Corporate Loaning: Ease of doing business

A five-member expert committee headed by K V Kamath, former Chairman of ICICI Bank, recently came out with recommendations on the financial parameters required for a one-time loan restructuring window for corporate borrowers under stress due to the pandemic. It sets the stage for the banking sector’s biggest ever loan restructuring programme.

Setting-up of a Committee

The Reserve Bank of India set it up last month. While the RBI provided the broad contours of the one-time loan restructuring plan, the committee was tasked to recommend the sector-specific benchmark ranges for financial parameters to be factored into each resolution plan for borrowers with an aggregate exposure of Rs 1,500 crore or above at the time of invocation. The process and conditions are being announced to ensure there is no evergreening of bad loans, and only genuine cases directly hit by Covid – 19 stress are provided the facility of one-time restructuring. The programme is being implemented as a six-month moratorium on repayments ended on August 31 and the economy faced contraction amid a continuing lockdown in several states.

Debt Problem of India

The Kamath committee noted that corporate sector debt worth Rs 15.52 lakh crore has come under stress after Covid-19 hit India, while another Rs 22.20 lakh crore was already under stress before the pandemic. This effectively means Rs 37.72 crore (72% of the banking sector debt to industry) remains under stress. This is almost 37% of the total non-food bank credit. The Kamath panel has said companies in sectors such as retail trade, wholesale trade, roads and textiles are facing stress. Sectors that have been under stress pre-Covid include NBFCs, power, steel, real estate and construction.

Key Proposals

The RBI has broadly accepted the committee’s recommendation to take into account five financial ratios and sector-specific thresholds for each ratio in respect of 26 sectors while finalising the resolution plans. These ratios are: total outside liabilities to adjusted tangible net worth; total debt to earnings before interest, taxes, depreciation, and amortisation (EBIDTA); debt service coverage ratio (DSCR); current ratio; and average debt service coverage ratio (ADSCR).

The RBI has now finalised sector-specific ceilings for each of these ratios that should be considered by lending institutions. The parameters have been specified depending on severity of the impact of the pandemic. The hardest-hit sector real estate, for instance, has been provided the highest permissible debt-to-EBIDTA ratio for a resolution plan.

Implementation of Proposals :

Banks will present their board-approved resolution policies taking into account the RBI final guidelines. Broad guidelines will also be put in place for restructuring of retail loans. The RBI has allowed banks to recast loans which were classified as standard as on March 1, 2020. For implementing resolution plans, signing of an inter-creditor agreement (ICA) is mandatory in all cases involving multiple lending institutions.

The resolution framework will be invoked before December 31, 2020 and will be implemented before 180 days from the date of invocation. The process has to be approved by lenders with 75% in value and 60% in numbers. Lenders signing ICA will have to make a 10% provision and non-signing lenders at 20%. Restructuring can be done via the extension of residual tenor by a maximum of two years with or without moratorium and may include conversion of loan into equity. Any default by the borrower with any of the lenders that signed an ICA during the monitoring period would trigger a review period of 30 days. If the borrower remains in default at the end of the period, all lenders would downgrade the account as a non-performing asset (NPA).

Sectors affected

Pharma, telecom, IT, FMCG, brokerage services, agri and food processing, sugar and fertiliser are among the sectors least impacted by the pandemic. Tourism, hotels, restaurants, construction, real estate, aviation, shipping, media and entertainment are among the sectors most impacted. Of the Rs 15.5 lakh crore loans impacted by the pandemic, the biggest ones are retail trade and wholesale trade as banks loan worth Rs 5.42 lakh crore have been impacted. Loans worth Rs 1.94 lakh crore to the roads sector and Rs 1.89 lakh crore to the textile sector have also been impacted.

Other major industries impacted, and to which banks have sizeable exposure, include engineering (Rs 1.18 lakh crore), petroleum & coal production (Rs 73,000 crore), ports (Rs 64,000 crore), cements (Rs 57,000 crore), chemicals (Rs 54,000 crore) and hotels & restaurants (Rs 46,000 crore) among others.

Small borrowers: Banks are working out individual plans for retail borrowers and small units; the conditions for big borrowers do not apply to them. At least Rs 210,000 crore (1.9% of banking credit) of the non-corporate loans are likely to undergo restructuring, which would have otherwise slipped into NPAs, India Ratings has said in a report.

Effect of loan recast on the economy

Restructuring announcements in the past (FY08-11 and FY13-19) had raised concerns about the efficacy of the restructuring mechanism, as most of the restructured assets eventually slipped into NPAs. While the RBI has put into place several guardrails this time in the form of defined timelines and external vetting, success of the plan will still largely depend upon a significant revival in the economy. The GDP, which contracted by 23.9% in the April-June quarter, is likely to continue contracting in the ongoing quarter.

According to India Ratings, based on an account level analysis, nearly 53% of this pool is at a high probability of restructuring/slippages. The balance 47% is at moderate risk of restructuring, and progress on these accounts will depend on the progress of Covid-19 situation. The biggest impact will be that banks will be able to check the rise in NPAs to a great extent. However, it’s not going to bring down the NPAs from present levels as legacy bad loans of close to Rs 9 lakh crore will remain within the system.

Impact of Earlier Schemes :

The RBI discontinued the corporate debt restructuring (CDR) scheme from April 1, 2015. For years, promoters of many big corporates were siphoning off bank funds while their units suffered. They approached CDR cells of banks to get their loans recast, some of them managing this more than once. Some of those who misused CDR are now in the bankruptcy court. The RBI later introduced three more loan recast schemes which either remained largely on paper or were abused by borrowers. The Insolvency and Bankruptcy Code finally kicked off and the RBI announced a stringent loan resolution process.

There are 26 Sectors wherein guidelines of Reserve Bank of India will remain operative while restructuring Covid-stressed loan exposures. The circular of RBI ,as earlier stated ,will focus on five financial parameters which need to be taken into account while deciding on a recast plan: total outstanding liabilities/ adjusted tangible net worth, total debt/Ebitda, current ratio, debt service coverage ratio, and average debt service coverage ratio. For each of these parameters, RBI has prescribed either a floor or a ceiling.

Experts observed that some of the ratios were strict. For instance, RBI has said the current ratio and DSCR (debt service coverage ratio) in all cases shall be 1.0 and above, and adjusted SCR shall be 1.2 and above. Lenders are expected to ensure that the ratio of the total outside liabilities to the adjusted tangible networth (TOL/ATNW) is complied with when the recast is implemented.

Moreover, this ratio needs to be maintained, in all cases, as per the plan, by March,31 2022, and on an ongoing basis thereafter. However, wherever there is equity infusion, the ratio may be suitably phased-in over the period. All other key ratios shall have to be maintained as per the resolution plan by March 31, 2022 and on an ongoing basis thereafter, RBI said.

The committee sets 180 days to implement the plan and makes an inter creditor agreement (ICA) mandatory. The tenure of a loan may be extended by a maximum of two years, with or without a moratorium, the panel has said. The resolution process shall be treated as invoked once lenders representing 75% by value and 60% by number agree to invoke the same.
The central bank said the resolution plans “shall take into account the pre-Covid-19 operating and financial performance of the borrower and impact of Covid-19 on its operating and financial performance’ to assess cash flows for FY21/FY22 and subsequent years, suggesting some degree of flexibility.

The sector-specific parameters may be considered as guidance for preparation of resolution plan. Also, lenders may adopt a graded approach classifying the impact on borrowers as mild, moderate and severe. “Considering the large volume and the fact that only standard assets are eligible under the proposed scheme, a segmented approach of bucketing these accounts under mild, moderate and severe stress, may ensure quick turnaround,” the report said.

Severe stress cases would require comprehensive restructuring. Exceptions to thresholds were made for five sectors — auto manufacturing, aviation, real estate, roads and trading — wholesale. Any default by the borrower with any of the signatories to the ICA during the monitoring period shall trigger a review period of 30 days.

If the borrower is in default with any of the signatories to the ICA at the end of the review period, the asset classification of the borrower with all lending institutions, including those who did not sign the ICA, shall be downgraded to non-performing asset (NPA) from the date of implementation of the plan or the date from which the borrower had been classified as NPA before implementation of the plan, whichever is earlier.

Pursuit of Knowledge

PreQ. While deciding a loan recast plan, how many parameters need to be taken into account ?

(a) 5
(b) 4
(c) 3
(d) 6

MainsQ. Briefly explain the need for loan recast plan for corporates despite announcement of a massive package of 20 Lakh crore earlier. Is this plan needed? Furnish reasons in support of your answer.