Corporate India – Distress Resolution Solutions Including Restructuring

May 2016

Background

Background• As its commonly known Indian Banking scenario is going

through unprecedented times with stressed loan portfolio touching all time high.

• As per Public Data available Distressed Loan portfolio of all Banks put together is more than 7 lakh crore which is > 10% % of total advances

• There is an apprehension that there could be significant additions as many stressed loan accounts have been disguised as standard.

• Realizing the problem RBI has come out with many changes and schemes to tackle such stressed accounts

• Most significant of which is withdrawal of assets classification benefit upon restructuring. Prior to 1st April 2015 Banks were allowed to restructure a Loan and retain standard assets class subject to certain conditions.

Stressed Assets in the Banking System

Debt Restructuring

What is debt Restructuring RBI definition of a Restructured account.

“A restructured account is one where the bank, for economic or legal reasons relating to the borrower's financial difficulty, grants to the borrower concessions that the bank would not otherwise consider. Restructuring would normally involve modification of terms of the advances / securities, which would generally include, among others, alteration of repayment period / repayable amount/ the amount of instalments / rate of interest (due to reasons other than competitive reasons).

Restructuring can happen before COD or post COD

Debt restructuring: Before COD Due to delay in implementation

› Change in repayment period due to change in COD is not counted as restructuring if change in COD is upto 2 years for infrastructure projects and upto 1 year for other projects

› Further extension by 1 years is allowed without account being considered as NPA. However account is to be treated as restructured. Application for extension should come before end of original COD.

› One more year of extension is allowed if delay is due to arbitration proceedings or a Court case

Due to cost overrun : Change in repayment schedule due to over run not to be treated as restructured if

Increase is on account of change in scope and size Increase is more than 25% excluding cost over run Bank does fresh viability study Rating is not downgraded by more than 1 notch

Post COD : Causes for debt restructuring:

Weak management Promoters integrity : Siphoning of funds Increase in Interest cost due to increase in interest burden Over optimistic projections Over leveraged positions Debt trap : Fresh debt to meet debt servicing Banks not extending required support in time Promoters inability to bring Equity Erosion of working Capital funds due to losses and

repayments burdens Dressing up of Balance sheet by hiding losses and inflating

current assets Non availability of raw materials labour etc.

Post COD : Causes for debt restructuring contd:

Change in exchange rate and unhedged position Delay in receipt of government approvals Change in Industry fortunes. Some examples

› Cut in Govt spending : Infra› Incentives by Govt to new Industries : Textile incentive

scheme by Rajasthan Gujarat MP Maharashtra etc› Global competition : Steel› Govt inability to take reforms : Power› Excess supply : Sugar› Global slowdown : Ready made garments› Upgradation or invention of new Technology

Options available in distress

RestructuringOne Time

SettlementReference to BIFRDeferring the

DecisionStake SaleAssets SaleAssets debt swap

RestructuringOne Time

SettlementSale/Assignment

to ARCRecovery through

DRTEnforcement

through SARFAESIAssets debt swap

Borrower Lender

Platform for restructuringCDR Bilateral

SDR5/25 Scheme

JLF

Change of Management Through ARC

Options for

restructuring

Corporate Debt Restructuring (CDR)

Meaning & Objective The scheme of CDR was put in

place by RBI In August 2001 to devise a system where restructuring of large corporate exposure from multiple banks could be carried out.

The scheme was framed based on the mechanism prevalent in countries like the U.K., Thailand, Korea, Malaysia etc.

It has a 3 tier structure - CDR Cell –initial scrutiny of

proposals Empowered Group (EG)-decides

whether to take up the restructuring or not and approves restructuring plan by CDR Cell

Standing Forum-lays down policies & guidelines to be followed by CDR Cell &EG

To ensure timely & transparent mechanism for restructuring debts of viable corporate entities facing problems for the benefit of all concerned.

To aim at preserving viable corporates that are affected by certain internal and external factors

To minimize the losses to creditors and other stakeholders through an orderly and coordinated restructuring programme.

Admission Criterion Loan assets with an aggregate debt outstanding (inclusive of non

fund limits) of Rs 10 crore and above and involving at least two lenders.

The case may be referred by a lender with exposure of minimum 20% by value. A corporate can also refer its case with letter of support from a lender or lenders with exposure of 20% by value.

Reference of any account / case to CDR Cell is asset classification neutral. Asset of any class can be admitted subject to certain specific stipulations.

Other stipulations regarding minimum margin from the Promoters, Personal Guarantee of Promoters, Pledge of promoters holding etc have to be observed.

Cases of fraud and misfeasance are ineligible. Cases of willful default may be considered if permitted by Core

Group depending on case specifics. BIFR cases are eligible subject to approval of Core Group and with

certain additional conditions.

Standard terms & condition Promoter’s contribution minimum 25% of sacrifices or 2% of debt

restructured, whichever is higher. 80% to be brought in upfront and balance 20% within 1 year Personal guarantee of the Promoter Directors Pledge of promoter’s shareholding Pooling of securities. Specific Securities provided to any lender

to be excluded Right of equity conversion in case of default Right to accelerate the repayment schedule if the cash flows

permit Right of recompense – has to be calculated at the time of

admission and to be disclosed in audited financials Decision of 75% in value and 60% in numbers binding on all Events of default : Default in payment/violation of

undertakings/Fail to renew insurance policies/withholding or providing misleading information/capex without approval/withdrawal of unsecured loan/diversion of funds/sale of assets without approval etc.

CDR Vs. BilateralParticulars CDR BILATERALNo of lenders Minimum 2 No restrictionQuantum of Loan Minimum 10 crore No restrictionSuper Majority Clause Yes NoAssets classification benefit*

Yes if implemented within 120 days from the date of filing of Flash Report

Yes if implemented within 120 days from the date of application by the borrower

Stand Still Clause Exists Doesn’t existPromoters contribution

Higher of 25% of sacrifice or 2% of debt

Higher of 20% of sacrifice or 2% of debt

*Regulatory forbearance regarding asset classification benefit has been withdrawn for all restructurings effective from 1 April, 2015.

Stressed Assets in the Banking System

Joint Lenders’ Fund (JLF)

Background Before NPA, banks are required to identify incipient stress

under following categories of Special Mention Account (SMA) :

RBI came out with a circular in Feb 2014 about compulsory formation of Joint Lenders Forum (JLF) mechanism in SMA – 2 Account with the aim to ensure that banking system recognise financial distress early, takes prompt steps to resolve it, and ensures fair recovery for lenders and investors

Category Basis for classificationSMA-0 Overdues less than 30 days but signs of incipient

stress SMA-1 Principal or interest payment overdue between 31-

60 daysSMA-2 Principal or interest payment overdue between 61-

90 days

Applicability of framework in certain cases

RBI has formed a Central Repository of Information on Large Credits (CRILC)

Banks are required to report Credit information of all accounts including classification of account as SMA to CRILC for exposure ≥ Rs. 5 crore

Upon report by any lenders to CRILC as SMA-2, banks should mandatorily form JLF if aggregate exposure (AE) ≥ Rs 100 crore.

Lenders have option of forming a JLF even when AE in an account is < Rs 100 crs and/or when the account is reported as SMA-0 or SMA-1

A borrower may request the lender/s, with substantiated grounds, for formation of a JLF on account of imminent stress.

Corrective Action Plan (CAP) JLF has to consider and decide one of the following Corrective

Action Plan (CAP) to resolve the stress in the account.

Rectification

Restructuring

Recovery

Corrective

Action Plan

Corrective Action Plan (CAP) contd.

Consider the possibility of restructuring the account if it is prima facie viable and the borrower is not a willful defaulter.

•Obtain commitment from the borrower supported with identifiable cash flows. •Possibility of getting equity/Strategic investors may be explored.• Intention is to achieve turnaround without any change in Loan Terms. •JLF may also consider providing need based additional finance.• Additional financing should not be provided with a view for ever- greening the account.

A: Rectification

B: Restructuring

C: RecoveryOnce the first two options at (A) and (B) are seen as not feasible, due recovery process may be resorted to. JLF to decide best recovery process.

JLF Rules• JLF is required to arrive at an agreement on the option

to be adopted for CAP within 45 days from (i) the date of an account being reported as SMA-2 by one or more lender, or (ii) receipt of request from the borrower to form a JLF

• Decisions by a minimum of 75% of creditors by value and 50% of creditors by numbers in the JLF would be binding on all.

• JLF should sign off the detailed final CAP within the next 30 days from the date of arriving at such an agreement.

• Accounts with AE of Rs. 500 crs and above will have to be subjected to an evaluation by an Independent Evaluation Committee (IEC)

• If restructuring is considered as CAP, JLF has the option to go to CDR or do restructuring outside CDR

Timeline for restructuring under JLF Outside CDR

Step Aggregate Exposure< 500 crore > 500 crore

Finalization of CAP 45 days 45 daysDetailed Final CAP Next 30 days Next 30 daysTEV Next 30 days Next 30 daysApproval by IEC NA Next 45 daysApproved by JLF and sanction

Next 15 days Next 15 days

Timeline for restructuring under JLF Through CDR

Step Aggregate Exposure< 500 crore > 500 crore

Finalization of CAP 45 days 45 daysTEV Next 30 days Next 30 daysApproval by IEC NA Next 45 daysCDR Cell to CDR EG NA Next 7 daysDecision by CDR EG Next 30 days Next 30Approval and sanction by all Lenders

Next 30 days Next 30 days

5:25 Scheme

5:25 flexible structuring scheme

As per the 5:25 flexible structuring scheme, the lenders are allowed to fix longer amortization period for loans to projects in the infrastructure and core industries sector (detail of eligible industries in subsequent slide), for say 25 years, based on the economic life or concession period of the project, with periodic refinancing, say every 5 years.

Repayment is considered as bullet repayment at refinance interval for the purpose of ALM of the Bank

DSCR and other ratios to be calculated for entire duration of the loan Refinance can be by same lenders or new lenders or combination Such refinancing repeated till the end of fresh loan amortization schedule Interest rates to be renegotiated at the time of refinance

Restructuring under 5:25 Flexible structuring scheme initially allowed for new project has

been extended to existing loans in Infrastructure and Core Industries

Scheme Eligible for outstanding Term loans > Rs. 500 crore Banks may fix a fresh amortization schedule for the existing

projects loans, once during the life time of the project, after the COD. Maximum tenure 25 years with refinance every 5 years

Such refixation not to be treated as restructuring subject to: The loan is standard as on date of change of loan amortization

schedule NPV of loan to remains same Fresh loan amortization schedule should be within 85% of the initial

concession period / life of the project A fresh viability study is carried out which is vetted by IEC

NPA accounts can also be restructured under the scheme. However, they shall be considered as ‘restructured’ and shall be upgraded after 1 years of satisfactory performance

Once an account becomes NPA further refinancing will stop

Eligible Industries under 5:25 scheme

Infrastructure Industries-Transport: Roads, ports, Inland, waterways, Airport, Railway track, Urban Public Transport -Energy: Electricity generation, Transmission, Distribution, Oil pipelines, Oil/Gas/LNG storage facility, Gas Pipelines,

-Water & Sanitation Infrastructure

-Communication: Telecommunication towers cable network and optic fibers

- Social Commercial Infrastructure: Education institutes, Hospitals, Common infrastructure for SEZ, post harvest storage facility, Capital Investment in fertilizers, Cold chain, Hotel, Convention centres, Soil testing labs

Core Industries

-Coal

-Crude Oil

-Natural Gas

-Petroleum Refinery

Products

-Fertilizers

-Steel (Alloy + Non

alloy)

-Cement

-Electricity

Stressed Assets in the Banking System

Strategic Debt Restructuring Scheme (SDR)

Introduction One of the common cause for loan account becoming

stressed has been management inefficiencies.

Concept of Strategic Debt Restructuring ("SDR") has been introduced by RBI to help banks recover their loans by taking ownership and management control in cases where borrower is unable to achieve viability parameters and/or non adherence to critical conditions despite restructuring granted by lenders.

Scheme is applicable only in cases where change in ownership is likely to improve the economic value of the loan asset and prospects of recovery of their dues

Eligibility For fresh cases of restructuring post SDR guidelines (8 June 15)

the restructuring agreement should contain provisions for SDR For already restructured cases SDR can be invoked if enabling

clauses are included in the restructuring agreement Henceforth all fresh loans to have SDR enabling provisions Lenders have to convert their loans to equity so as to have 51%

equity stake in the company within 210 days from reference date (decision to invoke SDR). Conversion has to be as per fair value (defined later)

Lenders have to divest minimum 26% equity of the company to new promoters within 18 months from reference date

Provisions Banks get standstill clause benefit for 18 months i.e.

till equity is diluted to new promoters. That means account status as on reference date shall remain

Upon transfer of equity to new promoters even NPA account upgraded to Standard

Banks can refinance loans to new promoters at mutually agreed terms. Such refinance not to be treated as restructuring. However, Banks have to provide for any diminution in value plus write off

New Promoters has to be unrelated to existing promoters

Current management not to be allowed to continue without Bank representative on Board and without supervision by Bank appointed agency

Provisions contd… Decision making as per JLF. 75% by Value and 50% by

numbers binding on all. Conversion under SDR to get exemption from SEBI

Capital Issue and Open offer provisions Banks get exemption from MTM provisions on equity so

converted for 18 months. However, as per latest circular bank has to provide for depreciation over 4 quarters

Equity so converted shall be exempted from ceilings on Capital Market exposure. However, Banks have to provide 150% Risk weight for 18 months

Exemption from investor – associate relationship even if individual Bank holds more than 20% of voting power

Valuation for conversion of Debt into Equity under SDR

Lowest of following› Market value (for listed companies only): Average of closing

prices during last 10 trading days preceding the ‘reference date’.› Break-up value (Book value) per share to be calculated from the

company’s latest audited balance sheet (without ‘revaluation reserves’) adjusted for cash flows and financials post the earlier restructuring; the balance sheet should not be more than a year old. In case the latest balance sheet is not available this break-up value shall be Rs.1.

However, since equity cannot be issued at a discount conversion price cannot be below face value.

The pricing formula stated above has been exempted from the SEBI (Issue of Capital and Disclosure Requirements)Regulations,2009

Exemption from making an open offer under Regulation 3 & Regulation 4 of the provisions of the SEBI(Substantial Acquisition of Shares and Takeovers) Regulations,2011.

Change of Management (Outside SDR)

Change of Management (COM)

RBI came out with another circular on 24th September 2015 allowing Banks to go for change of ownership outside SDR provided the stress was due to operational/ managerial inefficiencies.

Change in ownership can be by way of › Sale of shares by lenders acquired by invocation of pledge› Conversion of debt into equity (outside SDR) › Issue of fresh shares by borrowing entity› Acquisition of borrowing entity by another entity

Most of the provisions of SDR holds true such as › new promoters should be unrelated to existing › new promoters should have minimum 51% equity (26% if FDI rules

restrictions applies)› Bank can refinance the existing debt without considering it

restructuring. However, banks have to provide for diminution in fair value

› Upon change of ownership account can be upgraded to Standard› However, exemption from SEBI regulations for issue of capital and open

offer not available› Circular is silent about conversion price

Stressed Assets in the Banking System

NPA Resolution through ARC

BAD LOAN NPA

Asset Reconstruction Company (ARC)

Borrower

Bank

Functions of ARC Assets Reconstruction Companies are in business

of buying NPA accounts from banks and FI’s. ARCs’ are specialized Institutions for resolution

of stressed loans having domain knowledge. ARC has the same rights as banks have for the

purpose of recovery of dues. ARC broadly has following functions

› Acquisition of financial assets› Restructure / rescheduling of Debts› Enforcement of Security Interest› Settlement of dues payable by the borrower

ARC Rules and regulations ARC functions more or less like a Mutual Fund. It transfers the

acquired assets to one or more trusts (set up u/s 7(1) and 7(2) of SRFAESI Act, 2002) at the price at which the financial assets were acquired from the Lenders

Then, the trusts issues Security Receipts (SR) to Qualified Institutional Buyers [as defined u/s 2(u) of SARFAESI Act, 2002]. The trusteeship of such trusts shall vest with the ARC.

As per latest rule ARC has to subscribe minimum 15% of SR. ARC will get Trust management fee from the trusts and recovery

commission in addition to reimbursement of exps. Incurred for the purpose of recovery.

Any upside in between acquired price and realized price will be shared with the beneficiary of the trusts Lenders and ARC.

Any downside in between acquired price and realized price will be borne by the beneficiary of the trusts (Banks/Fis and ARC).

ARC can acquire a loan on cash basis as well. In such case all upside/downside belongs to ARC

How it works Banks calls for bids for their bad loans from ARCs Such bids can be either for cash or on SR basis Such bids can be for individual loan or a pool Banks normally seek competitive bidding after fixing up reserve price

which is to be based on Value of underlying securities / worth of guarantors /likely cash flow forecast etc.

In many cases borrower enters into an OTS with the Bank and instead of paying from own sources gets loan account funded from ARC by assignment of loan to ARC on all cash payment basis. Interest charged in such transaction would be around 25%p.a.

Once a loan is acquired by ARC it gets in touch with the borrower seeking amicable settlement/ payment schedule out of operations/sale of assets/other cash flow. Even issue of Equity in lieu of debt can be considered.

In some cases borrower and ARC enter into informal arrangement prior to bidding

Borrower thus gets time to settle/pay the loan at a much better terms than original lender and able to retain economic value.

Summary analysis of all options

Summary analysis of all optionsOPTION FEATURE CONCERNCDR Has been widely used earlier and

helped many companies in coming out of stressMajority decision making

Lost charm after withdrawal of forbearance benefit by RBINot helped much. Too many failures post CDR implies it was deferment of inevitable

Bilateral

Mostly used for individual casesHad worked well earlier

Very few cases considered by lenders now post withdrawal of forbearance benefits.

JLF Majority decision makingEarly decision making

Guidelines have come too late. Damage is already done Timelines are not maintained resulting in slow progress. As account becomes NPA upon restructuring most lenders prefer rectification or recovery route

5 by 25 Helps realign debt without restructuring tag

Available for large cases and a few select industries only

SDR Helps realign debt without restructuring tagWeed out inefficient management

For old cases cannot be forced uponExisting management may continue in disguise. Finding new promoter is always a challenge.

COM More flexibility than SDR SEBI exemption not availableARC Help in Realign/settle debt at a

realistic levelFaster decision making as question of accountability doesn’t arise

Banks are not able to realise significant portion of their duesIncrease in cost as ARC charge management feeARC’s capital base too limited compared to overall magnitude of stressed assets

Stressed Assets in the Banking System

What Next ?

What Next Parliament is expected to pass new Bankruptcy law soon which is in line with

Chapter XI of US Bankruptcy code This law is expected to change dramatically how business failures are handled

in the country BIFR is expected to be repealed There is a talk about special package for steel industry since all efforts to

realign debt of steel industry (CDR/ 5 by 25 etc) are not saving Bank loans from NPA

RBI wants clean up of Bank book by March 2017. RBI is very clear that Banks need to recognise problem and not pretend.

GOI has committed to provide need based capital to Banks. Tendency to hide NPA expected to get tapered off

Likely consolidation of Banks expected to improve decision making

The Insolvency & Bankruptcy Code

Applicability: All kinds of corporate enterprises, limited liability partnerships, partnership firms and individuals

Scope: Insolvency, liquidation, voluntary liquidation (solvent insolvency) and bankruptcy

Key Objectives: Preserve value by providing linear, time-bound

and collective process Improve time taken to resolve failure and provide

clear exit options to investors Increase recovery value Develop other avenues of financing businesses

(such as bond markets, venture capitals ) other than banks

Tribunal :National Company Law Tribunal (NCLT) is the proposed forum for corporate bankruptcy and DRT is for individual bankruptcy

Default

Appointment of an Insolvency professional

Calm period/moratorium period (180/270 days)

75% of creditors to approve

Yes NoImplement

the planGoes intoliquidation

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