Strategic Debt Restructuring – Eligibility, Conditions, Valuation

The concept of Strategic Debt Restructuring (“SDR“) has been introduced by the Reserve Bank of India (the “RBI“) in the SDR Scheme (the “Scheme“) to help banks recover their loans by taking control of the distressed listed companies. The Scheme has been enacted with a view to revive stressed companies and provide lending institutions with a way to initiate change of management in companies which fail to achieve the milestones under Corporate Debt Restructuring (“CDR“). The Scheme is subsequent to CDR or any other restructuring exercise undertaken by the companies. Now you can scroll down below n check more details for “Strategic Debt Restructuring”

2. Status Of Corporate Debt Restructuring (Cdr) And Non Performing Assets (NPAS)

Worrying Signs*	Estimated as on March 2015	Projected by March 2016
Gross NPAs	Rs.3.1 lakh crore (4.4% of total loans)	Rs.4.2-4.7 lakh crore (5.-5.9% of total loans)
Standard Restructured Advances	Rs.4.3 lakh crore (6.2% of total loans)	–
Gross NPAs + Standard Restructured Advances	Rs.7.4 lakh crore (10.6% of total loans)	Rs.7.4-8 lakh crore (9.5-10.5% of total loans
*ICRA estimate on banks’ gross NPAs and restructured advances (PSBs+ Private Banks)

3. Eligibility

• Conversion of outstanding debts can be done by a consortium of lending institutions. Such a consortium is known as the Joint Lenders Forum (“JLF“).
• The JLF may include banks and other financial institutions such as NBFCs.
• The Scheme will not be applicable to a single lender.

“It will be useful in cases where the borrower has been non-compliant and the bank is confident that a new promoter or buyer can turn things around. In other cases, the existing managements are better equipped to grapple with the situation” – Jaideep Iyer, Group President, Financial Management, YES Bank

4. Conditions

At the time of initial restructuring, the JLF must incorporate an option in the loan agreement to convert the entire or part of the loan including the unpaid interest into equity shares if the company fails to achieve the milestones and critical conditions stipulated in the restructuring package.

• This option must be corroborated with a special resolution since the debt-equity swap will result in dilution of existing shareholders.
• Such a mandate will result in the lenders acquiring a majority (51%) ownership.
• “If the company fails to achieve the milestones stipulated in the restructuring package, the decision of invoking the SDR must be taken by the JLF within thirty (30) days of the review of the account during the restructuring.
• The JLF must approve the debt to equity conversion under the Scheme within ninety (90) days of deciding to invoke the SDR.
• The JLF will get a further ninety (90) days to actually convert the loan into shares.

5. What happens after the debt-equity swap?

• On completion of conversion of debt to equity as approved under the Scheme, the JLF shall hold the existing asset status of the loan for another eighteen (18) months.
• The JLF must divest their holdings in the equity of the Company. If the JLF decide to divest their stake to another Promoter, the loan will be upgraded to ‘Standard’. The ‘new promoter’ should not be a person/entity from the existing promoter/promoter group.

“The measure is welcome in so far as it does create a sense of fear amongst borrowers, resulting in better credit compliance and responsible behavior” – Diwakar Gupta, former MD and CFO of the State Bank of India.

6. Need For Strategic Debt Restructuring

• According to Fitch, stressed assets of Indian lenders set to rise 13% of total advances by March, 2016 from 10.73% as at December, 2014
• CRISIL ratings & S&P’ Indian arm estimates the total bad loans to reach Rs.5.3 trillion by March, 2016
• Failure of Debt Restructuring package.

7. Process of  SDR

8. Valuation For Conversion Of Debt Into Equity

The conversion price of the equity shall be determined as follows:

1. Conversion of outstanding debt into equity will be treated at a ‘Fair Value’ which will not exceed the lowest of :
   • Market value, average of the closing prices during the 10 day average price in the market.
   • Book value per share to be calculated from the company’s latest audited balance sheet without considering revaluation resources.
2. In any case, the price cannot be lower than the face value of the share.

9. Open offer? Or not?

• The pricing formula stated above has been exempted from the Securities and Exchange Board of India (SEBI) (Issue of Capital and Disclosure Requirements) Regulations, 2009.
• Further, the acquiring lender on account of conversion of debt into equity will be exempted from making an open offer under Regulation 3 and Regulation 4 of the provisions of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011.

10. Difference Between Corporate Debt Restructuring(CDR) And Strategic Debt Restructuring(SDR)

Sr No.	Corporate Debt Restructuring (CDR)	Strategic Debt Restructuring (SDR)
1	The reorganization of a company’s outstanding obligations by reducing the burden of the debts on the company by decreasing the rates paid and increasing the time the company has to pay the obligation back.	SDR scheme allows banks to convert their outstanding loans into equity in a company if even restructuring has not helped.
2	The CDR system got evolved and detailed guidelines were issued by RBI on August 23, 2001.	SDR was announced on 8th June, 2015 by the RBI
3	It has a three tier structure which includes CDR Cell, Empowered Group and a Standing Forum. The Standing Forum is the top tier which decides on the restructuring.	A consortium of lending institutions namely Joint Lender’s Forum is formed which will decide on the conversion of debt into equity

11. Advantages to Banks

Conversion of debt into equity in an enterprise by a bank may result in the bank holding more than 20% of voting power, which will normally result in an investor associate relationship under applicable accounting standards. However, as the lender acquires such voting power in the borrower entity in satisfaction of its advances under the SDR, and the rights exercised by the lenders are more protective in nature and not participative, such investment may not be treated as investment in associate. On conversion of debt to equity as approved under SDR Scheme, the existing asset classification of the account, as on the reference date will continue for a period of 18 months from the reference date. Acquisition of shares due to the execution of strategic debt restructuring scheme will be exempted from regulatory ceilings or restrictions on capital market exposures, investment in para-banking activities and intra-group exposure.	“For such companies, the ability of banks to find buyers will be critical because the regulation clearly states that banks will take control only to cede control to another promoter” – Diwakar Gupta, former MD and CFO of the State Bank of India
2. Equity shares acquired and held by banks under the SDR scheme will be exempt from the requirement of periodic mark-to-market. On divestment of holding of banks in favour of a new promoter, the asset classification of the account may be upgraded to Standard. Further, at the time of divestment of their holdings to a new promoter, banks may refinance the existing debt of the company considering the changed risk profile of the company without treating the exercise as restructuring subject to banks making provision for any diminution in fair value of the existing debt on account of the refinance. Advantages for Bankers under the SDR Scheme.
Banks can bring in Foreign Promoters after taking over defaulting companies
3. Banks can convert shares at prices prevailing during time of restructuring, subject to floor of face value. Ø New RBI guideline will help banks avoid a “Kingfisher type Situation” where banks were compelled by the old SEBI pricing formula to convert loans at a 60% premium to market value although the airline was on the verge of bankruptcy. Ø New Indian promoters should hold at least 51%, foreigners can acquire control with 26% as long as they are largest shareholders.
4.Banks need not mark to market converted shares, nor do they have to follow investor-associate norms.

12. Issues Related To Strategic Debt Restructuring Scheme

13. Analysis

• RBI has recently proposed this concept in India. Although banks would get ownership and control over these corporates, at this stage, the value of the underlying assets would have deteriorated substantially. Banks are, in effect, left with a bagful of non-performing assets. It will be challenging for the lenders to continue to run the business of these companies till the time a suitable buyer is found and may have to deploy professional management to efficiently run and manage these companies leading to “putting good (public) money behind bad money”. Until these corporates turn-around and become viable, finding a suitable buyer for the lenders will be difficult and may take many years. SDR can be considered as a last resort to revive such companies which have already undergone a long drawn financial restructuring process.
• One of the critical problems of the Scheme could be the price at which the debt to equity conversion must take place. The conversion price could be higher than the market price as the market value of these scrips would have substantially reduced, whereas the lenders as per the Scheme will be required to convert the debt into equity at a price which shall not exceed the fair value (i.e. market value or break-up value, whichever is lower subject to the floor of face value). This may result in further losses to the lenders.

Sumat Singhal

(B.Com, CAIIB, DTIRM, ACA, ACS, CWA(F)