Restructuring essentials – Protection of the decision makers
Post pandemic economy is heavily reliant on restructuring primarily because revenue stream has been intercepted while liability is still escalating. In order to ensure that business units sustain the eventuality, regulator has taken a series of measures which include restructuring so that the accounts are not impaired and employees as well as suppliers dependant on the unit can continue to earn. The principle of restructuring is based on the inherent assumption of viability of the unit after the liabilities are deferred and synchronized with income stream. There are separate prescriptions for priority sector including MSME (up to a prescribed limit of Rs25 crores)and Corporate segment. The eligibility criteria is defined and broad contours of restructuring is prescribed by a committee headed by Mr K.V.Kamath.
(Below excerpts are reproduced from RBI circulars, exclusive of Priority sector etc )
The report submitted by the committee headed by Mr K.V. Kamath contain, interalia, the following preconditions for permitting restructuring:
“Borrowers classified as standard and with arrears less than 30 days as at01/03/20 .The resolution will be considered as invoked if accepted not later than December 31, 2020, to be implemented within 180 days from the date of invocation. The resolution is considered invoked once lenders representing 75% by value and 60% by number (Majority Lenders) agree.ICA to be signed by all lenders within 30 days of invocation. Lenders who have signed ICA, to make provision, higher of 10% or IRAC norms. Lenders who have not signed ICA, to make a provision higher of 20% or as per IRAC norms, upon expiry of 30 days from invocation. The residual tenor of the loan may be extended by maximum 2 years with or without payment moratorium. The moratorium period, if granted, shall come into force immediately upon implementation. For aggregate exposures greater than Rs. 100 crore, an Independent Credit Evaluation (ICE) to be obtained from any one Credit Rating Agency authorized by RBI.
In respect of exposures, 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 NPA from the date of implementation of the RP or the date from which the borrower had been classified as NPA before implementation of the plan, whichever is earlier.”
Based on the analysis of exposures, the committee recommended the following benchmarks for restructuring certain selected industries , as under:
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Sectors | TOL / ATNW | Total Debt/ EBITDA | Current Ratio | Average DSCR | DSCR |
Auto Components | <= 4.50 | <= 4.50 | >= 1.00 | >= 1.20 | >= 1.00 |
Auto Dealership | <=4.00 | <=5.00 | >=1.00 | >=1.20 | >=1.00 |
Automobile Manufacturing* | <= 4.00 | <= 4.00 | — | >= 1.20 | >= 1.00 |
Aviation** | <= 6.00 | <= 5.50 | >= 0.40 | — | — |
Building Materials – Tiles | <=4.00 | <=4.00 | >=1.00 | >=1.20 | >=1.00 |
Cement | <=3.00 | <=4.00 | >=1.00 | >=1.20 | >=1.00 |
Chemicals | <=3.00 | <=4.00 | >=1.00 | >=1.20 | >=1.00 |
Construction | <=4.00 | <=4.75 | >=1.00 | >=1.20 | >=1.00 |
Consumer Durables / FMCG | <=3.00 | <=4.00 | >=1.00 | >=1.20 | >=1.00 |
Corporate Retails Outlets | <=4.50 | <=5.00 | >=1.00 | >=1.20 | >=1.00 |
Gems & Jewellery | <=3.50 | <=5.00 | >=1.00 | >=1.20 | >=1.00 |
Hotel, Restaurants, Tourism | <=4.00 | <=5.00 | >= 1.00 | >=1.20 | >=1.00 |
Iron & Steel Manufacturing | <=3.00 | <=5.30 | >=1.00 | >=1.20 | >=1.00 |
Logistics | <=3.00 | <=5.00 | >=1.00 | >=1.20 | >=1.00 |
Mining | <=3.00 | <=4.50 | >=1.00 | >=1.20 | >=1.00 |
Non Ferrous Metals | <=3.00 | <=4.50 | >=1.00 | >=1.20 | >=1.00 |
Pharmaceuticals Manufacturing | <=3.50 | <=4.00 | >=1.00 | >=1.20 | >=1.00 |
Plastic Products Manufacturing | <=3.00 | <=4.00 | >=1.00 | >=1.20 | >=1.00 |
Port & Port Services | <=3.00 | <=5.00 | >=1.00 | >=1.20 | >=1.00 |
Power |
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– Generation | <=4.00 | <=6.00 | >=1.00 | >=1.20 | >=1.00 |
– Transmission | <=4.00 | <=6.00 | >=1.00 | >=1.20 | >=1.00 |
– Distribution | <=3.00 | <=6.00 | >=1.00 | >=1.20 | >=1.00 |
Real Estate*** |
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– Residential | <=7.00 | <=9.00 | >=1.00 | >=1.20 | >=1.00 |
– Commercial | <=10.00 | <=12.00 | >=1.00 | >=1.20 | >=1.00 |
Roads**** | — | — | — | >=1.10 | >=1.00 |
Shipping | <=3.00 | <=5.50 | >=1.00 | >=1.20 | >=1.00 |
Sugar | <=3.75 | <=4.50 | >=1.00 | >=1.20 | >=1.00 |
Textiles | <=3.50 | <=5.50 | >=1.00 | >=1.20 | >=1.00 |
Trading – Wholesale***** | <=4.00 | <=6.00 | >=1.00 | Instead Interest Coverage Ratio > = 1.70 | |
Others not specified above | To be decided by lenders | >=1.20 | >=1.00 | ||
The recommendations were accepted by Reserve Bank of India. In respect of those sectors where the sector-specific thresholds have not been specified, lending institutions shall make their own internal assessments regarding TOL/ATNW and Total Debt/EBITDA. However, the current ratio and DSCR in all cases shall be 1.0 and above, and ADSCR shall be 1.2 and above.
“Lending institutions are free to consider other financial parameters as well while finalizing the resolution assumptions in respect of eligible borrowers apart from the above mandatory key ratios and the sector-specific thresholds that have been prescribed. The above requirements are applicable even in cases when there is only one lending institution with exposure to an eligible borrower. The ratios prescribed are intended as floors or ceilings, as the case may be, but 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 at the time of finalising the resolution plan, to assess the cashflows in subsequent years, while stipulating appropriate ratios in each case. Given the differential impact of the pandemic on various sectors/entities, the lending institutions may, at their discretion, adopt a graded approach depending on the severity of the impact on the borrowers, while preparing or implementing the resolution plan. Such graded approach may also entail classification of the impact on the borrowers into mild, moderate and severe, as recommended by the Committee.
Lending institutions are expected to ensure compliance to TOL/ATNW agreed as per the resolution plan at the time of implementation itself. Nevertheless, in all cases, this ratio shall have to be maintained as per the resolution plan by March 31, 2022 and on an ongoing basis thereafter. However, wherever the resolution plan envisages equity infusion, the same may be suitably phased-in over this 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. The compliance in regard to meeting the agreed ratios must be monitored as financial covenants on an ongoing basis, and during subsequent credit reviews. Any such breach not rectified within a reasonable period, in terms of the loan contract, will be considered as financial difficulty.
The various requirements of the Resolution Framework, especially the mandatory requirement of ICA, wherever applicable, and maintenance of an escrow account after implementation of a resolution plan, shall be applicable at the borrower-account level, i.e. the legal entities to which the lending institutions have exposure to, which could include a special purpose vehicle having a legal-entity status, set up for a project. It is further clarified that signing of ICA is a mandatory requirement for all lending institutions in all cases involving multiple lending institutions, where the resolution process is invoked, and the requirement of additional provisions if the ICA is not signed within 30 days of invocation does not substitute for the mandatory nature of ICA. Compliance with this regulatory requirement shall be assessed for all lending institutions as part of the supervisory review”
Possible action items
The aforesaid floor/cap of ratios conforms to the typical financial structure of respective industries and reflects the realistic judgment of the committee. It may be observed that in case of aviation segment the prescribed current ratio is 0.40, which is much less than standard 1.33%. In fact in aviation segment primary raw material requirement is oil which is consumed by the aircrafts and because of immediate availability airlines do not hold higher inventory. Naturally while considering finance the working capital funds cannot be construed to be backed by security of stock. Further there are requirement of spares etc. which are not as significant against the total requirement. Other requirements eg, refreshments etc are outsourced. The long term funds are utilized for procurement of aircrafts/ infrastructure and revenue stream is dependent on the passenger traffic which is at a very low level at present.
Similarly the prescribed ratios in case of real estate and construction segment also reflects the practical judgment. However, in case of restructuring the major factor is viability of the unit after allowing deferment of the liabilities, for which individual banks have to apply their judgment based on analysis of fundamentals. It may not be possible for the banks to complete the task within the prescribed time frame and involvement of accredited finance professionals would be an essential prerequisite. It is advisable that banks identify select finance professionals and entrust the task of preparing a viability plan based on the principles prescribed. Selectivity of accredited professionals are vital for the bank before accepting any recommendation since the professional has to consider the present state of the economy as well as supply of raw materials / infrastructure and the change in dynamics of marketing after the change in export prospects post china rift. Bankers are now careful about the consequences and apprehensive of eventuality of accepting any proposal with potential for impairment. The situation calls for interdisciplinary approach by involving organizations engaged in technical as well as financial due diligence, so that the consequence of decision making , either way, should not be inflicted on the banks.
Original prescription for rehabilitating Sick enterprises
Rehabilitation of sick unit was always a concern of Reserve Bank of India and various committees were constituted for exploring avenues for rehabilitating sick units. It is time that we revisit their recommendation as accepted and implemented by RBI.”The Reserve Bank of India, in November 2000, had constituted the Working Group on Rehabilitation of Sick SSI units, under the Chairmanship of Shri S.S. Kohli, Chairman, Indian Banks’ Association, to review the existing guidelines in regard to rehabilitation of sick Small Scale units and to recommend the revision of the guidelines for rehabilitation of current sick and potentially viable SSI units, making them transparent and non-discretionary. Reserve Bank of India has accepted all the major recommendations of the Group”. There were subsequent improvements in the guidelines, the essence of which is still applicable. In the words of RBI “The banks should, therefore, take a sympathetic attitude and strive for rehabilitation, in respect of units in the SSI sector, particularly wherever the sickness is on account of circumstances beyond the control of the entrepreneurs. Banks are also advised to take a pro-active stance in providing timely assistance for rehabilitation of small scale units, which are affected by the industrial down turn and delays in payments against supplies made by them to large scale and other units.” (PCB.POT. 01/09.09.01/2002-03 July 19, 2002). Further ,”….A unit may be regarded as potentially viable if it would be in a position, after implementing a relief package spread over a period not exceeding five years from the commencement of the package from banks, financial institutions, Government ( Central / State ) and other concerned agencies, as may be necessary, to continue to service its repayment obligations as agreed upon including those forming part of the package, without the help of the concessions after the aforesaid period. The repayment period for restructured (past) debts should not exceed seven years from the date of implementation of the package”.
How do we identify the sickness
As advised by the committee and as accepted by RBI while advising the banks in 2002: “
- Outstanding balance in cash credit account remaining continuously at the maximum;
- Failure to make timely payment of installments of principal and interest on term loans;
- Complaints from suppliers of raw materials, water, power, etc. about non- payment of bills;
- Non-submission or undue delay in submission or submission of incorrect stock statements and other control statements;
- Attempts to divert sale proceeds through accounts with other banks;
- Downward trend in credit summations;
- Frequent return of cheques or bills;
- Steep decline in production figures;
- Downward trends in sales and fall in profits;
- Rising level of inventories, which may include large proportion of slow or non-moving items;
- Larger and longer outstanding in bill accounts;
- Longer period of credit allowed on sale documents negotiated through the bank and frequent return by the customers of the same as also allowing large discount on sales;
- Failure to pay statutory liabilities;
- Utilization of funds for purposes other than running the units.
- Not furnishing the required information/data on operations in time.
- Unreasonable/wide variations in sales/receivables levels vis-à-vis level of operation of the unit.
- Non co-operation for stock inspections, etc.
- Delay in meeting commitments towards payments of installments due, crystallized liabilities under LC/BGs, etc.
- Diverting/routing of receivables through non-lending banks.”
The parameters for identification of sickness continues to be the primary indication os sickness of the enterprises.
The prescriptions given for nursing the unit is as under:
If penal rates of interest or damages have been charged, such charges should be waived from the accounting year of the unit in which it started incurring cash losses continuously. After this is done, the unpaid interest on term loans and cash credit during this period should be segregated from the total liability and funded. No interest may be charged on funded interest and repayment of such funded interest should be made within a period not exceeding three years from the date of commencement of implementation of the rehabilitation program.Unadjusted interest dues such as interest charged between the date up to which rehabilitation package was prepared and the date from which actually implemented, may also be funded on the same terms as above.The rate of interest on term loans may be reduced, where considered necessary, by not more than three per cent in the case of tiny/decentralised sector units and by not more than two per cent for other SSI units, below the document rate.
Working Capital Term Loan (WCTL)
After the unadjusted interest portion of the cash credit account is segregated as indicated as above, the balance representing principal dues may be treated as irregular to the extent it exceeds drawing power. This amount may be funded as Working Capital Term Loan (WCTL) with a repayment schedule not exceeding 5 years. The rate of interest applicable may be 1.5 % to 3% points below the prevailing fixed rate / minimum lending rate of the bank, wherever applicable, to all sick SSI units including tiny and decentralized units.
Cash losses are likely to be incurred in the initial stages of the rehabilitation programme till the unit reaches the break-even level. Such cash losses excluding interest as may be incurred during the nursing programme may also be financed by the bank or the financial institution, if only one of them is the financier. But if both are involved in the rehabilitation package, the financial institution concerned should finance such cash losses. Interest may be charged on the funded amount at the rates prescribed by SIDBI under its scheme for rehabilitation assistance.Future cash losses in this context will refer to losses from the time of implementation of the package up to the point of cash break-even as projected.
Working Capital
Interest on working capital may be charged at 1.5% below the prevailing fixed / minimum lending rate charged by the bank wherever applicable. Additional working capital limits may be extended at a rate not exceeding the minimum lending rate chargeable by the bank.
Contingency Loan Assistance
For meeting escalations in capital expenditure to be incurred under the rehabilitation programme, banks / financial institutions may provide, where considered necessary, appropriate additional financial assistance upto 15 per cent of the estimated cost of rehabilitation by way of contingency loan assistance. Interest on this contingency assistance may be charged at the concessional rate allowed for working capital assistance.
Funds for Start-up Expenses and Margin for Working Capital
There will be need to provide the unit under rehabilitation with funds for start-up expenses (including payment of pressing creditors) or margin money for working capital in the form of long-term loans. Where a financial institution is not involved, banks may provide the loan for start-up expenses, while margin money assistance may either come from SIDBI under its Refinance Scheme for Rehabilitation or should be provided by State Government where it is operating a Margin Money Scheme. Interest on fresh rehabilitation term loan may be charged at a rate 1.5% below the prevailing fixed / minimum lending rate chargeable by the bank wherever applicable or as prescribed by SIDBI / NABARD where refinance is obtained from it for the purpose.All interest rate concessions would be subject to annual review depending on the performance of the units.”
As is evident from the aforesaid prescriptions the prescriptions are applicable for MSME units and also to certain extent larger corporate. It is true that the ailing units cannot service the interest burden for the interim period as also the compounded rate of interest. It is also true banks cannot forgo the interest , which will itself cause erosion of banks margin and result in sickness of the bank considering the volume of business requiring concessions. Carving out the amount beyond drawing power and creating WCTL can provide comfort to the unit, provided assessed working capital limit provides some space for utilization. Further by creating funded interest and allowing some time frame to repay may ease the burden on the entrepreneur. However , the primary concern is the viability of the unit under review and undertaking due diligence by engaging accredited technical and financial consultant , after incorporating the aforesaid concessions, would be an wiser way for accounts with certain cut off limit of say 1 crore and above.
