Banks get freedom to take 51% stake in defaulting firms

The move, amid a rise in slippages from restructured assets, is aimed at resolving stress in the banking system.

In a significant move to provide a more flexible process for lenders to recover bad loans, the Reserve Bank of India (RBI) on Monday allowed banks to acquire 51 per cent or more stake in companies defaulting after restructuring of their loans. 

The move, amid a rise in slippages from restructured assets, is aimed at resolving stress in the banking system. 

The RBI has, however, advised banks to sell the stake to a new promoter 'as soon as possible', but they should ensure the buyer is in no way related to the borrower.

The other measures announced under the new scheme 'strategic debt restructuring' (SDR) include allowing lenders to convert debt into equity within 30 days of review of companies' accounts.

In addition, lenders acquiring shares of listed companies under restructuring would be exempted from making open offers, according to the Securities and Exchange Board of India (Sebi) rules. 

These restructuring norms would also apply to all company accounts before Monday, the RBI said. 

When a debt recast is undertaken, several milestones, such as six months or a year, are set. Within these periods, the financial health of the borrower needs to be improved. 

In case an improvement did not happen, and borrower companies were not able to come out of stress due to operational/managerial inefficiencies, despite substantial sacrifices made by the lending banks, the RBI said, "change of ownership will be a preferred option". 

"If the borrower is not able to achieve the viability milestones, the joint lenders forum (JLF) must immediately review the account and examine whether the account will be viable by effecting a change in ownership," the RBI said. 

JLF is a group of bankers formed when the borrower is facing difficulty in repayment. The main role of JLF is to identify and resolve stress at an early stage, so that the account remains standard. 

"If found viable under such an examination, the JLF might decide on whether to invoke the SDR; that is, convert the whole or part of the loan and interest outstanding into equity shares in the borrower company, to acquire a majority shareholding in the company," RBI said. 

The equity conversion clause needs to be incorporated at the time of restructuring. 

The RBI said the conversion of debt into equity should be at a fair value and should not exceed the lowest of 'market value' or 'break-up' value.

Market value (for listed companies) is the average closing share price of the company in the 10 trading sessions preceding the reference date, which is the date when SDR was decided. 

Break-up value is the book value per share to be calculated from the company's latest audited balance sheet, adjusted for cash flows and financials after the earlier restructuring. "The balance sheet should not be more than a year old. In case the latest balance sheet is not available, this break-up value shall be Re 1," the RBI said. 

"After the conversion, all lenders under the JLF must collectively hold 51 per cent or more of the equity shares issued by the company," the RBI added. 

The JLF can take a maximum of 90 days to approve the debt-equity conversion and the entire process of conversion should be completed within 90 days. 

In a relief to banks, such an exercise will not attract higher provisioning like non-performing loans.

Banks will continue to treat the asset as standard for a period of 18 months, after which classification will done according to the health of the borrowing company. Such a conversion of equity is also exempted from calculation of capital market exposure and will not attract marked-to-market provisioning. 

If the new promoter is a non-resident, and in sectors where the ceiling on foreign investment is less than 51 per cent, the new promoter should own at least 26 per cent of paid-up equity capital or up to the applicable foreign investment limit. 

Rajnish Kumar, managing director, State Bank of India, said the scheme cleared the air over valuation of assets, and the timeline prescribed for the process were realistic.

Other bankers said many promoters had started seeing the writing on the wall and would cooperate with lenders to bring in new management and owners. 

Sinjini Kumar, director at PricewaterhouseCoopers said this would enhance lenders rights' as the banking system would have more options to deal with stressed assets. The conversion of debt into equity to have majority stake without making open offer enhances lenders' rights. This would also reduce apprehension of prospective buyers about litigation. 

Others, though, are not so convinced. Nikhil Shah, managing director of Alvarez & Marsal, a turnaround management outfit, said while it strengthened lenders, the problem was with the "ability of debtors to litigate". In the Indian scenario, legal forums were slow in giving decisions and the process was complex. 

Ashvin Parekh, managing partner at Ashvin Parekh Advisory Services, said what needed to be seen was how the JLF worked and how quick they were in resolving issues.

"So far, we haven't seen any high performance from the JLF, so that needs to be watched. And then there might be some other practical challenges like non-cooperation by labour unions, executives, etc. Sometimes, there can be delays in making changes to statutory provisions, making it a challenge to finish the entire process within a period of seven months," he added.

Power to lenders

Strategic debt restructuring will allow lenders to convert dues into equity shares

This will take place when a borrowing company fails to achieve financial milestones even after debt recast

The debt-equity conversion clause will be incorporated in the debt recast plan

Conditions

Decision to invoke strategic debt restructuring will be taken within 30 days of recast account review

75% of banks by value and 60% by number of banks must approve the proposal

After the conversion, lenders under JLF must collectively hold 51% or more of equity

The SDR package must be approved within 90 days of approval

Conversion of debt into equity under SDR must be completed within 90 days

Conversion price should not exceed the lowest of 'market value' or ' break up' value

Conversion will not trigger open offer