Stressed Assets: Upcoming RBI Norms and Long Term Plans

 

 

Recently, Reserve Bank of India (RBI) launched a discussion paper on early recognition of borrowers having financial distress and prompt steps proposed for resolutions and fair recovery for lenders. The highlights of the paper included the following points:

(a) Early formation of a lenders’ committee with timelines to agree to a plan for resolution.

(b) Incentives for lenders to agree collectively and quickly to a plan.

(c) Improvement in current restructuring process.

(d) More expensive future borrowing for borrowers who do not co-operate with lenders in resolution.

(e) More liberal regulatory treatment of asset sales:-

(i) Lenders can spread loss on sale over two years provided loss is fully disclosed. This incentive will be available upto March 31, 2015. Further, the promoters of the company/defaulting borrowers shall be barred from directly/ indirectly buying back the asset from the ARCs.

(ii) Takeout financing/refinancing possible over a longer period and will not be construed as restructuring.

(iii) Leveraged buyouts will be allowed for specialised entities for acquisition of ‘stressed companies’.

(iv) Steps to enable better functioning of Asset Reconstruction Companies mooted.

(v) Sector-specific Companies/Private equity firms encouraged to play active role in stressed assets market.

For early recognition of Non Performing Assets (NPAs), the paper mentions introduction of new asset category namely Special Mention Accounts (SMA) having three brackets: (1) SMA – Non Financial (NF) : signals of incipient stress; (2) SMA – 1 : Principal or interest payment overdue between 31-60 days; and (3) SMA – 2 : Principal or interest payment overdue between 61-90 days.

Under these proposed plans, RBI will set up a Central Repository of Information on Large Credits (CRILC) to collect, store, and disseminate credit data to lenders. Banks will mandatorily have to furnish credit information to CRILC on all their borrowers having aggregate fund-based and non-fund based exposure of Rs.5 crore and above. NBFC-SI (Systemically Important) will also be asked to furnish such information.

Under the guidelines to start with, reporting of an account as SMA-2 by one or more lending banks/NBFC-SIs will trigger the mandatory formation of a Joint Lenders’ Forum (JLF) and formulation of Corrective Action Plan (CAP) for accounts having aggregate fund-based and non-fund based exposures of Rs.100 crore and above.

JLF may explore various options to resolve the stress in the account which may include restructuring, rectification, or resorting to recovery. For prompt action the proposed plan stipulates timelines also i.e. deciding CAP options within 30 days from the SMA2 reporting date, Signing detailed final CAP within next 30 days. If the JLF decides on restructuring the account as a CAP, it will refer the account to CDR Cell for restructuring. CDR Cell will not prepare another preliminary TEV under its guidance, and will directly prepare the final TEV study and restructuring plan in consultation with JLF within 30 days from the date of reference to it by JLF. For accounts with aggregate exposure of less than Rs.500 crore, the cases referred to CDR Cell by JLF will have to be finally decided by the CDR EG within the next 30 days. If approved by CDR EG, the restructuring package should be approved by all lenders and conveyed to the borrower within the next 15 days for implementation.

Lenders can also resort to transfer of the promoters’ holdings to a security trustee or an escrow arrangement till turnaround of company. For restructuring of dues in respect of listed companies, lenders may be ab-initio compensated for their loss/sacrifice by way of issuance of equities of the company upfront. In such cases, the restructuring agreement shall not incorporate any right of recompense clause. In order to safeguard promoters’ control over companies, the equity so issued may bestow ‘call’ option/‘right of first refusal’ to the promoters group before the banks sell the same. However, such call option/right of first refusal can only be exercised, after the entire loan and the recompense has been repaid. Further, the price of shares under such call has to be equal to the fair value of the shares at the time of exercise. If acquisition of such equity shares results in breaching the extant regulatory Capital Market Exposure (CME) limit, RBI will give exemption to the lenders from the CME limit on a case-by-case basis.

Under the refinancing structure by way of take-out, the new lender can provide exaggerated repayment tenor which will not be treated as restructuring. The incentive to lenders for quick implementation of restructuring package will be retention of existing asset class of the account prevailing on the date of formation of JLF, as per extant guidelines. This incentive will be available for all the restructuring done before April 1, 2015. If the lenders fail to convene the JLF or fail to agree upon a common CAP within the stipulated time frame, the account will be subjected to accelerated provisioning as provided in the plans. Further, if the escrow maintaining bank under JLF/CDR Mechanism does not appropriate proceeds of repayment by the borrower among the lenders as per agreed terms resulting into down-gradation of asset classification of the account in books of other lenders, the account with the escrow maintaining bank would attract the asset classification which is lowest among the lending member banks. 

The plans also propose maintenance of a new database by RBI of Non Co-operative Borrowers (NCBs). NCB has been broadly defined as one who does not provide necessary information required by a lender to assess its financial health even after 2 reminders; or denies access to securities etc. as per terms of sanction or does not comply with other terms of loan agreements within stipulated period; or is hostile / indifferent / in denial mode to negotiate with the bank on repayment issues; or plays for time by giving false impression that some solution is on horizon; or resorts to vexatious tactics such as litigation to thwart timely resolution of the interest of the lender(s). Such borrowers will be given 30 days’ notice to clarify their stand before their names are reported as NCBs. Any new loan sanctioned to such NCB promoted company or a company in which NCB is present on Board, will attract higher/accelerated provisioning as provided in the plans.

The plans propose to allow sale of assets between Asset Reconstruction Companies (ARCs) which is not permitted at present and also allow ARCs to raise debt funds for rehabilitation of the units. Banks/NBFCs will not be allowed to sale assets to their own promoted (10% or more equity control) ARCs. Further, presently, an NPA in the books of a bank can be sold to other bank only after it has remained in the books for a period of two years. RBI will withdraw this minimum holding period for any initial loan sale. However, the bank purchasing the NPA will, have to hold the asset in its books for at least one year before selling the asset.

Presently, banks are not allowed to finance acquisition of promoters’ stake in Indian companies. Under the proposed plans, RBI would allow banks to extend finance to ‘specialized’ entities put together for acquisition of troubled companies.

Need for Long Terms Plans

The above mentioned proposed plans would be good measures by RBI for effective control of stressed assets. However, these are ‘Corrective Plans’. Regulators should also consider long term plans for managing the stress in borrowing entities. It is experienced that when a borrower faces stress, most of the time it does not have sufficient liquid capital for bringing its own contribution to support the CAP/Promoter’s Contribution. Under the BASEL III norms for maintenance of Capital by banks, there is provision for maintenance of Counter Cycle Capital Buffer to absorb shocks. The same principle needs to be applied for borrowers also i.e. by way of compulsory maintenance of Borrower Counter Cycle Capital Fund (BCCCF) from the profits before deduction of dividends. This could be minimum 2% to 10% of the net profit and may be accelerated with increase in secured borrowings. The funds may be allowed to be managed in the form of liquid assets (mix of debt funds, fixed deposits etc. and small part in equity funds etc). It would be good to link such BCCCF with net profit instead of net cash accruals because then borrowers would be a bit less aggressive in presenting very rosy financial performances. The implementation of such fund may be done over a period for existing borrowers and with immediate effect for new borrowers (i.e. companies not having any secured borrowing in their books at present). When a borrower undergoes restructuring, it may be allowed to dip into this pool for bringing its contribution. Over the period of restructuring, depending on the restructuring plan, the pool may be restored.

Yes, these types of plans may not be easy to implement without hiccups. However, as it is said ‘where there is a will there is a way’, solutions can be found for all the intricacies involved. There would be many difficult situations to be resolved for implementation of such plans, like:

If a zero debt company goes for a Rs.5,000 crore debt program, does it mean that at the rate of 10% crisis pool management, it will have to first arrange Rs.500 crore for the BCCCF?

If a company is presently having Rs.2000 crore of debt, and plans to raise Rs.500 crore additional debt, does it mean that it will have to arrange Rs.250 crore for the BCCCF?

Obviously, these looks to be very high targets to be achieved if these are to be achieved at one go. However, if these funds are saved over the years, borrowers would not face the difficulty, and that is the actual spirit of this proposal. These types of plans cannot be implemented over night. These are to be implemented over a period in phases say: 1% pool to be ensured in two years, to be increased to 5% in five years etc. OR say immediately out of the new IPO proceeds, OR say providing structures to ensure build-up of crisis fund (by way of quasi equity, unsecured debt etc.) OR with many other options taking into confidence the industry associations. The point is that maintenance of BCCCF would make borrowers more responsible for their debt, control presentations of very rosy financial performances, and conserve funds from earnings in good times, directly linked to debt levels.

Need of the Hour: Innovating the Cash Credit System

 

 

It has been disappointing to experience many borrowers defaulting in servicing their working capital (WC) dues in the current economic slowdown World over. But when it is economic slowdown then automatically the need for WC should get reduced since the need for Cash Credit (CC)/WC facility ultimately depends on the business volumes. In a downturn, volumes cannot be predicted to be high! So why is there need for more credit or non availability of the same resulting in default on the name of cash crunch? Many people give the argument that the slowdown is resulting into increased receivable period due to competition, inventory is not available, many of the receivables are turning out to be junk etc. Ok, agreed. But then it should be a one-time exercise when corporate/borrower analyzes its receivable pool and segregates the junk in a separate pool. The lender can come forward and analyze the pool to decide on the liquidity required as a one-time measure. But generally  corporates do not come forward for this, they keep on hiding the bad under the good, keep on extending the goods on credit to customers and ultimately putting the lenders funds on risk. Such practices lend the Corporate into undesirable Corporate Debt Restructuring (CDR).

 

Well, this is a fact and we have to live with this until we decide to think differently. If we think for a second holistically, it can be noted that over the years the war strategies have changed. The game strategies have changed. The communication technology has revolutionalized. Everything has been innovating, and not only innovating but also flourishing using the technology. In this scene, why are we sticking to same years old Cash Credit system of lending? Don’t we want to innovate and improve the lending system? Are we not open to reward the borrowers who practice good corporate governance and are open to justifiable use of the borrowed funds, leaving no room for misutilization?

In case of heritage Cash Credit (CC) style of lending, the total CC limit is decided based on the MPBF analysis. The actual CC limit is released when borrower submits the monthly Stock Statement, carrying brief details of inventory and receivables based on which drawing power is calculated by the bank and CC is disbursed to the borrower to finance its funds trapped in creating those inventory and receivables.

We need to give a thought that in an innovative World what is the need of Stock Statement when with the help of technology, banks can directly fund the suppliers and debtors of borrower?

The issue with the traditional CC operations is that the lender has to depend on the monthly Stock and Receivable statement prepared by the borrower. The only check on the authenticity of this statement by a third party is the annual stock audit which is also not very effective if the borrower has multiple factories at various locations. This system encourages many borrowers to miss use the CC facility. The lender does not have strong mechanism to check whether actually there is sufficient stock or the receivables as mentioned in the monthly Stock Statement. This lacuna needs to be corrected. But how?

There are some existing lending solutions available one of which is banks stop funding the receivables. The receivable may be made to be funded only by factoring agencies (which are mostly floated and funded by banks) as these agencies are fully focused on receivables funding so have hands on due diligence excellence of the debtors of corporate.

For inventory funding, banks may also rigorously pursue vendor financing/bills discounting under which the vendors are directly funded by banks.

Apart for meeting these major heads of funding the current asses, the other small requirement can be funded by long term working capital term loans which come with a fixed tenor and repayment schedule.

The out of box and revolutionary things to make it possible would be innovation to connect the inventory and stock management software of the borrower with the controls of the banks. This will provide a system under which the borrower and its suppliers both are connected with the lender and as soon as the sale of material by supplier/vendor to the corporate happens, the cost can automatically be debited to the borrower’s Cash Credit Account and credited to supplier’s Account subject to online approval of the transaction by the borrower. Such systems would bring more transparency in CC utilization and lenders would be also able to analyze the stocks and receivable position on real time basis.

I would like readers to contribute on this to bring more thoughts on improving the working capital lending system.