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RBI Welcomes Vulture Funds to Improve Corporate Culture - Outside View by PersonalFN

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RBI Welcomes Vulture Funds to Improve Corporate Culture
Dec 3, 2015

Up until about 5 years ago, only high-end mobile phones would have a front camera feature and taking a "selfie" was restricted to celebrities. Now almost every smartphone has an in-built good quality front camera, taking selfies is a raging trend. Similarly, cleaning the floor with a broom was considered a low-profile job not very long ago. This too has changed with time. It now makes a photo-op moment for celebrities to clean roads and other public places. The irony is many of them may have never even cleaned up their own houses, given that they probably employ house-help.

As you are aware, the Swachh Bharat Mission roped in Page-3 personalities to create awareness among masses. It's not just cleaning roads. But in reality, "Swachh Bharat Mission is about much more than building toilets. It is more about changing the mindsets and acknowledging the right of others to a clean and healthy environment", as quoted by the Union Urban Development Minister, Venkaiah Naidu. Clearly, Bharat is on a clean-up drive.

To make the clean-up mission broader, Reserve Bank of India (RBI) has joined the movement and has decided to allow vultures to eat carrions. Please don't even dare to think that the apex bank of India has encroached into the territory secured for municipal corporations. It is still doing what it knows best-to regulate. Within its purview of operations, it has beefed up the system to deal with the problem of rising bad loans effectively. And as a part of this effort, RBI has granted vulture funds an unobstructed entry in India. Read further to know who they are, what they do, and how could they clean up Indian system.

Vulture funds

In simple language, vulture funds are sophisticated institutional loan recovery agents. It may sound a little rude to compare a vulture fund with a recovery agent, but given the similarity in the nature of their work, it wouldn't be wrong indeed to compare the two. More often, they are a private equity funds or hedge funds.

How do they operate?

Vulture funds always fly high up in the sky so that they can have a hawk's eye on stressed loans anywhere in the world. The moment they get a good bargain, they shift all their attention to a defaulting continent, country, company, or even an individual. In simple worlds, vulture funds are constantly on a hunt for defaulters. They buy defaulted bonds from lenders at a huge discount and figure out ways to recover money, keeping the difference, that's their profit and that's how they work.

To give you an idea about the kind of reach and muscle-power they have, this example would be enough. A well-known U.S. based vulture fund bought the distressed sovereign debt of Argentina at steep discounts from the secondary markets, and later sued the Argentinean Government in the U.S. courts to recover money. Before that, it tried to confiscate the Argentinean ship on the Ghana coast by filing and wining a case in the Ghanaian court, demanding permission for such action. Although, UN Tribunal overruled the judgement of the Ghanaian court later, the vulture fund gathered courage from this episode to take more stringent actions in future.

Their role in Indian context...

You may dislike all governments in India, you may abhor the corruption around you, or under extreme conditions, you may even want to leave the country over serious social, non-secular issues; but one thing about India remains undisputable, at least at the movement-it is far away from a financial and a 'moral' default. So vulture funds may not spread their wings in India to the extent they did in Argentina.

Yet, the ugly truth is a lot of Indian companies are saddled with ever-mounting debt and many of them might even be on the brink of bankruptcy. As per Business Standard dated, November 27, 2015, S&P BSE 500 companies, excluding the financial ones, collectively have Rs 27 lakh crore in debt on their books. To give you a clearer idea about the fragility of the situation at the grassroots level, 1/10th of loans sanctioned by banks in India are stressed. In other worlds, for even Rs 1 crore worth loans disbursed; Rs 10 lakh worth loans are difficult to recover. This is where vultures may come to rescue and help clean up the rotten mangoes, and may indirectly save others from being contagion to the rot.

Impact of Vulture funds entering India:

Frankly, nobody till date explicitly stopped them from entering in India but they definitely needed clarity. And recently released RBI note has just provided that. The note said, "The FPI which propose to acquire such NCDs/bonds under default should disclose to the Debenture Trustees the terms of their offer to the existing debenture holders / beneficial owners from whom they are acquiring. Such investment should be within the overall limit prescribed for corporate debt from time to time (currently Rs 2443.23 billion). All other existing conditions for investment by FPIs in the debt market remain unchanged."

The possible positives are...

  • Vulture funds may help banks improve their balance sheets; as the rot in the books would be swallowed by the funds
  • Stress-relieved banks may then redeploy the freed capital for the developmental purpose
  • Cases such as Amtek Auto which spooked investors, may not get repeated frequently
  • Bad news for defaulting companies (especially for willful defaulters); vultures have mighty beaks, enough to beset them continuously unless the money is recovered.

The potential negatives are...

First off, banks will have to tighten up the noose and make their risk management processes watertight to resolve the serious problem of bad loans. Vulture funds may take away the compelling element for banks to think about doing so. One can only hope that huge discounts demanded by the vulture funds may act as a deterrent.

The gravitational force is all of a sudden going to increase several times for defaulting borrowers. If companies try to get away with defaults, vulture funds will push them down. If vulture funds act too tough, genuine companies would find it difficult to pacify them. As for vulture funds, the motive is simple and neon-bright-buy distressed assets at discount and somehow recover the dues.

The assuring factor is that Indian regulators have proven capability to handle complexities involved in overseeing interlinked markets. Vultures and scavengers keep the environment clean, but they are almost never become anybody's favourite. Municipal corporations might want many more of them to shoulder their responsibility. At present, it's anybody's guess how much success vulture funds may have in India. But, it is always better to call the glass half full than half empty.

Last word of caution:

Cash-strapped companies might offer you attractive rates on paper, but in the case of a default, you have very little power to make them budge an inch. You, as an individual investor should avoid at all costs taking inspiration from vulture funds. Carefully choose bonds and fixed deposit schemes and remain uncompromising on quality.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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