Strategic debt restructuring (SDR) seems to be the way out for lessening the weight of the Corporate Debt Restructuring (CDR) system. As of March 2015, total live restructured debt was Rs 2.86 lakh crore. This amount was 4.6% of outstanding bank credit at the aggregate level. However, assuming that restructured assets would be primarily in the manufacturing sector with limited exposure in the services segment (around 5% of total), the ratio is 10.7%. As most of the projects are inherently viable, but have run into rough weather due to unfavorable economic developments or managerial inefficiency, RBI has drawn up a scheme for lending banks to convert such debt into equity and offer the same for sale.
In brief, the SDR scheme involves a clause to be put in the debt restructuring agreement stating that there would be some minimum standards achieved and maintained in the financial ratios within a limited period of time. If the company is unable to fulfil the same, the Joint Lenders’ Forum (JLF) can opt to convert a part or whole of the debt into equity to take ownership to the extent of 51%. Such an act will adhere to all the rules that have been laid down by Sebi and RBI relating to conversion to equity/equity-holding by banks, etc, with some exemptions—like obviating the need to make an open offer or mark-to-market the securities periodically—being provided. Various conditions have been clearly put on the approvals required within the JLF entities, approving the same and the time lines for compliance, etc. So, how good is this scheme?
SDR will first put additional pressure on the promoter to perform because prolonged default will lead to her losing control of the enterprise. The fear of losing control in the eventuality of an absence of a turnaround will motivate the management to act and not just sit back. Therefore, it acts as a check on the company’s efficiency. Today, there is a moral hazard in the system, where the borrower, especially if the amount involved is large, has an upper hand when it comes to non-repayment when she knows that the bank will try as far as possible to accommodate the defaulter—otherwise, a provision has to be made, which puts a dent in the bank’s books. By having this clause and setting strict time-limits, the borrower will be forced to do her best or face the eventuality of losing control of the entity.
Second, the bank is able to offload such debt for which it has to now make provisions by converting to equity, and this is good for the system as a whole. This will be a good exit route, especially when projects look unviable and involve large sums of money. While infra projects come to mind, this would also hold in sectors such as steel, textiles, aviation and mining, which have been noted as being the more vulnerable sectors in terms of asset quality.
Third, SDR has a provision for the JLF selling off its stake to a new promoter who is not related to the existing one directly, in which case the asset can be treated as a standard one. Here even foreign investors could come in within the existing FDI limits that are permissible. This way, the banks would be better off, especially if they can sell at a higher price.
However, with banks looking at ownership, there will be a challenge for them if they are to run the company with a 51% stake. Their own core competence and expertise is in the area of finance, and having their own management run the entity would be difficult. The RBI circular does talk of the need to offload this equity as soon as possible as it is recognised that this cannot be a function of the bank. Banks are supposed to be protective investors and not active ones.
Similarly, even selling to a new promoter would require time, and selecting the right one—one that will continue to service the debt—involves some degree of uncertainty. Therefore, banks involved in the JLF will have to necessarily have separate teams to deal with these issues and, internally, have their own rules of engagement on these issues given that the scale could be high as every case would have to include such clauses of strategic restructuring.
The impact of SDR will be felt, to begin with, for the existing assets that are being restructured. At present, it may be tough to guess as to whether the banks will be better off or would be able to recover the amounts due, relative to offloading them with asset reconstruction companies as in the case of NPAs. Normally, distressed companies would have a lower market value as their earnings dip. The clue will lie in the difference between the conversion of debt into equity at a given price and the price at which it can be offloaded to a new promoter. The time consumed in the same can be significant and once the formula for eventual sale is announced, one can gauge the net gain or loss for the bank.
The impact is likely to be better felt on the promoters who are facing problems as they would have to take this factor into consideration when going in for any restructuring as they risk losing control. However, the less serious players may just find this an easy way to get off a mess when they take on high-risk projects and, hence, the JLF should be watchful of such cases.
Going ahead, if this works, it can be considered for also regular NPAs of a certain size with all lending agreements carrying such a clause of possible conversion of debt into equity in case of non-payments. This can be effective in tackling the growth of NPAs, especially when the business cycle turns adverse.
The author is chief economist, CARE Ratings. Views are personal