Loan recast scheme: A resolution plan without the subjectivity of the past

Now, the central bank has come up with a one-time loan recast scheme for companies hit by Covid-19.

Given the unprecedented circumstances post the pandemic, it was expected the government and central bank would extend support to businesses, small and large. While the government has guaranteed fresh credit of a certain amount for small enterprises, RBI allowed companies to defer loan repayments for six months. Now, the central bank has come up with a one-time loan recast scheme for companies hit by Covid-19. The scheme covers virtually every sector, given how 70% of corporate India is estimated to have been hit by the pandemic in some measure.

The resolution framework is fairly watertight and leaves little room for subjectivity while allowing lenders some flexibility. This is important to avoid a repeat of the restructuring during the CDR era, which resulted in losses of thousands of crores—70% of the restructured accounts turned into NPAs and banks took write-offs of 70-75%. This was because the norms were too liberal, leaving lenders room to evergreen the exposures.

This time, candidates are to be selected on the basis of five financial parameters specified by the central bank based on the recommendations of the Kamath Committee; these metrics are accompanied by floors or ceilings. For instance, the ratio of the total outside liabilities to the adjusted tangible net worth (TOL/ATNW) should be under 3-4 times while the total debt-to-ebitda should be under 4-6 times. However, some of these can be complied with by FY22 or FY23. Since borrowers must meet the TOL/ATNW criterion when the resolution plan is being implemented—the sector-specific threshold levels can be complied with by FY22—it would weed out companies with weak balance sheets. While banks may take a hit, it is better not to prolong the pain.

The central bank wants to ensure the relief is restricted to borrowers hit by Covid-19—so it is only those exposures that were not NPAs on March 1 that are eligible for a recast. Since lenders need to work with the pre-Covid-19 operating and financial performance of customers to assess cash future flows, there could be some borderline cases, and banks must be strict rather than lenient.

For the recast plans, banks have been permitted to reschedule repayments and offer borrowers a payment moratorium of up to two years, which is a reasonable time frame. Rather than taking haircuts, or converting loans into equity, it is better banks allow companies time to repay their dues. While the process threatens to be a tedious one, since the majority of lenders in a consortium must agree to the terms, there are strict timelines that need to be adhered to. For their part, banks would be keen to move quickly because there is a good chance many exposures will go bad without immediate support. Indeed, the success of any recast would depend to a great extent on how quickly banks decide on them; in the past, too many debt restructuring schemes have come to nought because lenders could not agree on the terms.

It is a good idea to rope in a credit rating agency to carry out an independent assessment; even otherwise, all plans with an exposure of Rs 1,500 crore or more will be vetted by the Kamath panel. An analysis by Nomura revealed that 30-35% of the companies in most sectors failed to meet the criteria—relating to the key ratios—based on historical data. This suggests a fresh round of NPAs.