Over the past five years, India has witnessed several macro developments and changes at the micro level. Improved economic growth potential and progress on nonperforming asset restructuring on the one hand, juxtaposed against a constrained funding environment on the other, is now making the risk-return proposition a little more realistic and comparable to the rest of Asia. That said, the various risks relating to investing in India remain significant, and therefore best addressed by ADM Capital’s diversified approach to investing across various developed and emerging markets of Asia.

ADM Capital was one of the earliest offshore private credit managers to venture into India, investing and exiting 14 structured investments totaling over USD536m in various sectors between 2004 and 2016, with positive returns despite steep challenges including the global financial crisis and India’s own domestic problems, policy deadlocks, tax disputes, and wavering investor confidence in the economy during this period.

What’s Changed?

India has witnessed several changes at the macro and corporate level over the past five years. Economic growth, which was artificially stunted at 4-6% throughout 2011-2014 following a domestic political crisis, has resumed on-trend growth, with macro economists forecasting 7-8% for 2019, even under conservative market conditions, including the uncertainties associated with an election year. Capacity utilisation rates are reportedly at their highest in over seven years. Structural improvements should also help boost India’s business environment over the longer term – The World Bank’s “Doing Business Survey” for 2019 showed that India jumped ahead by 23 places to rank 77^th out of 190 countries. India is also one of the few Asian countries that is not particularly exposed to protectionist policies of the US, since its exports to US accounts for <2% of GDP.

Such macro growth in a supply constrained economy like India has allowed the demand for credit to flourish. This has subsequently attracted consumer multinationals like Walmart, Amazon and IKEA into the market, which over time, should modernise supply chain networks and accelerate consumption. The number of households active in India’s consumer economy has grown to 122m today from 100m in 2015, with GaveKal research predicting it to rise at an accelerated rate to reach around 312m by 2030 in a medium growth scenario, with some segments of the consumer market set to grow disproportionately fast as incomes rise and the structure of demand shifts. In parallel, revisions in the bankruptcy code on NPL restructuring in 2016 that favour lenders, together with improved efficiency of the process, has increased the demand for restructured assets via white knight financing and court assisted restructuring.

In contrast, on the funding side, numerous corruption scandals at large state-owned banks coupled with asset – liability mismatches in the crowded non-banking financial companies (NBFC) sector have crimped these institutions’ willingness to lend to any but the most blue-chip of borrowers, and for extremely short periods. This has been offset to some extent by the strong growth in foreign investments, with over USD38bn of inbound deals executed in 2018. ADM Capital believes there is still a funding gap for mid-sized corporates.

It is expected that such a demand-supply imbalance will be conducive to growth in private credit opportunities. However, ADM Capital remains cautious about the various political, currency and inflation risks, volatile investor interests and complexities arising from the size, lack of homogeneity, and continually evolving regulation, all of which can easily and significantly impact returns.

ADM Capital’s Approach

Established in 1998, ADM Capital has developed multi-sector experience across the spectrum of credit strategy, including distressed, high yield, NPLs, private credit and special situations throughout developed, emerging and frontier Asia Pacific markets. In recent years, ADM Capital’s lending strategy has focused on bi-laterally negotiated private loans, supporting companies in growth and special situations who are unable to obtain financing via traditional channels. The vast majority of opportunities are sourced via proprietary networks.

This experience suggests ADM Capital is well equipped to consider India for future investment. The strong relationships we have developed in prior years help in sourcing transactions, providing ready access to expert views and collaborations. Secondly, ADM Capital’s two decades of credit experience across Asia Pacific provide knowledge of a wide array of well-tested financial structures that work for all stakeholders. Thirdly, our presence in various markets facilitates the identification of cross border opportunities that have significantly lower competition from other funding sources – in this regard, ADM Capital is seeing numerous opportunities that involve the Indian diaspora in numerous regions (e.g. US/Middle East/Singapore) seeking to expand their business in India. Finally, and of great importance to ADM Capital, India is slowly beginning to generate investment opportunities that are both commercial and responsible, achieving various Sustainable Development Goals, for example financial inclusion, health, clean energy, innovation and infrastructure, and sustainable cities among others.

Key Investment Themes

 ADM Capital is a sector agnostic lender, however, eschews heavily polluting, environmentally destructive sectors and those considered to negative ESG impact e.g. alcohol, mining, weapons, tobacco, and so on. ADM Capital aims to avoid competing with or crowding out traditional funding channels, and is currently observing a number of trends in the funding needs of mid-sized borrowers, largely reflecting the overall credit macro environment:

• Completion Financing – Numerous projects particularly in infrastructure and related sectors (transport/construction/logistics/energy) that commenced 3-5 years ago after the present government came to power, are now under strain for last mile financing to aid completion, mainly due to the ongoing funding squeeze in the economy.

• Cross Border Financing – As one of the few countries that is witnessing strong GDP growth of above 7%, there are numerous foreign investors seeking funding to invest in the country. Banks are still too regionally/locally focused to obtain comfort with these cross-border transactions, which fall naturally within ADM Capital’s territory and expertise.

• Working Capital Financing – Admittedly, the banking sector is the key funding constituent of this type of funding need, but of late, ADM Capital has seen numerous companies that are unable to grow to their capacity due to working capital limitations, either in terms of amounts or tenors. Most of the borrowers in the mid-size sector that we finance, seek financing of longer than a year, to give them some comfort that they can carry on with business despite potential hiccups in the funding environment. Across the board, ADM Capital sees financing opportunities that are a mix of CAPEX and OPEX for this reason.

• Asset Light Industries – Numerous “service” sectors, such as technology, food, healthcare, entertainment, finance that have become more active in recent years do not benefit from the level of real assets that were enjoyed by more traditional sectors. As such, traditional funding typically requires such hard collateral. While ADM Capital also maintains over-collateralised positions in its investments, we are more flexible in accepting the various types of security on offer. More importantly, we rely strongly on our loan documentation, structuring, covenants and the underlying borrower’s business and financial potential to give us the comfort that we will be paid without needing to resort to foreclosures and exercising collateral.

• Stressed and Distressed assets – India has been quite proactive in establishing the India Bankruptcy Code (IBC), launched in 2016, to speed up the restructuring of distressed assets. As at 30^th September 2018, 1198 corporates navigated the insolvency resolution process, of which 264 cases were resolved. The scale of the challenge is significant, given that NPL levels are close to 10% of the banking system (~USD118bn). Notably, defaulting promoters of distressed companies, or their family, are prohibited from bidding for the asset in the auctions that form part of the process. As a result, we are seeing numerous opportunities that are brought by Promoters of stretched companies that are fearful of losing their companies during the restructuring process. Simultaneously, we have seen other white knight financing opportunities to fund the takeover of a stressed asset by another company. Distressed assets that are undergoing the debt restructuring process are also aplenty, given the heightened NPL levels in the system. However, the relative lack of predictability in timing, the heavy legal processes involved, and the risk of these cases continually being challenged in Court, makes them less attractive.

Conclusion

India remains a complex market with heterogenous practices, frequent changes and multiple investing environments. ADM Capital observes an evolving business environment, reflected via various regulatory changes, including the bankruptcy code, removal of several barriers to doing business, and the efforts to provide infrastructure support to fulfil the growth potential. ADM Capital will continue to monitor various trends and opportunities in mid-sized companies and review the same for potential investment, proceeding with caution in the face of significant political risks relating to the elections this year.