Private credit is ‘solution capital’

Since India’s private-credit-to-GDP ratio is among the lowest in the world, the space has immense growth potential making it an attractive destination for private players and their capital.

By L Viswanathan & Sangita John

Private credit is the fastest-growing institutional asset class in the world, which has greatly evolved since the 2008-09 financial crisis to firmly establish itself as major source of finance for any economy. In India, following the continued bank NPAs and the NBFC crisis, private credit has started playing a key role for corporates.

It is widely acknowledged that a gap exists between India’s projected economic growth and the availability of sufficient credit required to move the real economy. We are seeing early signs of private credit players swooping down in a big way to fill this gap in the market that got created on account of regulations that restrict banks and the NBFCs. There are several situations where private credit players are coming in to provide capital. They complement the pivotal role played by Indian banks by providing them with their exits or take outs, resulting in banks getting their capital back.

The main attractiveness of private credit, or direct lending to middle-market asset class, lies in its ability to be customised according to a company’s risk-return portfolio. It is this risk-reward appetite of a business that draws private capital, and where regulated entities, governed by regulatory norms, find it difficult to provide that type of capital. Regulatory restrictions often prohibit banks from providing acquisition financing, lending against capital market instruments or real estate. Lenders have also become more conservative in the deployment of funds due to high NPA levels. On the other hand, borrowers find private capital more nimble as they can be deployed to finance stressed assets, have lower cost of funds, and operate within a market based but more limited regulatory framework on account of a paved compliance threshold for instance unlisted debt securities.

Borrowers are essential stakeholders in the general credit ecosystem. The availability of an assorted range of private credit gives borrowers the flexibility to pick and customise a credit solution that best suit their needs. The sustainability of private credit system has been enhanced after India enacted the Indian Bankruptcy Code (IBC) that gave borrowers greater access to different types of capital. Hectic activity in the last five years in the private credit market prove private capital players have become confident since the birth of IBC. The Indian legal regime had traditionally been friendly towards banks and other regulated entities, which is reflected in their preferred access to debt recovery tribunal, SARFAESI etc. But IBC created a level playing field for private credit providers by giving them access to the NCLT regime. Inevitably, private credit providers work with a certainty of outcome—either positive or negative—and have a ring-fenced approach towards lending. These providers also impose a degree of control allowing them to chart the destiny of the credit.

Since India’s private-credit-to-GDP ratio is among the lowest in the world, the space has immense growth potential making it an attractive destination for private players and their capital. Notwithstanding the economic weather, private credit will prosper in India, supported by an ever-evolving regulatory environment. The terms for end use of private debt availed from sources of capital or platforms like FPIs or Alternate Investment Funds (AIFs) offer a conducive route to private credit players to cater to the capital needs of Indian corporates in a regulatory-complaint manner including for purposes which banks are restricted to provide debt. Even in the distressed debt space, the combination of AIFs and Asset Reconstruction Companies (ARCs) can provide the necessary take-outs for the Indian banks. However, there are limitations on the end use of private debt raised from such entities as well—for example, purchase of land falls under the negative list of activities that can be financed by an FPI. Besides the progress in regulatory environment, enforcement regime has also brought in a lot of parity to the private capital providers. India has done very well in giving various options to private capital providers to come in and participate.

Foreign debt is subject to certain regulatory constraints in the form of maturity requirements, concentration limits and restrictions on repatriation of proceeds (for instance no more than 25% of the principal amount of debt raised from FPIs through the voluntary retention route can be repatriated within the committed retention period). Further, recourse to SARFAESI is not available for non-notified NBFCs, subscribers to unlisted or unsecured non-convertible debentures. Private credit deals should be structured to comply with rather than overcome these requirements.

Mitigants which may be considered include cash trap arrangements or switching over to different instrument or a different platform. In addition, infrastructure projects often carry an element of risk as they are implemented through SPVs, which initially have no assets. Investor risk in such projects remain high until the time they start generating revenue.

Structuring of a deal depends on the deal economics. The simplest principle for any credit will be to stay closer to the assets. Private credit providers can play an important role in providing solution capital for several corporates.

The authors are Partners, Cyril Amarchand Mangaldas
Views are personal