Empowering Bankers To Bridle Elusive Promoters

<p><em>RBI’s new scheme to reign in errant promoters is solid on paper, but it may not work in the real world in its current avatar<br><strong>By Raghu Mohan</strong></em><br><br>A few in India Inc., have long lived by the unique worldview: it’s against my principle to pay interest on the loan I took, and against my interest to repay the principal. It has worked really well as a way of life, but Mint Road decided to play the party-pooper; it took away the punch bowl on 8 June. Banks can now go in for Strategic Debt Restructuring (SDR). Simply put, if push comes to shove, they can band together, convert a funny firm’s loans to equity and kick the promoter out.<br><br>The idea’s a cracker — after all, what hurts more than a bad hangover is that you have to foot the bill for the party as well.<br><br>Banks’ gross bad-loan mountain is about $100 billion. While you can pin a large part of the blame for the mess on policy paralysis and wobbly business cycles, just about every other senior banker in town will tell you (off the record) that some borrowers do play truant. And will readily agree with the 16th century French writer Francois Rabelais’s pithy observation that “debts and lies are generally mixed together”.<br><br><img alt="" src="http://bw-image.s3.amazonaws.com/from-bad-to-wrose-chart-mdm.jpg" style="width: 300px; height: 501px; float: right; margin: 4px;">Rabelais was truly ahead of his times; is SDR ‘alive’ to ours? Says Muzammil Patel, senior director at Deloitte (India), “The proposition could work where there is a genuine interest from both the borrower and lender to regularise cash flows from the underlying asset. It’s a positive step for lenders as it allows them to potentially have a say in the working of the business and control over its associated cash flows”.&nbsp; When Patel refers to the “potential”, it only tells you that a lot many lenders had little say in such matters; and that they have now got a vuvuzela.<br><br>The buzz over SDR is, therefore, understandable. It neatly ties in the business-link between non-performing assets (NPA), asset reconstruction companies (ARC), the aggressive posture adopted by Mint Road and North Block on errant corporate managements, a comprehensive Bankruptcy Act (on the anvil), and centralised pricing guidelines on foreign investments. Since 2007, deals worth nearly $62 billion — all above $300 million (see Cleaning Up The Act) — have taken place as a result of companies seeking to improve their balance sheets. So, common sense has it that SDR will only make this pile grow bigger.<br><br>Siby Antony, managing director and CEO at Edelweiss ARC, feels that the new power to convert part of a loan into equity is another way for lenders to resolve the case in the event of a failed restructuring. “It can definitely open up M&amp;A opportunities with the possibility of transfer of controlling interest to a potential acquirer,” he says. Ananth Venkat, regional head, Corporate &amp; Institutional Clients for south-Asia, Standard Chartered Bank, feels: “It has the potential to add to M&amp;As; at least 20 per cent of the $100 billion (gross non-performing assets) we have.”<br><br><strong>Can You Find Money In The Dustbin?</strong><br>Just 48 hours after Mint Road’s viagra for banks hit the shelves, a pink daily reported that IDFC had removed KVK Energy as promoter from SV Power; that it had roped in Aryan Coal Beneficiation India (ACB). Did IDFC really do what other lenders can only dream about — overturning a promoter? BW|Businessworld reached out to IDFC which explained it as follows.<br><br>SV Power (SVPL), a special purpose vehicle of the KVK Group, had set up a 63 megawatt coal-washery reject-based thermal power-plant and a 2.5-MTPA (metric tonne per annum) captive-coal washery in the Korba district of Chhattisgarh (back then Madhya Pradesh). The plant was commissioned in June 2011, but operated at a very low capacity. This was due to numerous adverse conditions such as high cost of rejects, logistical challenges, non-availability of coal linkage and evacuation line, and low-merchant-tariff realisation.<br><br><img alt="" src="http://bw-image.s3.amazonaws.com/Ananth-venkat-mdm.jpg" style="width: 300px; height: 513px; float: left; margin: 4px;">“IDFC had engaged with the KVK Group and after detailed discussions, it was jointly agreed that sale of SVPL to a strategic buyer would be the best course of action so as to ensure that the project is recapitalised and continues to be viable. KVK Group, thereafter, voluntarily mandated IDFC Capital for sale of SVPL to a strategic buyer,” said IDFC.<br><br>ACB was identified as a suitable buyer, considering the fact that it has substantial experience in operating coal-beneficiation and reject-based power plants in Korba. The transaction concluded in March 2015, pursuant to which ACB took over the management control of the company. And here is the best line from IDFC: “The transaction was executed with full cooperation provided by the KVK Group and lenders, and at no point of time was the asset seized and security invoked by the lenders.”<br><br>What it tells you is that no Mint Road pill or mantra — as on date — can help a lender to “force” an Indian promoter to cede control of a firm; its pure fantasy to think so. But at a time when the political narrative is about a white-knight on a horse, any fairy tale is par for the (race) course!<br><br>Venkat at StanChart concedes, “Very few loans have a clause that provides for the conversion of debt into equity as was the case during the time of developmental financial institutions.” BW has learnt that the banking fraternity is now in a huddle as to how to incorporate such a clause at the corporate debt restructuring (CDR) level. Patel from Deloitte says, “It would be fair to expect that lenders would want to incorporate a clause for debt conversion to equity at the point of restructuring. One would also expect that new loan contracts will start incorporating this clause.”<br><br>Even if bankers can fit in this part of the jigsaw puzzle into the CDR, their brows will still be furrowed. Says Munish Dayal, partner, Barings Private Equity (India): “These covenants were anyway put in as a deterrent. So that promoters behaved. It’s an altogether different situation when it is given effect to.”<br><br>What’s unsaid here is that a promoter (even if bankers or the world thinks otherwise) can haul lenders to the courts for existing dud-loans ahead of CDR talks. In which case, it can only mean a further fall or an outright erosion in the value of the business; or it turns into junk. It may still attract buyers who may see junk as “strategic”, but that’s not what SDR is about in the first place.<br><br><img alt="" src="http://bw-image.s3.amazonaws.com/Siby-Antony-mdm.jpg" style="width: 300px; height: 566px; margin: 4px; float: right;">While Patel looks at the brighter side — “Certain stressed assets have already seen consolidation even before these guidelines. These guidelines provide a more considered approach to consolidation after constructive engagement with lenders” — Antony is sceptical: “I have doubts about the workability of the scheme.”<br><br>He cites three reasons: whether management change is practical in the Indian context; accessibility of data for due diligence by a potential acquirer (without which no new management will come forward to takeover); and, how much by way of sacrifice will lenders take to hand over control to a new management. “One other dimension is that lenders will be foregoing their charge on assets in the process of conversion into equity. So in the event of enforcement of assets as a last resort, secured loan would have been reduced to the extent of conversion,” explains Antony.<br><br><strong>Bankers Are Just That: Bankers….</strong><br>The entire SDR is premised on the fact that banks can convert debt into equity; overturn a promoter; get in a new one; unlock value and laugh all the way to the bank. What’s missed in the SDR debate is that “vast tracts” of business work on a perverse logic.<br><br>State-run banks continue to dish out loans to state electricity boards (SEBs) despite their poor financials as they know they will get paid somehow. This even as they charge SEBs higher interest rates which makes them an even bigger “basket case”. Is it any wonder that the Reserve Bank of India’s Financial Stability Report (FSR-June 2015) says that state-run banks will have to provide Rs 53,000 crore to a slippage in the quality of loans to the power sector? And how is SDR going to work in such cases? There is no empirical evidence that errant behaviour is restricted to the private sector!<br><br>The trouble does not end here. “It’s one thing to get to financially restructure the balance-sheet of a company. It’s not the same as running a business. It will be sometime before you get in a new promoter after having taken control of a company. Are bankers going to run it during that period?” asks Dayal at Barings.<br>&nbsp;</p><table style="width: 600px;" align="center" border="4" cellpadding="1" cellspacing="1"><tbody><tr><td style="text-align: center;"><span style="color:#ff8c00;"><strong>DEBT TO EQUITY: THE CONVERSION PRICE</strong></span></td></tr><tr><td><strong>Market value (for listed companies):<span style="color:#696969;"> Average of closing prices during the ten trading days preceding the ‘reference date’. Reference date is Joint Lenders Forum’s decision to undertake SDR</span><br><br>Break-up value: <span style="color:#696969;">Book value per share (without considering ‘revaluation reserves’, if any) adjusted for cash flows and financials after the earlier restructuring. The balance sheet should not be more than a year old in which case the break value shall be Rs 1</span></strong></td></tr></tbody></table><p><br>What’s being said here is that a new set of players will have to walk in. As Raja Lahiri, partner, Grant Thornton (India), explains: “Restructuring and turn-around experts would potentially be required to assist bankers (commercial) here to achieve financial turnaround of the company and also facilitate M&amp;As.&nbsp; Globally, banks along with private equity funds have led several successful turnaround situations and Indian banks can surely adopt some of the global best practices (of course, keeping Indian conditions in mind) to achieve maximum success in these restructuring situations.”<br><br>For now, Rabelais still rules! &nbsp;<br>&nbsp;</p><table align="center" height="212" border="3" cellpadding="1" cellspacing="1" width="572"><tbody><tr><td><a href="http://bw-image.s3.amazonaws.com/Table-popup.jpg" target="_blank"><img alt="" src="http://bw-image.s3.amazonaws.com/Table-thumbnail-mdm.jpg" height="200" width="566"></a></td></tr></tbody></table><p><br>raghu@businessworld.in<br>@tabonyou<br><br>(This story was published in BW | Businessworld Issue Dated 24-08-2015)</p>