Adani really likes loans

Or how lending is a lot like playing passing the parcel

Adani dancing on a dollar note by Stable Diffusion

There were two reactions to my last post on why Adani stocks have been going up -

1. “You ended on a cliffhanger! When’s the next post?”

2. “Umm, it’s obvious how a high share price leads to cheaper loans, it’s not much of a cliffhanger”

The “cliffhanger” was just a way for me to publish over procrastinate. I guess it had mixed results.

If you own a company, or a part of it, it is an asset. You can then go to a bank and get a loan against this asset.

Adani owns a whole lot of a whole lot of companies, most of which bear his name. The higher the stock prices of his companies go, the more loans he can get by keeping his shares as collateral.

The good thing about keeping your shares as collateral instead of, say, your house is that if your stock price goes up, you can then then ask the bank to keep fewer shares as collateral. Unlike a house, where if its market value went up, the bank wouldn’t be OK with just your bedroom. (It would make perfect financial sense to do that, mind you, just not practical sense. Try selling a bedroom without the rest of the house.)

Adani had ~50% of his shares in his flagship company Adani Enterprises put up as collateral at the end of March 2020. This was worth about ₹5,200 crores ($634 mn). At the end of June 2022, the equivalent figure was only about ~4%. But the value of this was ₹6,800 crores ($830 mn)—28% more!

Imagine you’re a bank that holds shares of Adani Enterprises as collateral. You begin with a good 50% chunk

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. The stock price goes up. That makes you happy. If you hold an asset as collateral and it gets expensive, that’s a good thing! You made the right choice of collateral; what you hold has gone up in value.

But then the stock price keeps going up. And up. And up. You’re nervous. And up. And up. Now you’re really nervous. You’re only holding ~4% at this point but the guy that you loaned money to still owes you all the money you gave him.

What do you do as a bank if at this point the guy you gave money went “lolol not giving you the money wat you gonna do”?

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I mean, you do have collateral. So the rational thing to do would be to sell it off and pocket whatever you’re owed.

But the collateral that you own are shares of a company with a maddeningly irrational share price propped up by unknown, shady foreign investors.

You have two choices -

1. Sell anyway; hope for the best

2. Hold; hope for the best

Whether you choose (1) or (2), there’s definitely a fair bit of hoping-for-the-best to do. If you choose (1)—the share price will tank. You’ll lose money. If you pick (2), you're stuck with owning a fraction of a company, which you didn't really want, and get no money, which you did want.

What if you’d rather hold the shares instead of selling and losing money. Is there a chance you recover your money?

Let’s see. A company is only as valuable as the money it makes. You own 4% of this company, which means that—in theory

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—this entitles you to 4% of its profits. If the company, Adani Enterprises in this case, made enough money in profit every year, you could just take out 4% every year until you made your money back, and then sell off your stock. The price wouldn’t matter, you already made your money back!

This works, in theory. But there’s a bit of a problem. The valuation of Adani Enterprises is out of whack! To give you an idea: the earnings yield for the company is around 0.25% at the moment. In human words what this means is that Adani Enterprises makes about 0.25% of its share price in profit annually, per share. If you’re this unhappy bank who’s stuck with these shares, it would take you about 400 years to make your money relying just on the earnings of the company. Of course, this is a simplistic version. Adani Enterprises would surely grow as a company. Probably get better and more efficient over the years. Then maybe you’d need just about a 100 years to get your money back.

Okay so who are these banks that have potentially put themselves in this predicament? And why?

Take a guess which bank(s) this could be. 10 seconds—one guess. Say it out loud.

If you’re mildly aware of how banking works in India, your guess was probably the State Bank of India. Or some other government-owned bank.

Your sentiment would be accurate but your answer not so much. I looked up Adani Enterprises’ disclosures. Turns out, most recently, it was IndusInd Bank, one of India’s 5 largest private banks, that lent to Adani with the company’s shares as collateral. In fact, India’s second largest private private bank, ICICI Bank, also lent to Adani against Adani Transmission whose stock price is similarly jacked up

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.

Why could this be? I don’t know. Maybe they liked Adani’s puppy face

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.

Not that the State Bank of India (SBI) and other public banks didn’t lend to Adani. Here’s ₹10,238 crores ($1.3 bn) in September. ₹6,000 crores ($730 mn) in June. ₹12,770 crores ($1.5 bn) in March. All of it this year, all from public banks led by SBI. Instead of going the shares-as-collateral route, they just lent this money to Adani-owned companies directly.

Rich corporate getting risky loans from public banks isn’t a new story in India. In August, credit risk research firm CreditSights very noisily highlighted that Adani Group is drowning in debt. We know this since the last 4 years, at least.

Adani Group wasn’t happy about this. So they wrote back. Here’s an interesting snippet of the only reporting around their response:

While loans from public sector banks in 2015-16 accounted for 55% of all debt of the group firms, in 2021-22, borrowing from PSBs (public sector banks) made up for 21% of all debt, it said.

In FY2016, private banks accounted for 31% of loans, which has now shrunk to 11%. Money raised through bonds has jumped from 14% of all loans to account for 50% now.

???

It’s bizarre to me that Adani Group thinks the split of their loans from public banks going down

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, while that of bonds going up, is somehow supposed to be a good thing.

Bonds are loans! Which can be traded in the market! But they’re loans!

When someone accuses you of taking too many loans to the extent that you might not be able to pay them back, the last thing you do is tell them you’ve found a better way to take loans just without calling them loans.

Anyway, Bloomberg reported last month that there’s a rout in Adani’s bonds

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:

Stocks of firms in his Indian business empire -- spanning ports to gas distribution and coal mining -- have jumped in part on soaring energy prices. Adani Ports & Special Economic Zone Ltd. has climbed 29% in 2022 and hit a record this week, while shares in some of his other companies have surged more than 1,000% in the past two years. 

But in the debt market, Adani Ports’ dollar bonds have dropped more than Indian peers on concern about the group’s debt, and its notes due in August 2027 fell to an all-time low this week, Bloomberg-compiled prices show. Bonds of group companies including Adani Green Energy Ltd. and Adani Transmission Step-One Ltd. also mostly underperformed the broader Indian market.

The thing with the bond market is that it’s not transparent like the stock market. You can’t just look up bond prices on a centralised stock exchange, because there isn’t any!

If you were Adani and wanted to sell bonds of your company (that is, ask for loans from anyone in the market) this is how it would work:

1. Go to an investment bank and tell them you need money via bonds (most likely though, they’d be the ones to advise you that you could/should raise money this way in the first place)

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2. Decide on an interest rate that you’d give for purchasing the bonds (in the context of bonds, this is called “coupon rate”) over a certain period of years. You gotta ensure that this is high enough for investors to be interested in your bonds, but low enough that you don’t pay them too much

3. Sell the bonds; pay the coupon rate every year or whatever to whoever owns the bonds

You may have bought Adani’s bonds thinking that Adani Group looked like a reasonably reliable company that’s willing to pay you an above-average coupon rate. Your investment bank visited you one Friday afternoon and told you about how Adani is India’s largest airport operator in the span of a year and is raising funds to invest in India’s second-largest airport. “Sounds cool, let’s buy some bonds,” was likely your first thought. “How do I get this banker to leave before he ruins my Friday evening,” likely your second.

But then for whatever reason you thought that maybe the controversy around Adani (and the foreign funds, the extent of debt, etc) was too much for you and you’d just like to get rid of those bonds. At this stage, for you, the importance of getting rid of these bonds

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is more important than getting a higher return on them. So if you’d bought these bonds for $100 each, you might sell them for $98. You make a slight loss on your capital but are glad to have most of your money back, and whoever buys the bonds from you gets a better interest for their purchase (because the coupon rate for the bond remains the same).

If enough buyers sell their bonds for cheaper than what they bought them for, the message is that they think that Adani probably won’t be able to honour the bonds

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. WHICH IS A BIG THING. A company can’t casually choose to not repay their lenders. They have to! If they can’t, they have to sell their assets off and then repay them.

Back in 2019, Scroll.in tried figure out where exactly Adani’s getting the money to fund his companies’ expansion. The answer honestly is pretty much wherever he can. Adani (the individual) is loaning money to his companies. His companies are loaning money to his other companies. Private banks are loaning to his companies (to a small extent). Public banks are loaning to his companies. Most recently international bond investors are loaning to his companies.

If you’re a lender to a company, you don’t really care where the money that’s repaid to you comes from as long as you’re paid back. If you buy a company bond, you don’t have to bet that the company will succeed; only that the company survives long enough to pay you back. The money might come from the company’s business (it isn’t), from the owner’s personal fortune, or hell, even from the most recent lender.

Lending to a company that doesn’t generate enough cash by itself

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is just the finance version of ‘pass the parcel’. Till someone continues to lend, it’s fine. But when the music stops, you don’t want to be the one left holding the parcel.

Thank you to Ishan Shah for helping with fact-checking and providing inputs.

1. This is actually 50% of about 75% that Adani owns; so about 37.5% of the whole company.

2. Apart from going to court, that is.

3. In reality, it’s up to the company’s management if they want to give out the profits to shareholders, invest it into the future, make a fixed deposit out of it, or whatever.

4. ICICI and IndusInd are just two of the lenders. There are others. And these two didn’t loan the whole amount, just a small part of it. But they are the most recent ones.

5. My guess here is that they probably decided that being in the good books of Adani was probably worth the risk. Adani is known to be close to and hold a level of influence with the current Indian government. This is really just a guess and I might be entirely wrong for what it’s worth.

Puppy face Adani by Midjourney AI

6. Specifying the % over the absolute value of the loan makes sense if you’re Adani. The Group hasn’t really reduced their loans, they’ve just taken on a whole lot more debt so the share of the earlier loans reduced by itself.

7. Ostensibly, this seems to be a message to international bond investors that if they buy Adani bonds, they needn’t fret cause they won’t be alone! A lot of investors have bought Adani bonds, it’s not just Indian banks that have lent to them.

8. Bloomberg’s article is mostly focused on Adani Ports, while my focus has been on Adani Enterprises. Unfortunately I can’t find a way to check bond prices. If anyone reading this has access to the Bloomberg terminal or Refinitiv, do hit me up!

9. You have to go to the US for this, that’s where investors managing billions are willing to take on risk for additional possible returns. Bond investors in India aren’t as ballsy.

10. And you can’t just sell these bonds the way you might a company’s stock. There isn’t a bond exchange. You have to convince someone to buy them from you! Or, more accurately, pay an investment bank to convince someone to buy them from you.

11. Bond prices are influenced by other factors; most importantly bonds in the US are influenced by the interest rate set by the federal reserve in the US. All bond prices have fallen, but Adani’s prices have fallen a lot more.

12. Remember that the earnings yield for Adani Enterprises is only about 0.25%!