The Hindu Business Line : Corporate debt restructuring

The basic objective of corporate debt restructuring should be revival of units by increasing their production within a time-frame and, if necessary, by changing the management with government support. The CDR mechanism has not proved effective in redressing loan delinquency by big borrowers; it has, in fact, enhanced the losses. The system must be reviewed to make it more effective, says O. N. Singh.

IN THIS era of globalisation and competition, Indian industry is striving to survive and prosper. Growth trends in the industrial sector reveal that the share of manufacturing in GDP has gone up only marginally, from 13.8 per cent in 1970-71 to around 15 per cent in 2000-01. The share of the services sector, on the other hand, has risen from 32.2 per cent to 46.8 per cent during the period.

There are, therefore, inherent problems in the manufacturing sector, such as declining competitiveness, rigid and rising costs of inputs and so on, which have affected corporate profitability.

Further, the bulk of portfolio investment currently is in the information technology and other knowledge-based industries. And as for banks and financial institutions, they are saddled with non-performing assets (NPAs) arising out of corporate accounts. In this context, the corporate debt restructuring (CDR) mechanism assumes significance.

CDR is a non-statutory voluntary mechanism applicable only to standard and sub-standard assets of banks and financial institutions with high priority given to potentially viable cases.

Thus, the main concern of CDR is revival of units with potential. Investments earmarked for CDR have been estimated at around 60 per cent of the total investments of industries, or 9-10 per cent of GDP.

With huge investment and manpower involvement, it is essential to look into the eligibility criterion for inclusion in the CDR system.

Background

As in the UK, Korea and Thailand, India, too, has developed a CDR mechanism, which ensures timely and transparent restructuring of the corporate debts of viable entities affected by internal and external factors. This restructuring mechanism will apply only to multiple banking accounts/syndicates/consortium accounts with outstanding exposure of Rs 20 crore and above with banks and financial institutions. Initially, CDR did not involve cases under the BIFR, the DRT and other legal entities. Recently, though, BIFR cases with minimum cut-off limit of Rs 25 crore of aggregate outstanding exposures have been considered for CDR.

Proposals under CDR entail mainly the following:

Extending the repayment period of loans;

Converting the un-serviced portion of interest into term loans; and

Reducing the rate of interest on outstanding advances.

The CDR system has a three-tier structure: i) the CDR standing forum and its core group; ii) the CDR empowered group; and iii) the CDR cell. The CDR standing forum lays down policies and guidelines and monitors the restructuring. The empowered group decides the acceptable viability benchmark levels, and the CDR cell assists in all the functions.

There are two categories of debt restructuring under the system. Accounts, which are classified as `standard' and `substandard' in the books of the lenders, will be restructured under the first category (Category 1).

Here, if the account has been classified as standard/substandard in the books of at least 90 per cent of the lenders (by value), the same would be treated as standard/substandard only for the purpose of judging the account as eligible for CDR in the books of the remaining 10 per cent of the lenders.

Accounts which are classified as `doubtful' in the books of the lenders would be restructured under the second category (Category 2).

In this category, if a minimum of 75 per cent (by value) of lenders satisfy themselves of the viability of the account and consent such restructuring.

The existing loans will only be restructured and it would be up to the promoters to firm up additional financing arrangement with new or existing lenders individually. The viability and rehabilitation potential of the company will be judged based on the parameters and benchmark levels shown in the Table.

Since inception, the CDR cell has received 108 proposals for restructuring, aggregating Rs 64,567 crore, that is, 4.53 per cent of GDP during 2003-04. The cell has approved 72 corporate proposals amounting to Rs 56,794 crore, rejected 19 proposals valued at Rs 2,501 crore and is processing the remaining.

Plugging the loopholes

The CDR system provides for an exit route so long as other institutional participants are prepared to buy out these loans. Once the CDR package is finalised, loan takeouts would also follow. However, banks/financial institutions would suffer some losses, as the discounting for such takeout is likely to be high, especially as the assets are actually non-performing.

The current system provides a preventive measure to curb NPA creation in financial institutions (FIs). But the same should be a productive one leading to increased production capacities.

The system gives more thrust to funds flow than cash flow, which depends on the market, economy and policies, and is essential for revival of an industry.

The longer settlement period of CDR or delayed payments affects the profitability of bank/FIs. The period of settlement should be equal to the period of the measure/relief, if any, announced by the Government.

Participating banks/FIs should have the right to refuse taking additional exposure in working capital loan of the company without any disincentive. [In consortium finance (cases of normal sanction as well as restructuring), member banks/FIs have such right.

Devolved letters of credit (LCs) outstanding represent non-payment of bills out of sale proceeds of finished goods. It is being treated as part of working capital term loan but it should be considered as part of the LC limit. Fresh LCs may be opened to the extent of deposits made in LC devolved accounts.

At times, short-term funds are diverted for long-term uses and this reduces the drawing power of the company.

Working capital financing lenders are required to curve out this as term loan and, in addition, sanction restoration or even increase the working capital facility.

Diversion of short-term facility to long-term uses should be financed by term lending institutions.

The amount of working capital term loan (WCTL) varies from bank to bank. The irregular portion during a period has been created because of non-payment of instalment, shortfall in drawing power, and so on.

The quantum of such irregularities may vary from bank to bank. In CDR-approved debt restructuring schemes (DRSs), WCTL has been allocated among banks/FIs on a pro rata basis; this should be avoided. Outstandings with any bank/FI exceeding its allocated regular limit would be its WCTL.

Term loans of FIs represent funding of interest over a period. In CDR-approved DRSs, a common date is identified for funding of interest.

However, interest booked and serviced during that period should not be insisted for refund or funding. It should be left to individual banks/FIs. The term loans of FIs should be quantified institution-wise. Irregularity with one bank cannot be transferred to other banks to regularise it.

In CDR approved DRSs, the individual bank may be allowed to settle its dues upfront based on discount cash flow. The basic objectives of CDR should be revival of units, by increasing their production within a specific timeframe and, if necessary, by changing the management with government support.

As such, the CDR mechanism has not proved to be that effective in redressing loan delinquency by big borrowers; it has, in fact, enhanced the losses. It is essential to review the system to make it more effective to resolve the problems.

(The author is CMD, Allahabad Bank.)