Wednesday’s announcement by finance minister Nirmala Sitharaman on the proposal to establish a Rs 25,000 crore fund has been welcomed by many bankers and market analysts. While this is a welcome step, there are a few important points that GoI must be cognisant of if it’s to be implemented successfully.
The loan to a real estate project becomes a non-performing asset (NPA) when the project is unable to generate the required cash flows as had been envisaged by the lender. Such a project causes loss and stress to all stakeholders: promoters, lenders, homebuyers, suppliers and the common people (through the slowdown in the economic process). All stakeholders in a stressed project obviously look for ways to minimise and, if possible, recoup the losses caused to them. When a business generates operational cash flow, it is distributed among the stakeholders in a legally pre-determined manner. But if a stressed business receives any cash flow from anew financier, the latter gets to negotiate on the terms of utilisation and, therefore, distribution of the funds among the stakeholders. As an aside, a large number of insolvent companies seeking resolution through the Insolvency and Bankruptcy Code (IBC) process are unable to accept fresh funds on account of a lack of agreement on the distribution of funds between the existing stakeholders.
Now, GoI says that it is planning to infuse Rs 10,000 crore of funds into stressed real estate projects. But what will be the characteristics of these funds? Most importantly, what is the objective of the financier — in this case, the government? The financiers to stressed projects under IBC or restructuring processes have the singular motive of making profit on their investments. Prima facie, that is not the stated motive of GoI in the current case. So, it’s important to state the motive. It would be facile for GoI to say that funds are aimed at benefiting all stakeholders. That can be a wish, but not the driving motive here. The appropriate, and even politically correct, motive would be to help the homebuyers. After all, it is the taxpayers’ money that is being given back to a subset of them. In that case, GoI will have to design the financing structure carefully to achieve that objective. For that purpose, it should ensure the following in its terms of financing:
* The funds should be against fresh equity shares issued by the borrower. Why? Because the financing of ahigh-risk project with all equity capital wiped off its books needs equity finance and not debt to further leverage it.
*The equity financing should be at a fair price. The fair equity value of any insolvent company is zero. So, GoI should get equity shares for free, or at a nominal price of .`1, for the entire funding. This price will have legal blocks, but can be resolved through appropriate shareholder resolutions. This is the only fair price and the existing shareholders need to accept this if they want the funds.
*The government should take over the management control of the project. The equity funding, on aforesaid basis, will make GoI the majority shareholder in the project. It should take control and entrust a capable developer to complete the project.
*The government should select the projects to be financed in a manner aligned with its objectives. If GoI wants to help the homebuyers, the projects beneficial to the maximum number of low-/middle-income homebuyers should be primary criterion.
For example, criteria like existing NPAs and positive net worth are redundant. They may give the impression of being objective. But why would GoI not finance a performing developer if the latter serves more homebuyers and is willing to raise fresh funds at stiff prices? If they are not expected to avail of the facility, then the clause anyway does not matter. Restraining good projects is a needlessly hazardous clause.
The terms of financing, including the write-offs on existing equity and debt values, should be negotiated on acase-by-case basis. Apart from the socio-political objective of helping homebuyers, GoI’s financial objective should be to not allow, by design or default, the existing investors to benefit at its own — or the taxpayers’ — cost. The existing investors and creditors are welcome to reap any benefits after GoI gets its rightful dues from its investment.
These broad, fundamental principles of designing the financing structure will need to be translated to multiple agreements through further efforts. There will be pressures on GoI from various interested stakeholders to design the financing in a way favourable to them. However, it is incumbent on the government to stay with the correct principles of capital allocation and pricing. That is the only way it can rightfully claim to have helped the homebuyers without compromising with fairness to all other stakeholders.