Banks may get to rework debt of stressed firms

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Mumbai: The Reserve Bank of India (RBI) may allow banks to rework the capital structure of stressed firms in a manner that will help these companies bring down the level of debt on their books, said three bankers familiar with the discussions.

The provision will largely be used in the case of companies that have excess debt which has not yet turned bad. Allowing banks to do this will also slow the build-up of bad loans across the banking sector, which had Rs.5.8 trillion in non-performing assets (NPAs) as on 31 March this year. The reworking of the capital structure, however, may come at a cost, as the regulator may mandate higher provisioning against such accounts.

As part of the plan, RBI will allow banks to convert the unsustainable part of the debt on a company’s books into long-dated instruments such as convertible preference shares, said one of the three people quoted above.

“It is essentially a deep restructuring exercise. What RBI is saying is that the unsustainable part of the debt can be converted into longer-term instruments and can be set aside, allowing for better management of debt,” the person said, requesting anonymity as a final plan is yet to be announced.

“Such structures are needed if we are to come out of the bad loan problem,” said the head of a large public sector bank.

From a company’s perspective, debt (and hence debt-servicing needs) will come down, making it easier for the management to turn around the business.

For banks, it will mean that accounts which were on the brink of turning into bad loans will now have a shot at revival. Banks will also have a chance to benefit from a potential upside on the convertible preference shares that they will hold in lieu of the unsustainable part of the debt.

“Since a majority of stressed companies are struggling because of debt that is not justified by their business, it is essential to cut this debt down. In this new structure, we can rightsize the debt, without necessarily losing out on the value,” said the second banker, also on condition of anonymity.

This banker explained that higher provisions against such accounts will not be a concern as the reformulation of the capital structure will prevent these accounts from turning into NPAs. Once an account turns into an NPA, banks have to set aside 15% in the first year and eventually move the provisioning up to 100% after the third year.

According to the third banker cited above, a draft of the proposals has been circulated among bankers for their views. The Indian Banks’ Association will give a collective response on behalf of all banks. The final guidelines may take some time to come, this banker, who works with a private sector bank, said, requesting that he not be identified.

“To begin with, this sounds like a very sensible and workable measure as you are segmenting the good part of the debt from the bad. Secondly, asking for additional provision ensures that the plan is far more mature and intricate than blind evergreening of stressed loans. Due to this, banks will not get away from the capital implications on such loans,” said Ashvin Parekh, managing partner at Ashvin Parekh Advisory Services Llp.

“But the industry will have to keep a close watch on these accounts and track the dynamic conditions under which certain assets become viable or unviable. Otherwise, we may see a repeat of the CDR (corporate debt restructuring) scheme where accounts got some time off and then came back to banks for further recast,” added Parekh.

The provision, once introduced, will add to a number of tools provided by RBI to help deal with distressed assets, which have risen due to a combination of factors, including stalling of infrastructure projects, a fall in commodity prices and poor lending decisions.

In December 2014, banks were allowed to extend the maturity of loans given to infrastructure companies for up to 25 years under the 5/25 scheme. Initially the scheme had been introduced for new projects but was later extended to existing projects.

In June 2015, RBI introduced the strategic debt restructuring scheme, which gave banks the option to convert part of the debt of a company into majority equity. The scheme was envisaged as a way to deal with errant promoters as it gave banks the option to change the management of a firm.

These measures came ahead of an asset quality review conducted by RBI in the last fiscal year, after which the regulator pushed banks to classify visibly stressed assets as NPAs. As a result of the review, bad loans of the 40 listed banks have surged to Rs.5.8 trillion.

Bankers have indicated that there may still be stressed accounts in the system which could slip into the bad loan category in the coming quarters.

The surge in bad loans has meant that banks have had to set aside a lot more capital as provisions against these loans, leaving a number of lenders under-capitalized.

Public sector banks will see their capital ratios deteriorate as provisions increase due to prolonged asset quality pressures, global ratings agency Moody’s Investor Service said in a note on Thursday.

“We expect the capitalisation profile of the PSBs (public sector banks) to further deteriorate, unless the government provides additional capital support,” it said. Moody’s estimates that 11 banks will need capital of Rs.1.2 trillion by 2020.