and Restructuring Services Partner

A seasoned corporate turnaround professional with over 22 years of experience in managing stakeholders in publicly listed, private and family owned businesses.

5 minute read 25 Nov 2021

Show resources

  • Evolution of Private Credit in India

We examine how private credit is emerging as a strong structural opportunity in India.

In brief
  • Private credit emerged as a significant source of financing to businesses in the US/UK and tracks the triggers for the evolution of these markets.
  • This article critically analyzes the private credit and deal environment in India and throws light on potential opportunities, growth imperatives, and key considerations for the evolution of the private credit market in India over the next 5 – 10 years.
Private credit – a global perspective

Globally, investors are diversifying their portfolios and seeking better returns by moving from traditional asset classes towards alternative asset classes. Private credit now accounts for about 12% of global private capital assets under management. With abundant liquidity, post the pandemic, money managers are scouring global markets for yields, and a lot of these funds are hitting the shores of emerging markets, including India.

Private credit has witnessed an annual growth in AUM of ~10% over the last 11 years. The North American and European markets constitute 90% of the total private credit AUM. The global private credit AUM in 2020 aggregated to US$848 billion (as a reference point, the AUM on the Private Equity markets is approximately US$3.9 trillion).

Our research indicates that not all jurisdictions are equally favorable for creditors. Variations between jurisdictions can explain why certain countries such as the US and the UK rank ahead of others in attracting private credit. The differences between jurisdictions can be on account of power of creditors, secondary trading of debt, stable currency and favorable regulatory policies. These are essential prerequisites for the growth of private credit.

Private credit in India – a structural opportunity

India offers a large structural opportunity for private credit investors. Post a spate of bad loans, traditional lenders have become risk-averse while NBFCs are recovering from a liquidity crisis that engulfed them in 2018. This has left a large void for private credit providers to capture. Credit enforcement, bolstered by the introduction of the creditor-friendly “Insolvency & Bankruptcy Code” supported by dedicated tribunals, has provided private credit with a great start in India. A series of economic and administrative reforms working towards a more business-friendly environment, coupled with the push for growth, provide the ideal platform for private credit to grow to potential. With abundant liquidity, post the pandemic, money managers are scouring global markets for yields and a lot of these funds are hitting the shores of emerging markets, including India. 

India will continue to offer opportunities across 12% – 24% IRR range as multiple dynamics are at play. Our estimate of the performing credit opportunity (Expected IRR 12% – 18%) range from US$39b to US$89b over the next 5 years. Stressed asset investment opportunities (emanating from the existing stock of unresolved NPAs and fresh credit defaults) and special situation opportunities could be worth around US$25b over the next 5 years. These stressed assets and special situation opportunities would attract private credit funds looking for higher yields (Expected IRR 18% – 24%).

Private credit – insights for operating in India

Fund setup and regulatory environment

Given the paucity of capital required to resolve stressed assets, the regulators have actively modified existing and developed new regulations to welcome private credit. Principally there are two types of structures funds can choose for investing in India: 

  1. Offshore investment routes (FDI, FVCI, FPI and ECB)
  2. Onshore vehicles (NBFC, AIF, ARC)

Each of the foreign investment routes come with pre-conditions as well as pros and cons. Choice of investment route depend on several factors which we have discussed in our whitepaper in detail. Getting the right structure/vehicle(s) is critical to doing deals in the Indian market. Each of these has it's regulatory, and tax conditions/nuances, and these are dynamic.

Deal origination and execution

A significant portion of India’s mid market, privately owned companies are based out of tier 2 cities. These businesses have typically relied on bank finance to fuel their growth aspirations. Traditional bank lending in India has a very straight jacket approach and takes a long time to secure approvals. Over the years, banks have also become very conservative to lend, given their last decades of experience with high NPAs and the arduous resolution process. Non-bank lending which is a leverage play is still reeling from the 2018 sector crisis. This leaves a huge vacuum to fill, especially as India embarks on significant growth journey.

Refinancing and one-time settlements of existing lenders in stuck / delayed projects and businesses in real estate and ancillary sectors is another large opportunity. Providing structured credit solutions for under-performing and non-core businesses of large conglomerates is another opportunity.

Identifying these situations, developing awareness about structured credit, developing confidence for a longer-term relationship, and finding the right capital solution will determine success in credit deployment.

Operations turnaround in India

Private credit operates in the higher end of the risk return spectrum. While theoretically, private credit lending is lower risk vis-à-vis private equity, high yield investing situations have their own risk nuances that private equity players would consider high risk and not engage with. These risks stem from inter alia operational and financial distress, lack of access to traditional bank financing even in the medium term, doubtful governance standards, depleted management capability, etc. This leads to operational decay in the business over months and years, with the borrower losing market share, and equipment and technology) and skewed working capital position.

Several examples (across industries like aviation, beverages, glass, consumer electronics, plastics, etc) where repeatedly businesses with excellent franchise have lost enterprise value and even ended up in liquidation. Some of the key solutions to address the specific nuances of Indian stressed situations and to ensure return of capital from operations or a liquidity event – comprehensive business monitoring to reduce information asymmetry, make the catchup investment upfront and become a proactive partner in value creation

Summary

Private credit in India is in the early stages of evolution and the future looks extremely bright. However, it would take a lot of work to improve ongoing delays in the enforcement of creditor rights, delays in decision making by incumbent lenders and removing some regulatory distortions in the secondary market for debt.

About this article

Authors
Dinkar Venkatasubramanian

EY India Partner and National Leader – Turnaround and Restructuring Services

Interim manager, restructuring advisor and insolvency professional. Actively involved in implementing the new insolvency regime in India.

Bharat Gupta

EY India Turnaround and Restructuring Services Partner

A seasoned corporate turnaround professional with over 22 years of experience in managing stakeholders in publicly listed, private and family owned businesses.