Investors come up with alternative funding plans for crisis-hit realtors

With developers hit by weak sales, investors offer innovative options to replace plain equity and debt lending

Private equity funds and non-banking financial companies are offering various modes of lending and repayment to real estate developers struggling with weak sales for the third consecutive year.

Innovative forms of investments are replacing plain equity and debt lending, with investors lining up special situation funds, uniquely-themed funds and construction finance.

ASK Property Investment Advisors, which made high risk-high return equity investments in the last seven years, is preparing to raise a special situation fund this year, which will invest equity-type (but not pure equity) money in residential projects for completion of development, or to replace existing high-cost debt and stay invested for 3-5 years.

Along with Rs.1,500 crore of pure equity dry powder, ASK believes there is need for a separate pool of capital for projects at an advanced stage.

“Real estate is passing through a difficult time, with project delays and repayment pressures. The need of the hour is to have different kinds of capital and funds are tweaking their offerings to fill in those funding gaps for developers,” said Sunil Rohokale, chief executive and managing director of ASK Group.

From the pure equity funds of 2005-06, structured debt and mezzanine debt instruments took over in the last few years, with PE funds and NBFCs demanding higher collateral and fixed repayments on a quarterly basis.

However, this put pressure on developers to service debt, as cash flows continued to remain tepid—it was not sustainable. Following this, PE funds and NBFCs started tweaking lending norms, offering more refinancing and repayment flexibility.

With a lot of liquidity chasing a few good projects, this also led to intense competition. PE funds moved towards debt-like structures.

According to Rajeev Bairathi, executive director and head of capital markets at Knight Frank India, NBFCs have evolved too. “From lending based on existing cash flows of a project, NBFCs are now offering acquisition financing to buy land parcels, construction finance as well funding for commercial office projects, different from simple lending to residential projects,” Bairathi said.

Altico Capital India Pvt. Ltd, an NBFC from Asia-focused investor Clearwater Capital Partners LLC, plans to offer construction finance and lend to commercial office projects.

Banks offer construction finance at 11-12%, while NBFCs charge a bit more, but the latter offer more flexible capital and an extended repayment periods.

“NBFCs are now well-capitalized and can compete with banks, by giving construction finance. We are also looking to offer construction finance but with established developers and also lend to office projects because there is a lot of potential in the office sector. We will do early-stage financing in residential and office projects to buy land and in pre-leasing stage respectively, and lend to projects in an advanced stage by facilitating transactions, in which we collect the last payments from customers,” said Altico Capital’s chief executive Sanjay Grewal.

Piramal Fund Management Pvt. Ltd, which introduced innovative financial products such as an apartment buying fund, Mumbai Redevelopment Fund and began construction financing early on, plans to focus on equity investments once again.

This year, it will execute a new strategy for equity investments in land opportunities for investors, to generate superior returns by investing in plotted land development. The firm is in the last leg of signing a $300 million offshore platform with a large Canadian pension fund and will also raise a second redevelopment fund. It also started deploying Rs.5,000 crore to fund commercial office projects this year, and introduced a Rs.15,000 crore line of credit to some of the top developers.

“When we started lending at 18-20% a few years back, it was opportunistic but not sustainable. We realized that developers need to be given time to repay, till the market revives. It is also important to have multiple pools of capital to service different kinds of financing needs but equity remains the need of the hour in the current scenario,” said Khushru Jijina, managing director, Piramal Fund Management, which has Rs.32,000 crore of assets under management, including equity investments and commitments made but not yet disbursed.

Customization is key while structuring transactions and each transaction is adapted to the needs of developers.

“Both equity and debt are offered through different customized products, but we think we will see more equity products coming in. With RERA (Real Estate Regulation & Development Bill) being implemented, investors will have more confidence in developers because there will be delivery timelines for projects, repayments,” said Chintan Patel, partner, deal advisory, real estate and hospitality, KPMG India.

Century Real Estate Holdings Pvt. Ltd, which raised Rs.720 crore from Piramal and Altico last year and an additional Rs.520 crore from Piramal in 2016, got an opportunity to refinance high-cost debt, use some of it as construction finance and to make land payments as well.

“These transactions offered much more flexibility in the usage of capital, which banks don’t offer even if it is cheaper. Because there are different kinds of capital involved, the blended cost of funding automatically comes down,” said Century managing director Ravindra Pai.

“They are under a little pressure in terms of margins, but if they want more margins, they have to take more risks,” he said.

Not only different capital structures, but repayment structures are also customized based on the risk-return perspective.

Repayment issues have cropped up, but funds and NBFCs have either refinanced their own loans to projects or given developers more time to service debt.

Balaji Raghavan, chief investment officer, real estate, IIFL AMC Ltd, said repayment structures are also being customized for each transactions, and instead of fixed repayment schedules, they are being matched with cash flows anticipated from a project.

“We are optimistic about investments in real estate over the next 24 months and are looking at substantial growth in India across investment platforms we have built and capitalized over the last 11 years,” said Rohan Sikri, senior partner, Xander Group Inc.

In the last two years or so, Xander has invested about $250 million mostly in residential assets through the preferred equity route. Separately, Xander Finance, which does senior secured debt transactions, has executed almost 50 transactions adding up to Rs.1,800 crore.

The question is, if the health of the sector doesn’t improve anytime soon, how long will the cycle of financing and refinancing help developers sail through this crisis?

S. Sriniwasan, chief executive of Kotak Realty Fund, is cautious and “hasn’t deployed any money in the last 18 months or so and is in wait-and-watch mode”.

Kotak Realty Fund raised $250 million from offshore institutional investors this year, to make equity investments in residential projects, at a time fund managers wary of equity risks extend only debt finance.

Piramal eyes more M&As in pharma, will launch new funds: Chairman Ajay Piramal

Piramal Enterprises has acquired US-basedAsh Stevens in an all cash-deal valued at $43 m

Piramal Enterprises has acquired the US-based Ash Stevens, a contract development and manufacturing company, in an all-cash deal valued at nearly $43 million. Ash Stevens will be the third facility for Piramal Enterprises in the North American market. Speaking to BTVI, Piramal Group Chairman Ajay Piramal says the company is looking at growing both organically and through acquisitions in the pharma space. The group is also looking at renewable and financial services as major growth opportunities, he said. Excerpts:

Can you take us through the benefits, the synergies and the rationale behind the Ash Stevens deal?

Ash Stevens is a manufacturer of high-potency API (active pharmaceutical ingredients). This is a niche, fast-growing market. In the last six years, the CAGR in this business has been about 9.9 per cent as far as the high-potency APIs are concerned. And we believe that this will form an important part of our client strategy

In North America, we have a facilityin Canada which makes high-value, low-volume products, intermediates and finished products. We also have an injectable facility in Lexington, Kentucky; and this will fit in well with that.

Besides, the customers that we have for Ash Stevens and our existing customers are very complementary to each other. Therefore, we will expand the customer base that we have; the sales force we have today will be able to sale these products as well. So we just increased our overall product offering to our customers.

You have been accumulating assets with niche abilities and capabilities. Where would your next focus area be in terms of geographic exposure or the addition of another such facility? Is it safe to assume that the interest will continue in the US?

In a pharmaceutical business, we have really three components. One is contract research and manufacturing (CRAM) or what we call pharma solutions. The other is critical-care product from which we make products such as inhalation and anaesthesia products, which go into critical-care centres such as surgery. And the third is OTC (over-the-counter).

Whereas CRAM and critical-care are both global businesses, OTC is an Indian business. So we look at growing both organically and through acquisitions in all these areas. So you could see acquisitions, both for products as well as for services.

It will not necessary happen only in the US, even though the US is the largest market. It could be also in Europe or in Japan as well. In the OTC space, which is only an Indian market that we carter to, we will do acquisitions only in India.

In the last eight months, we have acquired a series of three groups of brands for OTC in India.

You also recently invested ₹800 crore in ACME Solar. What is the rationale behind that and what are your future plans for it?

We are not really running these businesses as investment. It is not like we do in Ash Stevens. These are loans from which we earn interests over a fixed period of time and we will get it back. That is one thing.

On the other hand, we do feel that solar and renewable energy is a high-growth area and we want to back good promoters in this area so that they can create value and so can we.

The results have been good and you have been making acquisitions as well. What can we expect from the group in FY17?

As far as growth is concerned, I think we are fortunately well placed in those areas where we see good growth. So first, we see financial service, which is growing well with the growth in economy and PSU banks taking a little bit of back seat. It gives a good opportunity for NBFCs and private-sector companies to do well and gain market share. We will also launch a few funds in the near future.

RBI clears decks for universal banking

Issues new norms for ‘on-tap’ licensing; large industrial houses barred

The Reserve Bank of India on Monday unveiled guidelines for ‘on-tap’ licensing of new private banks, opening the door for entities such as Edelweiss Financial Services, JM Financial, LIC Housing Finance, Magma Fincorp, Muthoot Finance, Shriram Capital and UAE Exchange & Financial Services, which had missed the bus in the last round, to float universal banks.

The guidelines in respect of promoter eligibility, corporate structure, foreign shareholding, dilution of promoter group shareholding and listing on the stock exchanges appear liberal as compared to the 2013 guidelines under which IDFC Ltd and Bandhan Financial Services were allowed to set up banks.

Under the new guidelines, resident individuals and professionals with 10 years’ experience in banking and finance are eligible to promote universal banks. Previously, only entities/groups in the private sector, entities in the public sector and non-banking financial companies (NBFCs) were eligible.

Large industrial houses are excluded as eligible entities, but can invest in the (universal) banks up to 10 per cent. A universal bank is a bank offering retail, wholesale and investment banking services under one roof.

Under the new guidelines, a Non-Operative Financial Holding Company (NOFHC) is not mandatory for setting up a bank in case the promoters are individuals or stand-alone promoting/converting entities who/which do not have other group entities.

The RBI has said that in case a bank is to be set up through an NOFHC, a promoter/promoter group should hold not less than 51 per cent of the total paid-up equity capital in the holding company. Earlier, entities/groups had to set up a bank through a wholly owned NOFHC.

Entities/groups in the private sector that are ‘owned and controlled by residents’ and have a track record of at least 10 years, are eligible as promoters. If such entity/group has total assets of ₹5,000 crore or more, the non-financial business of the group should not account for 40 per cent or more in terms of total assets/gross income.

Existing NBFCs ‘controlled by residents’ with a track record of at least 10 years are also eligible as promoters. However, any NBFC, which is a part of the group that has total assets of ₹5,000 crore or more and where the non-financial business accounts for 40 per cent or more is not eligible.

Paid-up capital

The initial minimum paid-up voting equity capital has been left unchanged at ₹500 crore. However, thereafter, the bank must have a minimum net worth of ₹500 crore at all times.

The criteria requiring promoter/s and the promoter group / NOFHC to hold at least 40 per cent of the paid-up voting equity capital, which will be locked-in for five years from commencement of business, remains unchanged. The promoter group shareholding will need to be brought down to 15 per cent within 15 years (from 12 years earlier).

The (universal) bank has to get its shares listed on the stock exchanges within six years (from three years earlier) of the commencement of business.

The current aggregate foreign investment limit is 74 per cent will apply to universal banks. Under the earlier regime, the aggregate non-resident shareholding could not exceed 49 per cent for the first five years.

George Antony, Managing Director, UAE Exchange India, said: “…The final call on application for the universal banking licence will be decided post the board meeting to be convened shortly.”

BANKS ARE ILL, LONG LIVE NBFCs

Shares of Bharat Financial Inclusion Ltd, earlier known as SKS Microfinance Ltd, on Friday closed at 909.20—inching closer to the price at which retail investors had bought its shares in an initial public offering (IPO) six years ago. The 1,654 crore SKS IPO in July 2010, the first by any microfinance company in India and second in the world, was subscribed 13.7 times. The shares were sold at 985 in the IPO, but retail investors were given a discount of 50. It was listed on 16 August 2010 and soon rose to 1,490. That was before a crisis hit the microfinance industry following the promulgation of a state law in Andhra Pradesh. The law prompted large-scale defaults by borrowers and drying up of bank funds to the microfinance sector, and the SKS stock soon plunged to 54.5 as investors rushed to sell. 

The company posted a net profit of 235.91 crore in the June quarter, an almost four-fold increase from 61.16 crore a year ago on higher total income and a 96.85 crore tax write-back, beating analysts’ estimates. The gross non-performing assets (NPAs) for the quarter were 0.1% and, after setting aside money for bad loans, the net NPAs were 0.03%. Its loan portfolio rose 76% to 8,463 crore from 4,797 crore in the year-ago period.

Another listed microfinance company which is on its way to become a small finance bank, Ujjivan Financial Services Ltd’s stock rose to 540.85 on Friday before closing at 511.40. In May, Ujjivan’s 887 crore IPO was subscribed 41 times. In less than three months since its listing, the stock price has more than doubled. On Friday, Ujjivan announced a 71.37 crore net profit for the June quarter, more than double the profit it had reported in June 2015. Its loan book jumped 66% in the past one year to 5,850 crore. Its gross NPAs in June were 0.18% and net NPAs, 0.04%.

The third listed microfinance entity, Equitas Holdings Ltd, closed at 196.35 on Friday, losing around 2.5%, but it’s still trading at around 80% higher than its IPO price of 110. Its 2,163 crore IPO in the first week of April was subscribed 17 times. Its June-quarter net profit rose 60%.

Clearly, there is a re-rating of non-banking financial companies (NBFCs); investors are pulling out of banks and putting their money in NBFCs as they are growing faster than banks and their quality of assets is far better. The price-to-book ratio of Bharat Financial— which we get by dividing the current price of the stock by the book value per share—is probably the highest among all NBFCs barring mortgage lender Gruh Finance Ltd. Bharat Financial’s one-year forward price-to-book ratio is around 5.5, far higher than the best-performing private banks on the stock market like HDFC Bank Ltd and Kotak Mahindra Bank Ltd (both around 3.75), IndusInd Bank Ltd (3.5) and Yes Bank Ltd (close to 3). Among public sector banks, only State Bank of India’s one-year forward price-to-book value is higher than 1. Many of them are trading at half of their book value.

This is because most public sector banks have bloated bad loans and very few of them are actually growing the loan books. A handful of them announced their June-quarter earnings and they indicate that there is no respite from adding to the pile of bad loans and shrinking balance sheets.

The banks are not lending for fear of accumulating more bad loans and the NBFCs are taking advantage of that. What we are witnessing in the Indian financial sector now is quite unique. The Reserve Bank of India seems to be pushing for a bank-led financial system, but the business of lending is increasingly becoming sector agnostic because of the emergence of new channels such as mobile and Internet.

The banking regulator has given conditional licences to eight microfinance institutions to set up small finance banks; it also wants some of the larger NBFCs to become wholesale banks. However, for an NBFC, particularly a microfinance entity, the incentives to become a bank is far less today than in the past. They don’t need to entirely depend on banks for resources anymore; the Micro Units Development and Refinance Agency Bank as well as the National Bank for Agriculture and Rural Development are giving them funds. Besides, they can also collect deposits from the borrowers and cater to their need for savings by being a business correspondent of banks. Finally, new channels are being used to disburse loans.

Indeed, they will have to follow stricter norms for recognizing bad loans—from non-payment for 180 days to 90 days, on the line of banks—but this is not happening overnight. Similarly, their capital requirement by the end of the current financial year will not be as high as it was prescribed by an RBI panel in 2014. Finally, the drop in the yield of 10-year government bond, currently trading at its lowest since 2009, indicates that their cost of borrowing can only go down. No wonder then that the NBFCs have aggressively been building their retail books and the banks, though reluctant to lend to the borrowers directly, are happy to increase their exposure to these companies.

The NBFCs have got a fresh lease of life in the Indian financial system but does that explain the investors’ bullishness on a few of them, particularly the two MFIs that will become small finance banks? One thing is for sure that once they become banks, they will not be able to sustain the pace of growth in their loan book as they would need to focus on raising liabilities from the public in the form of deposits and that won’t be a cakewalk. There is also no clarity on whether Ujjivan and Equitas would need to tap the market again after three years of starting the bank. Under the RBI norms, listing is mandatory for a bank within three years. Both the entities have listed their holding companies. Of course, the regulator can always relax the norms either by accepting the listing of a holding company as a proxy for a bank or giving them more time for the bank listing.

LIC-led NBFC may offer up to Rs1 trillion credit guarantee

State-run insurer Life Insurance Corp. of India or LIC will structure its credit guarantee company in a manner that will allow it to guarantee infrastructure projects worth Rs.50,000 crore to Rs.1 trillion, said two people familiar with the development.

The credit guarantee firm, which will be set up as a non-banking financial company (NBFC), is part of the government’s plan to aid infrastructure projects by speeding up the flow of funds to the sector. In his Union budget speech in February, finance minister Arun Jaitley said that LIC will set up a dedicated fund to provide credit enhancement to infrastructure projects. The proposal is now starting to get fleshed out.

LIC will hold a 15-20% promoter stake in the proposed NBFC while the rest of the equity in the company would be offered to large foreign funds, domestic insurers and institutional investors, said the two people cited above.

“LIC will hold 15-20% stake or more if allowed by the insurance regulator and the government. Rest of the stake may be held by other public sector insurance companies, domestic financial institutions and global investors,” said one of the people cited above. “Discussions are on and the company should start by September this year,” this person added while requesting anonymity as talks are confidential.

An email sent to LIC on Monday seeking details remained unanswered.

The NBFC will provide credit guarantees to large infrastructure projects, especially those launched by the central and state governments in the road and power sectors.

A well-capitalized credit guarantor would be a good initiative, said Ananda Bhoumik, managing director and chief analytical officer, India Ratings and Research Pvt. Ltd.

“LIC itself is a large investor in the infrastructure space so it will be well-acquainted with the business. Once the product offerings from LIC’s credit guarantee fund start coming in, all credit rating agencies will have to evaluate the risks and help the market understand them in the context of credit guarantee and the structure of the model,” Bhoumik said.

A credit guarantee from an LIC sponsored firm will help bump up the rating of a infrastructure project in return for a fee. This could be particularly helpful for infrastructure projects in the post-completion phase when they can use an enhanced credit rating to raise cheaper funds from the market. These funds can then replace more expensive bank loans taken during construction.

“Throughout the construction period the entire funding is typically from banks, but post the construction if there is a credit enhancement their bonds will be upgraded to AA and it will be easier for them to get funding from the market so that they can free up the bank capital channel again and bring in more lending to develop their other projects,” Bhoumik said.

While bond investors typically want to invest in instruments rated AA and above, most infrastructure projects have ratings no better than BBB.

The LIC-led NBFC, which is likely to be headed by a finance ministry official, will begin with a seed capital of Rs.500-1,000 crore. If the amount of seed capital is high, the company will be in a position to provide a larger quantum of guarantees. Typically, the amount of guarantee offered by a credit guarantee fund or company is linked to the capital base of the entity and pre-determined number of times that the equity capital can be leveraged.

LIC will be the first contributor to the NBFC’s initial seed capital for its new unit, said the first person.

According to Pawan Agrawal, chief analytical officer, Crisil Ratings, the launch of credit enhancement fund will be an important step.

“Usually, the infrastructure projects even after completion are rated in the A or BBB category, primarily due to their highly leveraged nature, and low liquidity cushion. The credit enhancement fund can act as a bridge to enhance the ratings of these infrastructure projects, and enable their access to the bond markets,” Agrawal said.

“This also addresses an important identified need in the Indian market to increase the variety of credit enhancement providers, which can take the first loss risk, thereby providing credit enhancement. This credit enhancement fund, once operationalized, will address this need,” Agrawal added.

The talks between the government and LIC to set up the NBFC are in advanced stages. The government is likely to approach the Reserve Bank of India (RBI) for an NBFC licence in the next few weeks so that the company starts operations latest by September.

The proposed entity will not only provide credit guarantees but also may raise funds for infrastructure projects by issuing bonds at a later stage, the second person said.

To be sure, this is not the first time the government is attempting to use a credit guarantee model to help ease funding constraints faced by infrastructure firms.

At present, the government, through its wholly owned company India Infrastructure Finance Co. Ltd (IIFCL), provides partial credit guarantee facilities to infrastructure companies.

A partial credit guarantee is one which supports only a part of the project cost.

LIC will now join IIFCL in the credit guarantee business.

“It is a good business for LIC. We will prefer to fund only large, viable government-backed infrastructure projects. On a seed capital of Rs.500-1000 crore, the NBFC will be able to provide guarantees to projects costing up to Rs.50,000 crore-Rs.1 trillion,” said the first person cited above.

“LIC will charge fees for providing credit guarantee and unless the project fails in some rare event due to any unforeseen circumstances, the fees earned through credit guarantee will remain as a profit for the NBFC,” this person added.

With assets of around Rs.20 trillion, LIC is the largest and the only state-run life insurer in India. LIC Housing Finance Ltd and LIC Mutual Fund currently its two main subsidiaries.

RBI Cancels Registration Certificate of BNP Paribas, 3 Others

Mumbai: The Reserve Bank of India on Wednesday said it has cancelled registration certificates of four non-banking financial companies (NBFCs) including BNP Paribas India Holding Pvt Ltd.

The three other firms are Mumbai-based Financial Services Private Limited Bhageriya Financial, Capital Services Limited of Hyderabad and Kenny Commercial & Investment Pvt Ltd belonging to Jammu.

Following the cancellation of registration certificates, these companies cannot transact the business of a non-banking financial institution, the RBI said.

Commenting on the RBI's move, BNP Paribas said, "In view of BNP Paribas India Holding Company (BNPP IHC) being classified as an exempt Core Investment Company which will not access public funds, RBI has, on BNPP IHC's own request, cancelled its registration as an NBFC."

Over last few years, the RBI has carved out some specialized NBFCs like Core Investment Companies (CICs), NBFC-Infrastructure Finance Companies (IFCs), Infrastructure Debt Fund- NBFCs, NBFC-MFIs and NBFC-Factors.

Sun Capital