12 August, 2016
The Indian banking system has been riddled with non performing assets (NPAs) for some time now. To help lenders, the Reserve Bank of India (RBI) has introduced a variety of debt restructuring policies, including the flexible structuring of project loans and the strategic debt restructuring scheme. But these schemes have met with limited success, mostly due to the lack of funds available for promoters to invest, non-cooperation on the part of the borrowers and the sub-optimal levels of operations in the relevant companies.
The lukewarm economic environment has further amplified these woes. As such, ‘bad’ loans across 40 listed banks in India had increased to Rs. 5.8 trillion (approximately USD 85.9 billion) in March 2016 from Rs. 4.38 trillion (approximately USD 64.9 billion) in December 2015. Estimates show that weak assets in the Indian banking system will reach Rs. 8 trillion (approximately USD 118.5 billion) by March 2017.
To provide lenders with additional remedies against this challenge, the RBI, in June 2016, introduced the Scheme for Sustainable Structuring of Stressed Assets (S4A). The S4A provides greater flexibility by allowing the lenders to deal with stressed loans by splitting these into two parts: Part A being sustainable debt and Part B being debt which will be converted into equity or quasi equity instruments (Part B Instruments).
For Part A to be sustainable, an independent techno-economic viability study has to establish that at least 50% of loans (including new funding and non fund facilities crystallizing in the next 6 months) may be serviced at the same tenor and at the current (including the next 6 month) cash flow level.
A few key features of the S4A are as follows:
The S4A can be applied only for companies that have started commercial operations and have outstanding debt of at least Rs. 5 billion (approximately USD 74 million).
Lenders are required to form a resolution plan with the help of an independent agency, providing for a split in debt and other terms of the S4A. The plan needs to be approved by 75% lenders by value and 50% lenders by number, and ratified by an overseeing committee. The overseeing committee will be formed by the Indian Banks’ Association in consultation with the RBI.
For listed companies, the Part B Instruments (equity) are to be marked-to-market and other Part B Instruments/for unlisted companies, would be valued either at break-up value as per the latest audited accounts (i.e. the valuation method where the net value of assets of the company are divided by the number of shares to arrive at the value of each share) or by discounted cash flow method (i.e. the valuation method where the future free cash flow projections are discounted (the discount factor being aggregate of the actual interest rate charged to the company and 3% subject to a floor of 14%)).
Asset classification can be retained at ‘Standard’ subject to provisions of the higher of 40% of the amount held in Part B or 20% of the aggregate of the Part A and Part B debt.
The S4A provides respite to lenders after converting part of their debt exposure into Part B Instruments and not having to rush to find a new promoter to divest the Part B Instruments within a specified period to protect their provisioning benefits. Absent any malfeasance, lenders can opt to continue with the existing promoters in the company retaining management and/or control.
While the provisioning requirements for lenders may increase in the next four quarters, over a longer period of time provisions can reduce substantially or completely. This is provided, however, that the Part A debt is serviced satisfactorily and there is no substantial decline in the fair value of the Part B Instruments.
Although the provisions are higher than the 15% requirement for NPAs in the first year, it is less than the 100% requirement over a three year period. Therefore, the S4A aims at a win-win for both promoters and lenders by allowing the current management to continue and reducing the NPAs at the same time. If the promoters continue, they will have to provide personal guarantees and sacrifice equity in the same proportion as lenders.
Nonetheless, the S4A does not allow rescheduling or repricing of debt and applies only to operational projects. Also, the test of sustainability only considers current cash flows and does not look towards the incremental cash flows that may accrue as operating levels or the economic environment improves.
As mentioned above, the S4A contemplates the setting up of an overseeing committee which would lend transparency to the restructuring process by reviewing the resolution plan. This will also comfort the lenders from fears of future scrutiny, a major factor in decision-making for public sector banks. This may increase the time for approval and implementation of the plan, but the benefits outweigh the costs.
At the same time, the 3% addition to the discounting factor for valuation of the Part B Instruments may add strain on the lenders. Further, lenders may not want to convert the Part B Instruments to equity at current share price levels.
Notwithstanding the same, the legislative intent behind S4A is clearly aimed at equipping lenders with the ability to deal with weak assets and to curb NPAs in the near term. As such, they only stand to gain following the S4A, at least for the Part B debt in any event.
For further information, please contact:
Cyril Shroff, Managing Partner, Cyril Amarchand Mangaldas
cyril.shroff@cyrilshroff.com
