Revitalising stressed assets in India: An outlook

Corporate Debt Restructuring (CDR)s have met with limited success in reviving stressed loans owing to poor evaluation of business viability and lack of effective monitoring

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Overview of Stressed Assets Market Media reports in recent months have highlighted the rapid growth in stressed loans in the Indian banking system. The Reserve Bank of India (RBI) has underlined the rising incidence of stress as a serious issue and has taken policy measures to address it. The stressed loans of Indian banks are of the order of 14 percent of gross advances ($161 billion) as of March 2015.

Reviewing the trend of growth in the number of stressed loans, over 30 percent are from the Infrastructure sector– primarily in the power space.  A large proportion of these loans are to government-controlled power generation and distribution companies. Operating inefficiencies (technical and commercial), lack of adequate availability of cheaper domestic coal and inability to pass on the increased costs to consumers have impacted these companies adversely.

In addition, there are certain issues which are specific to iron & steel, textiles, aviation and mining - sectors that, along with Infrastructure, contribute to over half of the total stressed loans.

Current challenges
Banks have preferred to address the problem of stressed loans through restructuring of debt under the aegis of Corporate Debt Restructuring (CDR). While the CDR mechanism was used extensively, the objective seems to have been to provide temporary relief to the borrower rather than make active efforts to revive businesses. CDRs have met with limited success in reviving stressed loans owing to poor evaluation of business viability and lack of effective monitoring. As of December 2014, of the 520 approved cases, only 15 percent exited successfully, 30 percent failed and the balance cases are still in the restructuring process.

Recovery of assets is mainly the responsibility of banks. Banks are not well equipped to manage recoveries and hence we need to promote agencies like distressed funds, Asset Reconstruction Companies (ARCs) or introduce bankruptcy laws to enable more professional recoveries.

The sale of stressed loans to ARCs is also a route that has been sporadically explored by banks since the formation of ARCs in 2002. The spiralling level of stressed loans resulted in a significant amount of loans being sold to ARCs during FY14 and Q1 of FY15. To enforce more objectivity in their evaluation of these stressed assets, the RBI increased the minimum cash contribution by ARCs when acquiring these assets to 15 percent (versus 5 percent earlier).

Another significant challenge is faced by stressed asset funds in acquiring NPAs. Dry powder of $3 to 5 billion is available with stressed asset funds in India, but so far their involvement has been limited due to promoters’ lack of credibility, financial irregularities, and difficulties and delays in dealing with lenders.

Steps to revitalise stressed assets
In 2013, the RBI introduced stringent regulations, including higher borrower contributions, increased bank provisioning and proposed a robust review of companies prior to restructuring. Besides, in early 2014, RBI issued a framework that would lead to an early and earnest identification of stress in order to enable credible and timely resolution of such loans.

Some of the recent developments to revitalise stressed loans are highlighted below. These initiatives by the regulatory authorities will surely contain the proliferation of such loans:

• Starting from April 1, 2015, regulatory forbearance on restructured loans has been withdrawn and as such, restructured loans would be treated as non-performing assets (NPAs) with higher provisioning requirements.
• Restructuring under Joint Lender Forum (JLF) route has become the preferred option for lenders for stressed loans that are overdue for more than 60 days.
• As a step towards creating a level playing field between large NBFCs and banks, the finance ministry has proposed to extend the applicability of the securitisation laws (SARFAESI Act) to large NBFCs for a faster recovery from stressed loans.
• The finance ministry has also proposed to introduce a uniform Bankruptcy Code similar to Chapter 11 of the Insolvency Act in the US and the Enterprise Act in the UK.
• Recently, RBI introduced a flexible refinancing structure (popularly known as the 5:25 scheme) for projects characterised by long gestation periods in the infrastructure and core industries sector.
• Additionally, SEBI has recently relaxed norms on debt – equity conversion by banks in stressed listed entities. This could enable the banks to get a controlling equity stake in such companies so as to enforce a change in the management.

Right time to gear up for revival
In the last couple of years, as Indian economy witnessed downturn trends, the banks have been straddled with high levels of stressed loans. Macro-economic dynamics may be a major contributor, however, we also believe that inadequate credit assessments and monitoring during the upturn in the economy has also contributed to the same. All participants in the ecosystem viz the banks, regulators and borrowers need to take responsibility.

From the RBI’s perspective, the regulatory has been trying to do its best by introducing various measures time and again so as to bring in a more transparent system. However, it will take a while to achieve the objective of transferring risk off the banks’ books. The RBI definitely has a role to play, by clarifying provisions granting institutions the right to unilaterally enforce changes within defaulting companies, especially non-cooperative ones. Even in situations where the existing management is cooperative, quick and decisive actions are critical to enabling a revival. This will mean greater coordination among lenders, more information sharing and the willingness to accept cash flow structures that would attract distressed asset investors.

While we cannot undo the mistakes or errors that have been committed in terms of credit assessment and monitoring, effective steps needs to be taken and a holistic approach is the best way forward. Further regulations such as sector specific resolution of stressed assets, implementation of a strong bankruptcy code and institutionalising a formal mechanism to revive sick companies are needed to resolve stressed loans. Above all, a credible, timely and realistic mindset is required to ensure sustained recovery management.

The views expressed in this article are personal

- By Abizer Diwanji, Partner and National Leader- Financial Services, EY and Rahul Srivatsa, Director - Restructuring, EY contributed to the article

The thoughts and opinions shared here are of the author.