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The Srei Group Crisis, Explained: What Happened to the NBFCs?

Oct 7, 2021 12:54 PM 5 min read

Even as the Evergrande debacle spews chaos across the Chinese infrastructure sector, a similar behemoth’s failures threaten to strike India’s.

On Monday, citing “governance concerns and defaults", the RBI superseded the Boards of two NBFCs - Srei Infrastructure Finance Ltd. and Srei Equipment Finance Ltd. - and said they would be taken for insolvency proceedings under the IBC. A writ petition by the Srei Group against this move was dismissed by the Bombay High Court today.

While the Srei Group said it was “shocked” by the Central Bank's actions, this was a long time coming. Srei's sorry saga had its genesis in the IL&FS bust in 2018. The ensuing NBFC crisis dragged the Group down along with its peers - most notably, DHFL and KIFS. And the pandemic proved to be the icing on a rather unsavoury cake...


The Srei Group has seen better days.

At its zenith, it was one of India's leading asset finance and leasing institutions. It was the first Indian infrastructure NBFC to be listed on the London Stock Exchange. It was also the first firm to lay the ground for passive telecom infrastructure sharing in the country. Its list of stakeholders included big names from Germany, Finland, Belgium, Germany and the World Bank, among others.

However, the IL&FS implosion in 2018, the NBFC liquidity crisis, and a slowdown in the infrastructure sector led to delayed payments and stressed books.

FYI: As of March 2021, the two NBFCs together reportedly had debt obligations of over ₹29,000cr ($3.88bn). These include long-term facilities, short-term facilities, NCDs, long-term infrastructure bonds and perpetual bonds.


Boom to Bust

Srei’s key customers are primarily EPC (engineering, procurement and construction) companies. It also has a network of global original equipment manufacturers (OEMs). All in all, its lending activities have evolved to become overly infrastructure-centric.

The first cracks in the pavement began emerging in 2017. The slowdown in India’s infrastructure sector hit the company’s books. NPAs that year jumped to 8.12% from 2.93%. Shortly thereafter, the shadow banking party ended with the IL&FS bust. The liquidity crisis that followed further hurt the Srei Group.

Management rushed to adapt. Blueprints for an IPO were duly shelved. Efforts were put in place to move away from infrastructure financing. Plans were afoot to slow down disbursements and focus on the co-lending model. In July 2019, a host of businesses under Srei Infra was transferred to Srei Equipment, with the aim of consolidation.

It wasn't enough. Or perhaps the remedies may have played out better had it not been for the coronavirus. The pandemic brought the infrastructure sector to its knees, halting most projects and sparking a disastrous labour shortage.

The RBI's remedial measures during this period - which included loan moratoriums and debt restructuring directives - were aimed at helping borrowers. Which they did. But for lenders, especially the ones with precarious finances (like Srei), this made a bad situation worse by leading to severe cash flow mismatches.


Vision 2021

On the brink of being labelled a defaulter, the Group approached the NCLT last year, proposing to pay its mountain of dues in a structured manner. Some creditors accepted its plan, some did not. (FYI: some lenders might have been peeved over Srei's failure to take them into confidence before announcing its consolidation plans.)

The Srei Group Crisis, Explained: What Happened to the NBFCs?Either way, a sequence of events followed, which culminated in an RBI audit, which flagged over ₹8,000cr ($1bn) of related-party lending by the Group (30% of its consolidated loans at the time). Earlier this year, the Central Bank appealed an NCLT order which forbade any coercive steps against the NBFCs by either creditors or regulators. This order was later set aside, signalling the stern action that was to follow. Meanwhile, ratings companies were downgrading the Group's papers, citing continuous delays in debt repayments.

Finally, on October 4th, the RBI effectively took control of the two shadow lenders. Rajneesh Sharma, former Bank of Baroda Chief General Manager, has been appointed as the administrator for the two companies. The resolution process under IBC is expected to be kickstarted soon.


The Great Indian NBFC Saga

In more ways than one, the Srei story is the story of the Indian NBFC sector. In 2017, shadow banks were riding high, benefiting from the uncertainties faced by formal lenders, whose bad loans had come home to roost. That year, NBFCs outperformed traditional banks for the first time.

But only a year later, shadow banks were caught in the middle of the perfect storm. An over-reliance on mutual funds, banking on short-term borrowing to cater to long-term lending, and the prolonged macroeconomic slowdown that struck the Indian economy took their toll.

Moreover, the very nature of these entities’ assets - many NBFCs were HFCs, lending primarily to developers or homebuyers - was an Achilles’ heel. The real estate sector is a risky business - capital-intensive, labour-intensive, with long gestation periods, and susceptible to various external factors, from land acquisition controversies to environmental assessments. In 2017-2018, Indian real estate went somewhat bust. And took the shadow banking sector down with it.


Turning Tables

That said, regulators have not been turning a blind eye. The RBI’s measures - such as an accommodative monetary policy, targeted long-term repo operations, restricting dividend payouts, an SPV for HFCs etc. - aimed to boost liquidity in the system. An internal working group has also batted for large NBFCs to be allowed to convert into banks. The DHFL debacle was also wrapped up with the lender being bought by the Piramal Group.

The infrastructure segment is also doing relatively well. EPC companies and the construction sector as a whole have performed better than last year despite the severity of the Second Wave. Strong orders, healthy execution and the absence of a national lockdown kept revenues afloat while on-site stay and safety arrangements for labourers reduced migration. EPC players - especially the larger ones - could even end up logging a 15-20% revenue growth in FY22.

However, with NPAs slated to rise à la the COVID-19 economic downturn, more financial pain seems to be on the horizon. Besides, the macroeconomic outlook remains tenuous, with the pandemic still raging.


The Road Ahead

As for the Srei NBFCs, a DHFL-style resolution may be on the cards. It may be some time before their fate is sealed - DHFL took over two years from default to buyout.

If the DHFL resolution is taken as a precedent, not all lenders and bondholders may be able to recover all their dues, with the share of recovered payments likely to be based on different slabs and nature of instruments. Among financial institutions, NABARD, SIDBI and IFCI are likely to be the most-affected, since the three together have about ₹2,000cr ($268m) of exposure to the Group.

The Srei companies’ plight was probably unavoidable, given the strong sectoral realities and developments working against their favour. However, no lender should over-expose themself to a single sector, especially one as touch-and-go as infrastructure.

Eventually, it boils down to performance against all odds. The Group’s About Us page states, "[The] robustness of any company can be assessed by how it performs in its most challenging times."

Evidently, Srei’s performance simply wasn’t robust enough!


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