In the last few weeks, there has been a lot of interest shown by international funds to participate in distressed assets of banks. Despite all the provisions and the NCLT process, Indian banks have close to Rs.11,00,000 crore ($150 bn) of NPAs in their books. Not all these are bad and some may be substantially recoverable. These are just NPAs that adhere to the RBI norms for making provisions. It is here that the markets appear to be quite excited about these new animals called distressed funds.
Enter vulture funds
Globally, these distressed funds are also called vulture funds; although the name may not look alluring. Like the vulture that feeds on the dead, the vulture funds also buy distressed assets at a huge discount and then look to hive off this portfolio at a neat profit. Different vulture funds have different models like equity participation model or leveraged models etc. The bottom-line is that these vulture funds look to provide an immediate exit from the NPA mess and allows the bank and the shareholders to appropriately monetize these locked up assets. Vulture funds would again pick and choose assets because they may not be keen on assets that are too sticky. These vulture funds have a role in the sense that they help the banks to put a value to their assets and also to quickly monetize the same. However, in the Indian context, it is essential to be a lot more cautious about vulture funds.
Asset stripping is a risk
India needs to tone down its enthusiasm about such vulture funds. There are two big risks with such vulture funds, as has been seen in the context of the West, where such models have been applied in the past. Firstly, vulture funds tend to be choosy about the assets they will select. So, banks will not be able to hive off their NPAs as a basket but allow these vulture funds to pick and choose. Obviously, these funds will pick the more promising NPAs leaving just shells behind. Secondly, some vulture funds will show interest if they are able to carve these NPAs into a separate entity and get further funding. This will also mean loss of control for government.
Creates market volatility
But the bigger risk is that these vulture funds or distressed funds substantially add to the volatility in the markets. Here is why! Firstly, when these vulture funds do the due diligence on bank NPAs, they have the opportunity to take contrary positions in the F&O market. This can distort the price and add to unnecessary volatility in the markets. The second risk arises from the fact that most of these funds tend to be heavily leveraged. So time has a huge cost for such funds. That means; they will strip good assets and make an exit rapidly so that waiting costs do not add up. This creates huge volatility. Hence, we need to be a little more tempered in our enthusiasm! ©