Corporate Debt Restructuring Boon acidified to Bane?

The best of intentions get defeated when a system is not used judiciously. K.C.Chakrabarty

What is Corporate Debt Restructuring?

Corporate Debt Restructuring is a mechanism by which a company attempts to reorganize its outstanding obligations. This can be done in any of the following ways: Increasing the tenure of the loan Reducing the rate of interest One time settlement Conversion of debt into equity Converting unserviced portion of interest into term loan

There are occasions when corporates find themselves in financial hitches due to factors beyond their control and also sometimes due to internal glitches. For the resurgence of corporates and for the security of the money lent by the banks and financial institutions, timely support through restructuring of genuine cases is called for. Why do corporates go for CDR and also what interests does it serve of lenders? Borrowers perspective: When a company is having outstanding debts which cannot be serviced under its existing operations, it can either go towards not so sustainable path of enhancing its quantum of debt with an expectation to increase its profitability and repay its original debt which comes with its own risks or cease the operations of the company leading to its natural death. A more viable alternative which is formulated by governments of many countries is to consider a structured plan to renegotiate the current debt with its existing lenders itself. This is where restructuring gains prominence. Lenders perspective: The primary interest of lenders lies in recovering the principal amount lent to corporates along with returns on that investments and not in liquidation of assets. Apart from this liquidation, proceedings are notorious for yielding low returns for creditors. CDR gives lenders a unique opportunity to avoid being encumbered with NPAs.

Hence, CDR becomes an instrument for lenders, i.e. banks to aid the transformation of otherwise NPAs into productive assets.

How does CDR work?

The Corporate Debt Restructuring (CDR) Mechanism is a voluntary non-statutory system based on Debtor-Creditor Agreement (DCA) and Inter-Creditor Agreement (ICA) and the principle of approvals by super-majority of 75% creditors (by value) which makes it binding on the remaining 25% to fall in line with the majority decision. The CDR cell negotiates the exits of companies whose loans are being restructured if they fulfill conditions as follows: Have been in the CDR mechanism for at least 5 years, Reported a 25% growth in earning before interest, tax, depreciation and amortisation (Ebitda) for the last 2 years, Declared more than a 10% dividend Undertaken major capex expansion.

How has the CDR cell helped the Indian companies?

As per the latest data available with CDR cell, a total of 466 cases, involving total debt of Rs 2.46 lakh crore, have been referred to it since its inception. Of this, 101 cases involving about Rs 64,000 crore have been referred in 2012 itself. Of the total 466 cases referred to CDR cell so far, 75 cases involving Rs 27,400 crore have been rejected by the bankers, while 64 cases (totalling over Rs 31,000) crore are under finalisation of restructuring packages.A total of 327 cases have been approved since the start of CDR mechanism as on September 30, 2012 for a total amount of Rs 1.88 lakh crore.(BusinessLine, 2012). Between its inception in 2001 and March 2013, the corporate debt restructuring (CDR) cell will have successfully negotiated the exits of over 80 cases worth over R60,000 crore.(Financial Express, 2013). Major companies benefitted from CDR so far were Subhiksha Retail, Vishal Retail, Kingfisher Airlines, Wockhardt, Hindustan Construction Company, Suzlon, Essar Oil, Essar Steel, Jindal Steel to name a few. Also due to the non-availability of coal and indigenous natural gas power plants are lying idle and due to the price increase in coal input cost of discoms and power producers become very high which they cannot transmit over the consumers because of government regulations hence their balance sheet have seen red color often. According to the power ministry, the Cabinet took up a proposal to recast about Rs 2 lakh crore debt of the power distribution companies to provide

financial support for the sustainability of those companies however CDR cell approved only 3869 crores which also helped power and distribution companies to survive. So during economic downturn CDR provides fresh blood to the companies which are striving for cash flows.

Whats in for banks?

Also, the banking system has improved the quality of its assets over the years - the industry has reduced the outstanding gross NPAs from 11.4% in FY01 to 2.3% in FY11.Further, the overall net profit of the banking industry in FY01(before CDR was implemented) was merely 10% of the outstanding gross NPA. This has become 75% in FY11.(Economic Times, 2012) An attractive mechanism, isnt it?The most vital statistics often hide more than they reveal.

Why did so many Indian companies opt for CDR?

Many companies started raising money through FCCB (Foreign Currency Convertible Bonds) for their expansion plans and to cater to their capital needs. However, the actual cash flow generated from the growth plan didnt meet the expected level of return, thereby leaving them with insufficient amount to pay debts. Also, during recession, as the stock market crashed, the shares of most of the companies plummeted meaning conversion unviable for bondholders. This was further catalyzed by the depreciation of rupee. Hence, most of the companies were finding it unviable to continue their operations. Adding to the prevailing difficult scenario was rise in interest costs, which led the companies to default on their financial obligations, resulting in sharp increase in CDR cases. The story of how companies get themselves into debt distress has many strands. Consider Iron and Steel Industry which is a cyclical business. During boom times, they go ballistic on expansion. Capacity addition leapfrogs suddenly, which means they take a lot of debt. When the economy slows, raw material and inventory move slowly, and revenues do not go fast enough to recover the debt. Consider retail firms. Vishal and Subhiksha based on consumption forecasts, expanded rapidly. Soon, they found themselves buried under a mountain of debt. Due to high real estate costs, excessive inventory and falling revenues, their balance sheets were awash in red, taking them down the road to a painful CDR.

So, what went wrong?

What happens when foreign holders and bondholders, and domestic banks dont do a deal? This is evident from KSL case. KSL and Industries, a textile company which is a part of the Tayal group wanted to restructure its 700 crore loans to state owned banks. It had also raised 500 crloan by the way of foreign currency convertible bonds. Bank of Mellon New york, trustee of

bondholders, filed a petition in the Bombay HC said that they would lose out from the restructuring if they were not part of it. KSLs Response: It bought back the FCCB from the foreign banks by raising loans through the Indian Banks, thereby leaving the Indian banks holding the bag. If the reason for the current increase in restructured accounts is the downturn in economy, it should have been echoed equally across public as well as private and foreign banks. This reflects arguable mirrors that public sector has not been as judicious in the use of restructuring as a credit management tool as the private sector and foreign banks. Lopsided burden sharing: It has been discovered that the public sector banks share a disproportionate burden of such accounts.Chennai's Indian Overseas Bank has the highest percentage of restructured assets, 9.7 per cent, followed by Mumbai-based Central Bank of India, 8.39 per cent. In comparison, the restructured assets of ICICI Bank, HDFC Bank and Axis Bank, are all below two per cent.(Business Today, 2012). Also, the data on restructuring suggests that the restructuring is substantially biased towards more privileged borrowers vis-a-vis small borrowers. This highlights an issue if the misuse of CDR by banks as well as corporate. It has been observed that availability of standing regulatory forbearance to CDR mechanism has prompted banks to avoid using other means of credit management judiciously , i.e., proper due-diligence before sanctioning a credit facility, regular and proper monitoring of accounts after disbursal and taking prompt corrective action on the first signs of weakness in the accounts.

Source: Economic Times, 2012

Misuse of CDR by borrowers: The CDR route for debt mitigation has also been found to be unfairly exploited by Kingfisher, a private airline, by getting a part of its massive debt to banks converted into equity at inflated valuations.

The Way Forward:

Make it Personal: One of the prominent recommendations by the RBI working group was to ask promoters to provide a personal guarantee to the loans so that they do not see loans just as the liabilities of the corporate but have their own skin into it. The problem faced is some of the promoters do not agree to provide personal guarantee but the group of RBI went on recommending that the RBI should prescribe promoters personal guarantee as a mandatory requirement for all cases of CDR.

Develop Specified Risk Architecture: Banks should develop specific risk architecture to analyze the credit worthiness of borrower prior to go with the restructuring. For example, banks need to examine the effective levels of leveraging in the project. Higher leveraging raises the risks of a project especially in an uncertain environment. There have been many instances of even the promoters equity component being financed out of debt. There have also been instances of debt flows being structured as equity and of the private component of Public Private Partnership projects being debt finance. Borrowing from another bank is not equity and adds to the burden of debt servicing. It is thus important to ensure, at the time of restructuring that projects are not over leveraged. It would also be important to establish that the borrowers are sincere about the project, in particular, that the borrowers, or at least the senior management of the borrowing companies, are willing to tighten their belt and share the burden of restructuring (Dr. K. C. Chakrabarty). Equal attention to small players: There should be a structured mechanism for restructuring of retail, SME and agricultural loans same as for larger accounts. This structure will need to be built in at various levels at the state, the district, the region and the bank level. Hence, our entire approach towards restructuring should be reoriented to depict more compassion towards small players.

Time: Time is very often a critical essence in the turnaround of the companies and therefore an elongated process of restructuring assessment could erode the viability of the project. Hence, for restructuring process to be successful in helping the borrower tide over the temporary difficulties, it is vital that the assessment of the proposal and its approval gets done in a specific time period, around 90 days. Rightly put by a veteran bankerwhen a small man owes a few thousands to a bank, he is in deep trouble but when a big tycoon has outstanding running into crores with the bank, it is the bank that faces the music!

References:
Adhikari, A. (n.d.). Vaulting Past Rules. Retrieved 2 25, 2013, from Business Today: http://businesstoday.intoday.in/story/best-banks-2012-debt-restructuring/1/189854.html Corporate Debt Restructuring Mechanism. (n.d.). http://www.cdrindia.org/: http://www.cdrindia.org/ Retrieved 2 21, 2013, from

How Corporate Debt Restructuring Helps Companies in Recovering Debts. (n.d.). Retrieved 2 25, 2013, from Business Maps of India: http://business.mapsofindia.com/articles/corporate-debtrestructuring.html Shukla, A. (2013, 2 27). Moneyworks4me Stockshastra. Retrieved 2 27, 2013, from http://stockshastra.moneyworks4me.com/current-events-news/kingfisher-and-suzlon-go-thecdr-way-know-what-exactly-is-corporate-debt-restructuring/: http://stockshastra.moneyworks4me.com/current-events-news/kingfisher-and-suzlon-go-thecdr-way-know-what-exactly-is-corporate-debt-restructuring/