Cerberus, JC Flowers put Indian bad debt on map

India's struggle to work through bad corporate loans is on the verge of shifting from overburdened bank boardrooms to where it ought to be: in the hands of experts. Investment firms JC Flowers, Apollo Global Management and Cerberus are leading a fight to take charge.

Yes Bank needed a rescue in early 2020 after its infrastructure and property loans soured. Heavyweight lenders from State Bank of India to HDFC Bank bailed it out as the pandemic rolled in. Now the recovering bank is auctioning off dud debt that had a face value of 480 billion rupees ($6 billion). It's a milestone in both its turnaround and India's embrace of such transactions, as the country's largest-ever such deal.

The business of offloading bad loans in a timely manner and at a fair price to maximise recoveries, and to free up bank balance sheets for productive lending, is common in the West. India's banks, though, have preferred to work things out themselves or wait for creditors to force bad assets into India's new bankruptcy regime. The former was rarely effective, and the latter is promising but experiencing growing pains.

The winner of Yes Bank's sale will get a leading position in India's private debt workouts. Of the 30 or so licensed asset reconstruction companies, one of the largest is backed by Edelweiss and Canada's CDPQ and has about $5 billion of assets under management. Whoever triumphs will also acquire influence in any subsequent effort to agree a common restructuring plan or to aggregate debts because the bank was the largest creditor in many loan consortiums.

The prize position warrants a premium to the 111 billion rupee base bid, an implied 23% recovery value, as assessed by anchor bidder JC Flowers, which will have the right to match any winning offer. A rival might be willing to pay more. Cerberus, for example, is teaming up with Apollo Global Management and India's ICICI Bank, per the Economic Times. The ultimate buyer will pay 15% of the bid in cash and issue securities to Yes Bank for the rest. That so-called pass-through paper will rise in value if the final amount salvaged turns out to be better than its initial estimate.

Of course, these legacy loans have been in trouble for a while. What distressed debt investors are really looking forward to is a time when they will be able to get hold of ones that have only recently gone sour. That's where recovery rates tend to be higher. Competition is ramping up, too: State banks may soon follow suit in pursuing market-based solutions. The government is also setting up its own bad bank.

The timing is right: The share of gross non-performing loans in India's banking sector fell to a six-year low of 5.9% in March. That figure is now regarded as largely reliable as a result of the Reserve Bank of India kicking off a review of asset quality at lenders in 2015. Some two years later the central bank forced a "dirty dozen" companies comprising a quarter of total duff loans at the time into insolvency courts. It's a sharp contrast to the distrust in asset quality at Chinese banks grappling with a property crisis; that shortcoming is one reason why such large transfers of assets to private buyers are rare in the People's Republic.

The competitive auction will boost Yes Bank's collapsed $4.6 billion market capitalisation as it prepares to raise $1 billion to bring its equity capital ratio closer to the level of most its non-government-controlled peers. Private equity firms Carlyle and Advent are fronting that cash call, report local media. The bank's board is meeting on Friday to judge proposals. Investors all round have lots of reasons to say yes to Yes.

(The author is a Reuters Breakingviews columnist. The opinions expressed are her own.)