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The Kolkata-based non-banking financial company (NBFC) twins – Srei Infrastructure Finance Ltd. (SIFL) and Srei Equipment Finance Ltd. (SEFL) – which have been synonymous with infrastructure financing are in the eye of a storm, and the men in focus –Hemant Kanoria, the founder, along with his brother Sunil. Just a few days ago, the Reserve Bank of India (RBI) had sent these two companies into bankruptcy proceedings by superseding their Boards on grounds of concern over the quality of governance and inability to service debt. The RBI had even appointed a
former senior banker as an Administrator to oversee the insolvency proceedings.

For over three decades, SIFL had been the face of the private sector in infrastructure financing and a pioneer of several path breaking innovations and Hemant and Sunil, its dynamic leaders. So, how come they are today staring at a reputation crisis? Business Economics’ research presents a ring-side view of the evolution of Srei and a unique peek into the peculiar universe of Indian infrastructure.

The Beginning

In 1989, India had not opened up, the economy was in a sorry state. The GDP growth rate hovered just around 3% per annum. The physical infrastructure was in shambles. There was hardly any quality investment in infrastructure projects. There was a severe liquidity crunch. Government controls were in every sector choking the business environment.

It was then that Srei was conceived to address two of the nation’s most critical problems – financing and infrastructure. Both these were extremely difficult domains, and government had a dominant presence in both. A private player in infrastructure financing was almost unthinkable at that point. But the founders had correctly assessed the ground reality
and realized that it was only a matter of time before a
resource-constrained government, in order to meet the country’s massive infrastructure needs, opens up the doors to welcome private sector participation.

The founders embarked on a journey with a noble intention. They aspired to see the rise of a bold, stronger and confident New India. Beginning with very limited capital, the founders were practical enough to realize that the closest that they could get to infrastructure was by financing equipment to contractors and construction companies. Financing of construction equipment was then seen as a high-risk business, but they chose the path less treaded. In 1988, acting upon the advice of some reports, they decided to get into leasing of infrastructure and construction equipment. Till then, leasing was mostly restricted to financing of cars and trucks in India.

It is worth noting that the annual sales of construction and mining equipment back then pan-India was only about `150 crore for the industry as a whole. Today, the annual sales are over `50,000 crore and Srei played a major role in nurturing and expanding this market. In India, the big developers who take up an infra projects usually break up the work in parcels and then sub-contract those parcels to smaller companies who carry out the excavation, construction work, transportation and provide myriad other ancillary services. Now, these players are small and, in many instances, some of the balance sheets are tax optimised or simply unavailable. Thus, the banks do not find them loan-worthy……at least that was the case when Srei started. And this is where the Srei founders spotted an opportunity. They adopted proxy assessment approaches, like evaluating the borrowers based on the basis of the contracts in hand, undertook site visits and started reference checks from their principals, and this combination of qualitative and quantitative factors, proper checks on the source of orders of the organisations helped them in assessing the potential borrower’s ability to service a loan. Accordingly, appropriate credit calls were taken with suitable risk mitigants. A system-oriented and process-driven mechanism was put in place which provide SIFL a distinct edge. As time progressed, they honed their market intelligence capabilities as well as collection processes and built a robust, profitable and sustainable business model. In fact, they created a whole new business segment from scratch, and later several players emulated their business model with various degrees of success. Even some of the institutions like ICICI, Citi, GE Capital later entered this equipment financing space.

Mechanization in infrastructure/mining projects has definitely picked up in the last few decades. This has immensely brought down the construction period and also brought in higher levels of efficiency. The improvement in the quality of infra projects is clearly visible for everyone.

Srei was instrumental in galvanizing the international equipment manufacturing companies such as Caterpillar, JCB, Komatsu and Volvo and bringing them to India. This encouraged many of these companies to set up their manufacturing bases in India. Thus, in a way, Srei made ‘Make in India’ happen long before it became a slogan.

Srei had a first mover’s advantage. It emerged as the undisputed market leader in the equipment financing segment and before the group hit this recent air pocket, it was enjoying a 35% market share. It has today more than one lakh customers and 60% of them are repeat customers which reflect the strong brand loyalty the group has managed to build. Over the years, it helped many small and medium contractors grow into bigger project developers. And Srei evolved into a Systemically Important NBFC. The consolidated assets under management as on 31 March, 2021 stood at `39,498 crore, which is roughly a little over $5 billion.

The founders believed in making a business model with the customer at the centre – the guiding principle being, “If the customer grows, so does the company”. Clearly anticipating the client’s requirements, SIFL innovated to make customised product offerings. That brought the customers back to
them again and again. No wonder Srei still enjoys a strong brand recall. Srei has been supporting its borrowers in their critical period.

Innovations

Srei has followed an asset-based lending model and their USP has been the asset management solutions along the entire life-cycle of the asset – right from the stage of need evaluation to providing guidance on purchase/rent to asset acquisition to operation and maintenance to redeployment and finally to its disposal. This enhances Srei’s value proposition to the customers.

Srei brought to the market a number of innovative offerings. Notable among them were Paison ki Nilami (a unique Dutch auction of interest rates for financing infra equipment by bringing together customers and equipment manufacturers on a common platform), Srei Money Bag (a special credit card created exclusively for Srei’s premier customers for purchasing equipment from select manufacturers), Srei Lotto (where retail customers played a game of Lotto to select the rate of interest for financing from Srei) and a 3-in-1 scheme (whereby customers could avail a composite deal for getting their equipment financed along with insurance and maintenance services). There is a long list of such offerings, the latest being the creation of a digital platform to bring together customers, manufacturers and financiers to carry out ‘remote’ business, something extremely relevant in today’s life where ‘social distancing’ has become an accepted norm.

Another segment that the team explored was to buy out non-performing loans (NPLs) and leverage Srei’s ability to recover money through legal means. This was the
pre-ARC era and Srei met with considerable success in several cases (e.g. Kingfisher Airlines). In many of these cases, the
banks were unable to recover their dues from the borrowers and were willing to sell their NPLs to Srei as they appreciated the value we brought to the ecosystem. The complementarity with banks was a win-win for all. To purchase such assets
from the banks and also to invest in various infrastructure assets, Srei came up with a SEBI-registered Alternative Investment Fund structure in 2006.

Interestingly, the logic behind the creation of the Bad Bank structure by the government is pretty much the same as
that of the AIF structure which Srei had experimented with 15 years ago. The basic premise is to enable a quick
turnaround of a stressed company by changing the management. That would ensure continuity, protection of stakeholders’ wealth and future growth.

Funding

Although the founders went for an early Initial Public Offering (IPO) for SIFL in 1992, their initial growth was aided by the funding support from a number of global financial institutions. Between 1994 and 1997, they received funding from several such institutions, like the DEG (a financial institution owned by the Govt. of Germany), IFC Washington (a sister organisation of the World Bank group) and FMO Netherlands (owned by the Govt. of Netherlands). Over the subsequent years, financial institutions such as BIO (owned by the Govt. of Belgium), FINNFUND (owned by the Govt. of Finland), Nordic Investment Bank, PROPARCO (owned by the Govt. of France), OeEB (Development Bank of Austria), European Investment Bank (EIB), etc. had provided funding support to Srei through debt and, in some cases, through equity participation as well.

But what was more important than funding during those formative years was the knowledge that the team gained from those institutions in terms of systems and processes and the mechanisms to mitigate risks. These institutions followed very stringent norms in terms of risk assessment and provisioning. The Srei team was made to adhere to those rules and automatically global best practices became ingrained in the working culture. In fact, those stringent norms helped them weather several storms earlier, like the late 90s NBFC shakeout in India and the post-2008 Great Financial Crisis. While many players shut shop, Srei emerged stronger from every phase of turmoil.

Srei invested in nurturing and strengthening its
relationships and partnerships with all its stakeholders – their customers, employees, equipment manufacturers, investors and bankers. In this regard, the domestic banks deserve a special mention. They have always been a huge
pillar of strength in their growth. Srei enjoyed very cordial relationship with our banking partners. Keeping that
history in mind, this recent phase of misunderstanding has been a very unfortunate one.

Srei always aspired to make the equipment financing
business real big. Having established their footprint in the construction and mining equipment financing space, during the mid-2000s, Srei had started diversifying into leasing of other asset classes like medical and healthcare equipment, agriculture equipment and IT hardware for the growth of economy and employment. At this point, they felt that bringing in a global player was the logical next step to make the brand global. They met the senior team of BNP Paribas who were then very bullish about India and were eager to partner through their wholly owned subsidiary BNP Paribas Lease Group (BPLG). In 2007-08, Srei Equipment Finance Ltd (SEFL) was incorporated as a 50:50 Joint Venture between SIFL and BPLG by transfer of the business undertaking along with the liabilities of SIFL. BPLG was to extend support on the liability side to expand the equipment financing business. However, subsequent to the 2008 Great Financial Crisis, the access to external commercial borrowing (ECB) got majorly restricted, and thus BPLG’s ability to extend funding support also got curtailed. Subsequently, there were changes in their internal policy and BPLG needed to dilute its stake to a minority. BPLG settled for a share swap agreement with SIFL in 2016 whereby they transferred their entire stake in SEFL to SIFL and in lieu took a stake in the parent, SIFL.

This joint venture also helped Srei to aim for greater heights, and become more active in the infrastructure project financing space. By then, the team had already taken some small exposures in project financing. In fact, India’s first toll road financing in 1997 was done by a consortium which had Srei and State Bank of India. SIFL was also providing advisory services towards infrastructure development in multiple projects. The ultimate aim was to position Srei as a holistic infra finance player in India alongside players like the government backed IDFC and IL&FS and the newly formed government sponsored IIFCL. Incidentally, by 2011, Srei was accorded the status of an Infrastructure Finance Company (IFC) status by the RBI and a Public Financial Institution (PFI) by the Ministry of Corporate Affairs.

External factors for downfall

The root cause behind Srei’s fall, according to Hemant,
was a systemic failure. The eventual cloudburst was the culmination of a number of many factors, but the build-up
to this event was gradual.

A lot of private investment had flowed into the infrastructure sector in India ever since the mid-90s. However, a phase of judicial pronouncements and policy paralysis during 2012-14 pressed the brakes on the growth of this sector. Sectors like telecom, mining, roads, power suffered in particular.
The private sector took a major hit and the financial
institutions which had taken exposure in infrastructure had collateral damage from this episode. Even institutions
like IDFC and IIFCL had to bear the brunt. Srei was no exception. But anticipating the stress this could cause to the Balance Sheet, the management decided to systematically reduce Srei’s exposure to project financing. The group has been doing that since 2015.

The situation worsened with the implosion of IL&FS and from late-2018, access to fresh funding, particularly for infrastructure NBFCs like Srei, became extremely challenging. It hit the business growth of Srei hard. In addition, problems in several infra verticals like road and power led to stress on the books for Srei due to delays in payment by clients. In fact, an IPO for SEFL had to be shelved post-IL&FS crisis as the market sentiment deteriorated drastically.

The proverbial “last straw that broke the camel’s back” was the COVID-19 pandemic induced lockdown. Infrastructure projects came to a grinding halt. The contractors’ revenue stream dried up and they were unable to service their debts. Today as many as 483 infrastructure projects (each worth `150 crore and more) have been hit by cost overruns totaling more than ` 4.43 lakh crore. This has also affected private sector stakeholders, including some intermediaries and NBFCs involved in these infra projects.

As it is, in the infrastructure sector, one perennial
problem has been the inordinate delays most big private developers and government agencies make in settling payments to the contractors and service providers. On top of that, huge amounts of arbitration awards and claims
remain stuck for years because of prolonged litigation.
Because of this, small and medium contractors often face difficulty in servicing their loans. This is a problem which even our Union Minister Shri Nitin Gadkari has publicly acknowledged. Thus, most of Srei’s borrowers were not in a position to service their debts.

The Finance Ministry intervened and instructed the
RBI to provide relief to the borrowers. The RBI directed all the lending institutions to offer moratorium and recast debts of micro, small and medium enterprises (MSMEs) and large enterprises. However, NBFCs like Srei, as borrowers
from the banks, were not allowed to restructure their debt under the guideline. That was the biggest blow to Srei – as it led to cash flow mismatch, plus no respite was provided to the NBFCs. SIFL and SEFL had to abide by the new rules, their revenue sources dried up completely. Meanwhile, their role as borrowers got overlooked. This resulted in a severe liquidity crunch despite assets being more than liabilities,
thus precipitating the crisis that they find themselves in
today. The management thereafter focused more on co-origination / co-lending.

Apart from the above sequence of events, several regulatory developments over the years also played a crucial part
in this saga. A 2011 RBI Report of a “Working Group on the Issues and Concerns in the NBFC Sector”, chaired by former RBI Deputy Governor Smt. Usha Thorat, set the ball rolling for regulatory convergence between the banks
and the NBFCs, but only from the asset side and not the
liability side. While banks can mobilise public deposit and the NBFCs with superior credit ratings (being either government owned or are backed by big corporate houses) can tap the market for their funding needs, the other NBFCs with relatively lower ratings have always found it challenging to mobilise resources.

The Srei founders had been repeatedly appealing to the RBI to expand the revenue mobilisation avenues, but that remained mostly unaddressed. Srei had tried to fill in the void created by the exit of the erstwhile development finance institutions (DFIs) during the 90s. However, the government has revived the concept of DFI now. Just a few days back, we got the news of K V Kamath being appointed the chairman of NaBFID - the new DFI. Had Srei been converted into a DFI (as it was an ideal fit for it), that would have solved Srei’s funding needs as well as provided India with a DFI, up and running by now.

Within the non-bank financial institution (NBFI) universe, the National Housing Bank serves as a refinancing agency for the Housing Finance Companies (HFCs), but there exists no such facility to cater to the refinancing needs of the NBFCs.

The NBFCs were made to go for a phased adoption of the Ind-AS, while the banks are yet to do so. For preparation of financial statements, the NBFCs now have to work out two sets – Ind-AS as well as the conventional method.

2017 onwards, the RBI merged the supervision of banks and NBFCs into one department to increase the intensity of monitoring. This led to further convergence of the regulations.

Allegations of related-party transactions with ‘sweetening of loan terms’ and ‘funds siphoning’ have been leveled against the founders by a segment of the media. When asked about these charges, Hemant was emphatic “Look, we are a developing nation, and for developing our infrastructure, ‘structured credit’ is a must. We picked up our lessons on ‘structured credit’ from the global financial institutions who helped us grow. We learnt from them the importance of aligning the customer’s repayment schedule as per their projected cash flows and the value of the underlying assets. This has been the guiding principle behind the ‘structured credit’ deals as well when Srei diversified into project financing. Thus, which loans are to be offered to whom and at what terms are essentially decided after taking these factors into consideration. These allegations of ‘sweetening’ of loan terms to connected parties are being refuted. We have a team of professional and highly qualified individuals who work out the loan terms, the proposals get vetted at different layers, thus no question of favoritism can arise. The expression used in the newspaper reports is ‘possible related party transactions’. The RBI has highlighted exposures to probable connected parties which has been duly reflected in the annual accounts of the company for 31 March, 2021.The assets are more than debts. These exposures do not, as per the Companies Act or the Ind-AS norms, come under the definition of ‘related party transactions’. They are investee companies with the various SEBI-registered
funds where Trinity has been appointed as the investment manager / advisor. Trinity itself is a public company incorporated under the Companies Act, 1956.”

In July 2019, the Boards of SIFL and SEFL decided to consolidate the lending business by way of a slump exchange to SEFL. Technically, it was transferring the lending business, interest earning business and lease business of SIFL together with the associated employees, assets and liabilities to SEFL. This decision was taken by the Board of Directors and the shareholders together, and not a decision of the founders alone. This was done in discussion with the potential investors who were interested in taking a majority stake in a consolidated entity. This move was expected to improve efficiency and cost reduction, and attract the needed capital. However, that did not quite go down well with the consortium of our lender-banks in spite of the fact that the lead bank had given the approval and also the shareholders, ECB lenders and bondholders had given their consent.

Consolidating the lending business was a big bold step on part of the founder, according to many market observers and analysts. This episode perhaps marked the beginning of the souring of relationship between the Srei team and a few.

The other incident was a more recent one. With things going out of control during the pandemic and its immediate aftermath, SEFL took another crucial but risky decision to approach NCLT (Kolkata Bench) with a scheme that proposed to pay full dues to all creditors in a structured manner. SEFL had approached NCLT with a scheme of arrangement to obtain consent from the required majority of lenders (for transferred cash credit, working capital demand loan and term loans to the completed acquisition by way of slump exchange from SIFL). The Board took a decision that the only option was to file for Section 230 of the Companies Act, not under IBC, but in the NCLT, which allows a restructuring of the debt and which will be in alignment with the cash flow of the company.

Srei had an impeccable record for 31 years of not missing a single payment deadline. Till date, they have paid `30,000 crore as interest and `20,000 crore as principal. The pandemic changed the scenario. RBI’s regulations to provide moratorium and restructuring to NBFCs’ borrowers without allowing the NBFCs to avail the same facility from their lenders (the banks) put the NBFC twins in a fix. They had commitments to honour to the bankers, NCD holders and other creditors. The payment deadlines were approaching, but they had little or no source of revenue. Their reputation was at stake, that desperation prompted them to file that application in October last year. They requested the bankers in that application how they intend to repay, spread over a period of 10 years, and presented a plan with a schedule for making the entire payment with interest. But that upset the bankers, although that step was taken with the intent to pay to everyone in a systematic manner.

For the first time in the history of the company, a scheme for payment to creditors was submitted to the court for realignment of debt. Some creditors accepted this scheme, while others, including some bankers, did not. But it definitely peeved the bankers for not being taken into confidence. The consortium of banks subsequently took control of SEFL’s cash flows. Salaries were capped and between November 2020 and earlier this year more than 200 employees (including senior management officials) had quit.

The NCLT hearings went on till 2020, but the damage had been done. The bankers had lost their confidence. The move clearly backfired, and metamorphosed into a giant financial crisis. In the scheme, it was mentioned that pursuant to the circulars issued by RBI in August 2020 (in relation to one-time restructuring), majority of the borrowers of SEFL have sought or are expected to seek one-time restructuring of their loans, which has resulted in and will result in severe cash flow shortage. SEFL only has the option of restructuring as per RBI guidelines its assets and not in its liabilities. The resultant temporary asset-liability mismatch despite cumulative assets being of higher value has forced SEFL to enter into certain arrangement with the secured creditors for conversion of not less than 75% of the total debts due to the secured creditors as on August 31, 2020 into secured NCDs of such number and value as the secured creditors in their meetings may decide.

Sometime back, CARE Ratings had placed the ratings of SIFL under credit watch with negative implications pending outcome of the special audit initiated by RBI and proposed meetings of creditors for considering the Scheme of Arrangement amidst stressed liquidity position of the group. In its press release, CARE Rating said, “The consensus of creditors is critical for the consolidation credit risk profile of the company amidst stressed liquidity position. There is no clarity as yet on the stance of the consortium on the
slump exchange and restructuring scheme. A likely delay and lack of unanimity among the creditors in view of recent happenings may further impact the consolidated credit risk profile of the company.”

In the interim, the founders were also in talks with private
equity players for raising capital. “We had received
expressions of interest from 11 global investors, and subsequently, received non-binding term sheets from Arena Investors LP and Makara Capital Partners. But now, after RBI’s action of superseding the promoters and the possible insolvency on the cards – there is a big question
mark on whether investors will at all support at this crucial juncture – a typical catch 22 situation” observed Hemant.

The two companies got tagged as defaulters even when collections were still trickling in. Almost `3,000 crore was collected which the banks had distributed amongst themselves. The fact that the NCD-holders and other creditors were getting left out was also one of the triggers for moving NCLT. The founders wanted an equitable distribution of whatever money comes in among the stakeholders.

What now?

This is one case where the promoters perhaps cannot be blamed entirely for the failure of the troubled companies. There were several other factors which were way beyond their control. They did make some judgment errors for sure, but they seemed to be hoping for an orderly resolution.

Most interestingly, Hemant still refuses to associate the word ‘failure’ with his NBFC twins. “How can you say that the companies have failed? Even within this crisis the teams have been making collections. Between the two companies, they have receivables worth more than `50,000 crore, including contractual dues, lot of arbitration awards and claims and valuation of physical assets in infrastructure projects. These will eventually come into our books. What we really need now is a solid strategy backed by concerted efforts to recover this money. But yes, money recovery is an art, and very few have been able to master it. Following the rulebook to declare an asset as an NPA can be done by anyone, it is only the skilled ones who can assist the borrowers in overcoming the problems. An account remaining normal is in the greater interest of everyone. Even in the ancient Indian scriptures, it is mentioned that it is easy to kill, but it is more challenging to protect and preserve. We molded our belief system around this valuable learning. Time and again, we have come across customers who found difficulties in servicing their loans. At Srei, our philosophy has always been to be accommodative and to work out possible solutions, even out-of-the-box ones at times, for helping him to tide over his problem and overcome their challenges. Declaring the asset as an NPA and repossessing and liquidating has always been the last option. Probably, this is why our customers prefer to stick with us” explained Hemant.

Incidentally, the founders have full confidence in the capability of Rajneesh Sharma, the RBI-appointed Administrator, in turning around the Srei twins. The founders have already communicated to him that they will extend full co-operation and support. However, the founders are of the opinion that the focus should be on the collections for the time being. Hemant explained “There are creditors who are banks, NCD-holder, ECBs and others. We need to repay them in an orderly fashion. So, SEFL needs to concentrate on the collections first, and co-lending may resumesimultaneously. Some borrowers may try to take advantage of the situation. It needs to be communicated to them well that under IBC, it is business-as-usual, and repayment obligations must be honoured.”

In the last few days, speculation has been rife about the intent of the founders and even their family name has been maligned. The founders wish to set the records straight. Hemant elaborated “We set out on a journey with all sincerity to create a better future for India which is high on Hunger Index too. Srei played a huge role in nation building, promoting financial inclusion and fuelling entrepreneurship and employment. ‘Working with devotion’ has been our family ethos. We had brought all our investments under the Kanoria Foundation, so that the resources that we generate can be channelized to diverse philanthropic activities for the betterment of society. These include activities in the areas of education, vocational training, healthcare, environment, harmony and peace and rehabilitation of acid attack victims. Tell me, if we had malafide intentions, would we have attached our family name and put our honour at stake? If we had any ulterior motive, we would have been out of this country long back. Whatever reputation we have today was built painstakingly over
decades of hard work and sacrifice. Our family reputation has been for over two centuries. It truly hurts when one’s integrity gets questioned. It is a matter of honour for us now. We are right here, and we will continue to be here. Our
topmost priority is now to extend any kind of help possible from our end to revive the Srei twins. We have an obligation to our creditors, our employees, our customers and to the society at large. We hope for a quick and orderly resolution so that all these stakeholders ultimately benefit.” Whether the founders get to play a role in the re-emergence of Srei remains to be seen, but it is clearly too early to  draw any conclusion on whether the founders were  guilty or were victims of circumstances. But one fallout of this episode is very likely – if this can happen to the Srei founders who started as self-proclaimed entrepreneurs and have been in the business with distinction for over three decades, this episode can scare away many budding entrepreneurs.