RBI debt recast norms: Banks will be left holding the bag if no buyers for firms turn up

Sharemasterindia.com: The Reserve Bank of India (RBI) has permitted banks to take control of 51 percent of stake in a company that has failed to recover financial health even after a period of financial restructuring, typically due to management inefficiency or other factors.

This provision, part of the strategic debt restructuring exercise (SDR), is aimed at ensuring promoters of defaulted companies have more ‘skin in the game’. The RBI’s move is part of a coordinated action plan with markets regulator, Securities and exchange board of India (Sebi), which in March had allowed banks to convert part or full debt of listed defaulter companies into equity.

 Both the RBI and Sebi have made the process easier for banks and become aggressive in taking control of defaulter companies. The RBI has said banks do not need to make provisions (money that is required to be set aside on high-risk perceived capital) since the exercise will not be treated as financial restructuring. Sebi too has relaxed the regular rules that will apply when acquiring significant stake in firms such as an open offer to minority shareholders.

Theoretically, the new rule, if it comes with correct pricing for equity conversion for banks, will enable lenders to push a takeover of a firm or exit at a better price.
 For companies too, this will offer relief since they will be free from interest payments once the debt is converted into equity. However, such a relief might come at the cost of losing management control.

But the critical point is that can banks manage to pull off a fast sale of the asset. Typically, there aren’t many suitors for a loss-making asset.
The process often takes years. The fact is that banks have been pushed to take the SDR route as the company has failed to revive even after a period of, say six months or one year, of financial restructuring process, such as reduced loan rates and moratorium on repayment.
At this stage, the value of the underlying asset and brand value would have deteriorated substantially.
 Banks are, in effect, left with a bagful of skeletons - non-performing assets. Although banks get ownership control,
they aren’t in the business of running companies, nor do they have the sector expertise to handle businesses. Until the time banks are unable to find a buyer, equity conversion wouldn’t do much help to banks to recover their bad loans.
Most of the NPAs, restructured assets on the books of banks, are in the infrastructure, manufacturing segments.
Many of these firms, with high debt on their books have seen their share prices crash over years,
resulting in significant erosion in their market caps. In some cases, bank debt is much higher than the market cap. Take the case of grounded Kingfisher airlines and many other debt-ridden companies, where share value has plunged making some of them penny stocks. Hence selling shares in the market wouldn’t yield much in return.
The reason for stress in the balance sheets of companies typically occurs due to external factors, delays in projects and slowing demand, in turn, severely impact their cash flows. Not many buyers will be interested in acquiring these firms, which means their future continues to remain uncertain.

Also, given the past experience, in the event of a take over of management control and transfer of ownership, banks are dragged to court rooms by the existing promoters and the fight goes on for years and even the skeletons disappear.

Having said that, in a country, where there are no bankruptcy laws, such a provision is indeed a useful step for banks, if they can push for a faster sale of the firm. Some bankers are hopeful that ability to convert debt into equity would help, provided the pricing is correct. Indian banks are sitting on a massive bad debt pile.

In recent years, the proportion of stressed assets has gone up substantially in the backdrop of a prolonged slowdown in the economy, absence of fresh investments and lack of reforms pertaining to land acquisition and availability of natural resources. There are two channels for banks to recast loans - under the corporate debt restructuring facility (CDR) and through bilateral loan recasts.

The bottomline: Equity conversion may not do much help in actual recovery of money unless banks manage to pull off a quick sale of the distressed assets, which is difficult in normal scenario. Before converting the debt into equity ownership, they need to a keep a buyer ready, besides preparing themselves for a watertight case in the court room. Else, equity conversion wouldn’t help much.