Strategic Debt Restructuring (SDR) Scheme: Overview

Recently RBI has come out with a new circular on June,8, 2015 wherein it has elaborated in detail the modes operandi of loan conversion into shares leading to management takeover . The scheme is in continuation of its’ efforts in devising framework for Revitalising Distressed Assets. The concept is based on the general principle of restructuring i.e. Shareholders bear the first loss rather than the debt holders.

This will enable the lenders to convert the loan into equity and thereby management control from the promoters.  The scheme has been named as Strategic Debt Restructuring (SDR) scheme as it involves change in management temporarily or permanent too. The scheme is based on the presumption that the existing management is either not capable to revive the unit or does not intend to do so. Also this will give more ammunition to the lenders to pressurize the borrowers.  This scheme can also be applied to the cases where restructuring is done earlier and the MRA has necessary clause to this effect. The circular gives in detail guidelines towards conversion ratio and all related matters.

In my view, such draconian clauses needs be studied properly. An entrepreneur who has already lost all the properties, business and credibility is further pushed to corner. There may be some willful defaulters but not all are willful. In business uncertainty is always there and the entrepreneur services the obligation to the maximum possible. By threatening to takeover, there is least probability of recovery, rather the fear in borrower may further push the company to dust. Also the lender is not always at fault for NPA, even lenders are also equally responsible for such disaster. In most of the cases timely relief could have saved the borrowing unit from slipping to NPA. Always the delay in support plays major role in such situation. I also feel that the lenders should also be made equally responsible and thorough investigation should be carried out into their role and actions. Borrower should be given unbiased and patient hearing as he is the person who has taken maximum risk by pledging every thing . The takeover of shareholding and transferring to some New Promoter at later stage may be part of some conspiracy . This may also lead towards new kind of corruption. The scheme also mentions about the divestment to new promoter and also refinancing the debt to new promoter. Such refinancing may lead to some kind of conspiracy . Thus such scheme is not only impractical but full of flaws.

CP Jain

Stressed Accounts- Settlement Process

In continuation of my posts in relation to the stressed accounts, I wish to share my views in regard to the settlement and closure of the account . 

Once an account becomes NPA, the recovery process starts which ultimately leads to the realisation of funds . This is either done by way of auction of properties , realisation of certain assets , recovery from the guarantors and by bringing strategic investor in the company. In every situation the funds so received are adjusted against the loans outstanding . Settlement is a very important process which if not handled properly can cause lot of damages to the borrowers and the guarantors. Most of the settlements are made in parallel with the legal recovery process. Also if the settlement is not worked out properly , the amount deposited initially may be a sheer waste. Hence over commitment can be very dangerous . Also while doing settlements it must be ensured that it relieves the promoter from any future liabilities too. Value of intangible assets and business potentials should also be taken into consideration. We should be well aware about the maximum time available in settlement.

Since the legal process of recovery can be too long, it needs to be considered that both sides get affected in delaying the settlement . 

These days ARCs are also useful for settlement and can play a fruitful role. 

CP

NPA Accounts-Way Forward

In current scenario the non performing assets are increasing day by day. As per rough estimates the NPA loans are estimated to be over 4 Lac Crore or 70 Billions. These are official figures and unofficially it can be near to 6 Lac Crores or 100 billions. More than 4 Lac industrial units have been forced to close the operation due to loan defaults . Promoters of these units are facing the legal heat and most of them would be soon finished as the legal system will also not support them much. Other side the employees and other small enterprises depending upon such units have no option but to look for alternative options. As per rough estimates more than 12 million people have faced unemployment due to NPA and loan defaults.

The moment an account is declared defaulter or NPA, all the  promoters and guarantors are branded defaulters and the names start appearing as defaulter in CIBIL lists. This results into prohibiting such promoters and their guarantors from raising any money, means doors closed to survive. In this situation it is very important to be aware of the various options of fund raising and survival.

A. Fund raising options:

 i. There are some NBFCs and High networth individuals who can rescue the unit and lend money for short period but at higher cost. Since banks don't support, this is most common method to raise money and settle with the banks. Also there are structured funding available in the market against specific order, contacts or sales under escrow mechanism to give some breathing to the stressed unit.

ii. Sale of non core assets is another option if the lending institutions permit because most of the assets are under the charge of the lending institutions. This may help to a great extent in reviving the unit.

iii. Private equity is another major source if there is good potential in the unit.

Above options are in addition to the support of available from the existing bankers. Banks resist but if convinced can look into  revival proposal positively. Most of the revival/restructuring proposals have failed due to very impractical approach . The revival is based on more theoritical approach than practical thinking. Recently RBI has come out with Flexible restructuring scheme under which for certain segments, the loans can be restructured for 25 years too. 

B. Survival Options:

 Legal remedy is always available if there is injustice to the stressed units. If the unit is in operation, the courts take positive view and help ion revival also.

Overall, the NPA declaration is not the end, there are lot of options available if properly handled.

CP

Stressed Accounts: Common Feature

I thought to share something about the corporate stress .

While advising the clients mainly in stress, I noticed certain common features. These can be used as warning signals too which may help businessmen to avoid the trap of stress.

Common Factors :

1. A team of highly paid Executives : In most of the cases, I noticed that the companies hire highly paid executives who roam around for more and more salaries. These people are not committed towards the organisation but they will try to extract more and more for themselves. They are good at communication skills and that skill is mainly used in marketing for themselves. Such people boast a lot and take the credit for every good thing in the organization and blame the promoter for all the failures. Such people can’t face the tough time and run away immediately after the warning signals or the promoters also throw them away once their real capabilities surface. High employee cost adds fuel to the fire and cause serious losses to the organization.
2. Expansion of capacities: Generally the company runs well at the initial stage of operation. The performance lures the promoters to expand the business. The confidence turns into over confidence and hence capacity expansion is always many fold. Such decisions are generally taken in boom time which does not last long. By the time the higher capacity is in place, demands slow down and the selling becomes tough. More capacity reduces margins, increases competition and the terms of sale are liberal. This situation leads to a dangerous zone where recovery may be a big issue. Gradually the company falls in the trap and gets into stress due to low recovery.
3. No control or supervision on the cost part: When time is good , profits rain and promoters loose the focus from the costing. This is quite common feature in stress accounts. By the time the capital starts wiping out, it is too late. The promoters live in different impression of high margins. The fact that the costing does not support the business, the capital starts wiping out immediately. The signals come bit late and by this time the situation goes out of control.
4. No change in product mix: The impression that business is growing, margins are same or higher and fear to move forward leads to this situation of stress. The management of the company does not try to different product mix fearing loss. They believe that same product mix will give same or high margins for indefinite period. They get shock when suddenly the existing product mix does not yield the same margins or even resulting into loss. By the time they take action it becomes too late.
5. High overheads: No control over costs, high business development cost and extravagance in day to operations leads to great damage to the company. This acts as a slow poison because such expenses can not be curtailed at later stage. The promoters attach their show off with day to day business and the percolates to the down side. Executives too spend lavishly. There is no control over expense vis a vis result.
6. Old team which does not allow the new blood to enter into policy decisions: We noticed that the team which is in place since long indulge into politics. They don’t allow new team to grow and hence new ideas are not entertained. Existing team circles around the promoter which acts as a solid barrier to look into the outside reality.
7. Over support by the Bankers: When going is good , financiers (Banks particularly) chase a lot to the borrower to take more money. This is basically done to achieve more business. This provide more fuel to burn. The over support and carelessness damages the company in long run as the company becomes highly leveraged and interest burden increases. If the revenue generation is not same or less than projected, the stress automatically enters in the company.
8. Absence of timely support by the bankers: Bankers behave like fair weather friend. When going is good, they offer more than required funds, but when it is tough they try to pull out of the company or even destroy the company with sole purpose of recovery.
9. Overdependence of the promoters on key people: As mentioned above, some people take full control over the promoters and they call the shots. Such people play politics and never allow others to enter into the artificial ring. Promoters also get comfort in this ring but it damages extensively to the company. By the time promoters understand the situation, it is too late and the company goes into stress. Later on such team gradually fades away once the situation gets worse.
10. Rampant Corruption and inefficiency in team: Stress is mainly caused due to inefficiency of the team, Over confidence of promoters and over flow of funds. In this situation the promoters start loosing the grip and surrounded by few people who know how to handle the promoters. These people also start enjoying power of relationship with the promoters. This results into the rampant corruption and politics. This results into severe stress and mismanagement in the company. It has been noticed that certain company officials make more money than the promoters and run away from the company. They also possess lot of sensitive information and hence the promoter can not take any action.
11. Promoters’ overconfidence in business development: This is one of the major reason for stress. Most of the expansion decisions are taken during the boom time. Promoters feel that the current success will continue forever and they will be able to get higher success even if the business expands manifold. The expansion takes away liquidity from the business and stress starts. Gradually repayment of loans and interest becomes problematic and huge holes are created in the business.

Thus common features for stress in a company can be summed up as mis-management, promoters’ overconfidence, inefficient & Corrupt team and poor cost control.

CP

Role of Asset Reconstruction Companies (ARCs)

I wish to share my views on Asset Reconstruction Companies operating in India, their purpose and approach. ARCs have not only failed in our country but also damaged the economy.

Asset Reconstruction Companies (a dangerous nexus )

When an entrepreneur dreams of setting up new business or industry he is the first to put in his money and borrow from the bankers by further giving his properties as security . By the time he set up the unit he is exhausted and left with nothing except his dreams . He put in efforts 24*7 every day for end number of years. Till he honours all the commitments he is respected by the lenders. Interestingly, he is rather instigated to borrow more and more by the bankers. It is this push in most of the cases which leads to NPA. Bankers in the process to achieve the targets and get promotions quickly lend money so loosely that the seeding of NPA is done at that moment itself . Later the officers get promotion and move career ladder fast. The situation becomes so volatile that any mistake by the entrepreneur can collapse the whole organisation. In business mistakes happen and the result is defaults in repayment of loans and interest. By the time account gets NPA the officer reached to untouchable heights. On the other hand borrower is pushed to corner now and does not get any help from any side . He is cursed, abused, insulted and pushed to the corner to such an extent that he is branded as thief. Gradually legal process starts and he is so much stressed that instead of focusing on business he starts fearing and try to detach himself from the business and take various course of action to avoid the repayment. By this time he is branded a defaulters or fraudster. He is threatened by investigations and CBI and so on..the news and notices are published in newspaper along with his name, photo and so on. Instead of running business this poor business man gets stuck up in taking various actions to safeguard himself and his family interests.

The process in the banks and lending institutions starts to finish off the promoter. He is never helped to revive the business . In fact sometimes it is felt that the some bankers wait for this situation to happen so they can en cash this moment for their benefits. Please remember in most of the cases loans sanctioning officers are moved by this time and new officer is not interested in reviving such units as there is no benefit to him. Then new phase starts and the real game is on. Bankers clean up the balance sheet and auction the loans to Asset Reconstruction Companies ( ARCs).

Here I would like to mention about ARCs , their purpose and current status . ARCs are basically formed under RBI guidelines to help in revival, reconstruction or resolution to a company which in stress and defaulting in repayments. ARCs were expected to handhold such companies to help them in standing again and also help the society to survive. Currently 14 ARCs are operating in our country and have acquired loan portfolio of more than 1.00 Lac crore rupees. Once the loan account is assigned to an ARC, no question is asked to the bankers and they are relieved from any responsibility. Due to this reason the bankers use this tool so they can safe guard their personal interest. Once you assign the loan to ARCs, any settlement will be by the ARCs and hence no question asked. Also there is there is a cartel who captured maximum loan portfolios. The basic purpose of these ARCs is no where near to revive the units , they go for quick money which is into disposal of the assets. In the process they also become lenders with interest charging more than 24% p.a. These ARCs are minting money at the cost of our economy. Poor businessman gets crushed under their butcher activities and can not survive for long. He losts every thing and top of that branded as defaulter whom no one can lend money. His name appears in CIBIL list and becomes untouchable. ARCS have cornered huge money which is directly indirectly under nexus with the Banks.

There should be detailed investigation into :

a)  Role of ARCs, Loans assigned to them, how many units they really helped in reviving, how many assets they have disposed off and what is their earning in last 5 years.

b) Why banks should not help the units to revive? When they lend, they appraise the unit then how it happens that account gets NPA . The end of an unit leads to unemployment of large number of poor people who become victim of all these nexus.

C)Why the responsibility of bad loans is not put on the complete chain of officers who have sanctioned the loan and monitored through various system and procedures. Why they should not be made responsible for revival.

d)  The investigation shouldn't be of the entrepreneur only but also the banker.

C P

Due diligence and Credit appraisal system of banks and financial institutions in India

Lot of views are expressed on mounting NPAs in the country in last 3 years. We blame lenders for their poor monitoring system or borrowers for their malpractices. Have we ever thought where else can be a problem? Monitoring and investigations come at later stage when the loan is already sanctioned and disbursed. In fact we can narrate the whole process of financing as under:

a) submission of Loan proposal;
b) appraisal and sanction of loans;
c) disbursement of loans;
d) monitoring and evaluating the loans already given;
e) recovery of the loans along with interest;
f) investigations, settlement, restructuring, if not repaid in scheduled time; and
g) concluding the chapter or litigations. 

Generally we discuss about the issue from monitoring onwards by which time, money is already disbursed and lenders are left with no option but to submerge with the plans of the borrower.

In fact, the most crucial decision is to accept the proposal of the borrower and disburse the same in planned way. Generally the proposal when submitted contains lot of information, analysis and viability support. It mostly has rosy picture prepared solely to impress the lenders to lend money and earn a lot with fully secured module. There may be some hidden or unwritten agenda which also push to lend money. The proposal travels to various layers and moves upward with strong recommendations by each concerned authority at every level. It means every mid size proposal pass through the hawk eyes of many experienced bankers. Not only this it is also scanned by outside agencies like rating agencies, TEV studies, marketing reports, government statistics etc. Then how come there is so much jump in defaults. 

Real fault lies with the appraisal system of the proposal received for financing. Indian banks have age old system where each application is submitted fitted with lot of ratio analysis and lending methods. These formats are analysed by the people working on that who are also given instructions verbally in most of the cases as to how it should be directed.  This is where the cases are manipulated. Due diligence and analysis system in our country is quite old. Except the up gradation in mode of presentation (from typewriting to computerized), the core is not yet changed. The system of due diligence and appraisal need lot of amendments mainly to sync with the economy, macro and micro factors, government policies and the expertise of the borrower. Current system is based on the security, reputation or net worth of the promoter and general business trend. There is assumption that if something going good for long it will remain as it is. No provision for the sudden change in the situation. Further the appraisal does not consider the new technology, start ups, their knowledge, professionalism, team etc. We believe that the promoter and his family has the best guts to run the business. 

Appraisal system should not only consider above factors but also the global trend of appraisal. If this is not improved, lenders may continue to loose hundreds of billions of rupees every year towards NPA accounts and Governments will fund them again and again.

More about the appraisal and due diligence in next posts.

CP Jain, FCA