Debt Restructuring – Breakdown or just a pit stop?

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Recently you might have heard or read this term a lot – Strategic Debt Restructuring (SDR). You might remember reading how RBI had come up with the list of corporates as defaulters. And as it comes almost daily in news these days, on how the corporate sector is stressed and how a lot of companies are opting for SDR. Also, you might have read about how Reliance Communications had unveiled its plan to exit SDR.

So, what exactly is SDR? And in which scenarios does SDR come into play?

SDR is one of the several steps that RBI has taken to tackle NPAs. Under SDR, banks who have given loans to a corporate borrower, gets the right to convert the full or part of their loans into equity shares in the company who has borrowed from them.

The scheme was introduced by the RBI in June 2015 which helps banks recover their loans by taking control of the distressed listed companies. Last year in June, RBI had released a list of 12 defaulters which were referred to NCLT. These companies have outstanding debt of more than Rs. 2.4 lakh crore. The total non-performing assets (NPAs) in the banking system are estimated at 8.5 lakh crore.

The SDR an initiative can be taken by the group of banks or JLF that have given loans to the particular defaulted entity. The basic purpose of SDR is to ensure more stake of promoters in reviving stressed accounts and providing banks with enhanced capabilities to initiate change of ownership wherever necessary. The Joint Lender Forum (JLF) is a committee comprised of the entire bankers who have given loans to a potentially stressed or stressed borrower.

The decision on invoking the SDR by converting the whole or part of the loan into equity shares is taken by the JLF. The decision should be documented and approved by the majority of the JLF members (minimum of 75% of creditors by value and 60% of creditors by number). This gives banks more power in the management of the company who has taken loan and has defaulted. Change of management means share transfer from the promoter to the banks.

SDR cannot be used for any other reason.

What has happened so far?

As per an estimate, around 400 plus cases under the Insolvency and Bankruptcy Code(IBC) have been taken to NCLT.When a case is referred to the NCLT under the IBC, banks have to make a 50 per cent provision for loans in their profit and loss accounts. If the result is liquidation, banks have to make a 100 per cent provision for the loan. If the resolution fails, the banks will have to write off the loan. Overall, the repercussions are huge for any bank.

The Strategic Debt Restructuring (SDR) allows banks to convert part of their debt into equity and become owners of the companies. The SDR mechanism essentially helps the borrower to procure a longer time period to pay up, and this works only in genuine cases. But too many cases haven’t been helping the banks because the companies continue to be sick and have been defaulting despite the concessions and the banks still have a problem on their hands. Banks have a limitation too. They normally don’t possess the skills and experience to deal with stressed company turnarounds. The sustainability of debt, is a major roadblock too.

What now and in future?

I had been reading an article where it said that SDR was an overhang for the banks as they lack the expertise to deal with such situations. This argument requires a real valid counter agreement if we don’t want to agree with it.I find it real hard to not agree with it.

The move of RBI for pitching in SDR may help banks gain more control of the asset base, but it is not helping control the situation.This is something banks were never prepared or asked to do before in their entire history. SDR is an out the box solution for RBI, but it fails to assess that not everyone fits in the same size.The assessment of debt sustainability requires professionals to assess the overall business situation.

It won’t be wrong to say that this is not the job of the banks.The basic operation of the banks has been the same of deposit and lending. SDR is consequence which gives a lesson to banks of being more careful and do more due diligence when giving out loans. Banks need to develop their learning curve and if they want the SDR to work, they need to hire or consult professionals.IBC won’t help them recover their money.If they do get a buyer for the asset, they will probably have to make a very big provision. If they don't find a buyer, the property goes into liquidation and again banks end up losing almost all the money they lent.