India Inc's maha kumbh

It was the perfect rags to riches story for Jaishree Yadav, who started off as a cart loader in Bombay in the 1970s and over the years moved up the curve to become a wooden drum supplier for Cable Corporation of India. In 2000, he scaled up the business by setting up a service centre for Tata Motors with his son Pravin. Everything was going well for the father-son duo: from a single workshop they went on to build their second 31,000 sq ft workshop, when the patriarch was diagnosed with terminal-stage cancer in late 2006. The death of his father in 2008 left Pravin shattered. Faced with the daunting task of running the business on his own, he informed the local branch manager of State Bank of India (SBI), the family’s long-standing banker, about his bereavement. But words of solace from the manager did not last for long.

Within a few days the bank slapped a notice seeking immediate settlement of ₹26 lakh cash credit outstanding, since the original proprietor was no more. “I had sufficient blank cheques signed by my father that I could have used to run the business. But knowing it was illegal, I chose to inform the bank, only to find the tables turned on me,” says 38-year-old Pravin. Despite having mortgaged the plot on which the workshop stood and deposits enough to make up for the loan, the notices kept coming. “I explained to the officer [from the bank’s SME credit centre] that I would be able to settle the dues only after the Mumbai High Court clears the family’s probate petition [the legal process for executing a will]. I even suggested freezing our deposits lying with the bank till the order came through, but they said they had to play it by the rules.” Thankfully, before things turned ugly, the HC order came through. Though Pravin has since settled the loan, the bank’s approach has left him bitter.

Pravin’s case is an all-too familiar one for small borrowers. Remember the saying: “If you owe the bank $100, that’s your problem. If you owe the bank $100 million, that’s the bank’s problem.” Think Kingfisher Airlines and you know how apt the quote is. Unlike a small borrower who won’t be given a second chance, the King of Good Times has been given an exceptionally long rope to run a business that’s apparently “too big to fail”. Never mind that the lenders’ generosity has cost them a hit in their books even as Vijay Mallya is yet to show any credible signs of paying up his dues or reviving the airline. More on that later, but what is scarier is that the problem is turning chronic. More and more banks, especially state-owned, are opting for corporate debt restructuring (CDR) — the art of altering debt terms to suit a borrower that also allows banks to keep their books squeaky clean. 

The birth of CDR

The 19th floor of the IDBI Bank Tower at Cuffe Parade is host to a forum of bankers called the Corporate Debt Restructuring Cell, which was set up in 2001 to counter the fallout of an economic slowdown. The idea of CDR was to create a common ground where multiple lenders could come together to help a distressed corporate borrower with over ₹10 crore exposure. 

The three-tiered, 54-member group includes a standing forum, empowered group and the CDR cell. While the standing forum lays the broad policies and guidelines, the cell, comprising employees on deputation from member-banks, does the initial scrutiny of proposals and makes a detailed restructuring plan in conjunction with the lenders. Then, the empowered group, comprising EDs of banks, deliberates and approves the restructuring proposals. A loan is eligible for CDR provided it has the support of 75% of the creditors by value, and 60% by number. Originally intended to cover sub-standard debts, CDR’s ambit was widened in 2003 to include doubtful, BIFR cases and standard loan assets, barring wilful defaulters.

The outstanding obligations are usually restructured in one or more ways: Increasing the tenure of loan, reducing the rate of interest, one-time settlement, conversion of debt into equity and converting the unserviced portion of interest into a term loan. The repayment period, including the moratorium, doesn’t exceed 15 years in the case of infrastructure loans and 10 years for other advances. The promoter has to shell out a minimum of 25% of the banks’ sacrifice, offer a personal guarantee and pledge his holdings. Sacrifice, also known as recompense, is primarily the difference between the original rate of interest and the lower rate offered under CDR. Earlier, banks could offer rates as low as 5-7% but now cannot lend below the base rate of 10-10.5%. The borrower exits from the mechanism either voluntarily or on completion of the restructuring period after paying a recompense amount. 

What brings bankers to the forum is that the mechanism has worked versus conventional ways of addressing distressed loans, points out B Ravindranath, executive director of IDBI Bank and chairman of the CDR cell. “What banks can recover out of cash flows is much more than what they would make by selling off an asset. That’s why CDR is critical both for banks and corporates.” However, with the economy on a roll, there was nothing left for the cell to do and there was talk of the forum being wound up when the 2008 crisis happened. The Reserve Bank of India’s (RBI) generosity in allowing banks to restructure standard loans under CDR and retain them as a standard asset, if the process is completed within 120 days from the date of approval, too played a key role. 

Not surprisingly, CDR is now proving to be the holy grail of Indian banks, something that’s got the regulator’s goat. KC Chakrabarty, deputy RBI governor, remarked recently: “It appears that the provisions of the mechanism have not been used very ethically and judiciously, giving rise to the unprecedented increase in cases under CDR.” Though the RBI now wants to do away with the asset classification sop, it is constrained by the current macro problems.

On their part, bankers argue that the slowdown and too-rigid regulations are to blame for the rise in CDR cases. Sitting in his plush office at SBI’s corporate centre in Mumbai, Pratip Chaudhuri, the 58-year-old chairman, is vocal about his concerns. “Driven by the good times in the past and robust operating margins, corporates committed themselves to unbridled expansion and shorter repayment terms. Now their assets are ready but they are unable to repay their loans. Also, it’s unrealistic to expect infra projects to return debt in 8-10 years, given that the useful life of an infra asset can outlive an entire generation,” he says. Also, the rule that if a project misses its commissioning date would be considered as non-performing, even if it has been servicing the debt, is riling bankers. Says Chaudhuri, “It’s a bit of an overkill and is not done anywhere else.” 

Drawing global comparisons, the SBI chief points out that when Dubai World extended its loan repayment tenure from six to nine years and Jaguar Land Rover swapped its five-year loan in the UK with a nine-year bond, their respective banks and regulators did not treat them as NPA or restructured loan. As of September 2012, SBI is straddling a restructured book of ₹40,000 crore, of which a large part is accounted by the mid-corporate group. 

Chaudhuri says, “There is no point destroying assets [by going for recovery] — you end up destroying jobs. It’s time to be more understanding. If there is reasonable long-term viability, go for it, though viability is a subjective matter.” And that’s where the catch lies, or rather begins.

Truth is there to seek

In FY11, 87 cases worth ₹67,889 crore were referred to the cell, followed by 98 cases totalling ₹59,088 crore in the nine months to December of FY13. The number of referrals and the pace at which they are being approved is worrying, raising questions over their viability (See: Rush Hour).This brings to the fore the critical role of techno economic viability (TEV) study, not just for evaluating CDR proposals but also in case of fresh loans. 

Rush Hour

Referrals made to the CDR cell have been much higher than seen in the previous downcycle

Unlike auditors, TEV consultants operate in a largely unorganised environment with no industry body to regulate their functioning. There are over 1,000 consultants operating in the country, and some work simultaneously with several banks. Sayantan Consultants, for instance, is empanelled with SBI, Indian Overseas Bank, Uco Bank and Bank of India. Says Dilip Dutta, director and CEO, “We charge fees from ₹50,000 to ₹3.5 lakh depending on the project size and the time required to assess the TEV of a project. We normally take 21 to 30 days to make a report, including the time required for factory/site visits and discussions with representatives of clients/banks.”

Paying too little could impact the quality of analysis and that’s a huge risk, given the size of loans riding on such projects. Chaudhuri, however, dismisses such concerns. “All our consultants are seasoned industry professionals, including former directors of big PSUs,” he says confidently. While some consultants suggest linking the fee to the project size or 1% of the project value to ensure more credibility, not all think it’s gospel. Indeed, HDFC Bank has institutionalised that attitude and it is reflected in the quality of its books. Says Kaizad Bharucha, country head, credit and market risk, HDFC Bank, “TEV studies can run into 400 pages and, honestly, you cannot read through the entire report. But you need to know what is of relevance [in the TEV report] and what is not.” 

In other words, bankers have to sweat it out themselves before sanctioning a loan: ask the right questions to the right people, make personal visits and challenge assumptions. “There is also no point doing a sensitivity analysis on an Excel sheet sent by a company CFO and adding some assumptions of your own and then basing your funding decision on a base case scenario. Sometimes, it just goes down to basics — seeing whether the land for a project has indeed been acquired and there are no issues with farmers. In a nutshell, ask, seek and check,” sums up Bharucha.

Under CDR, the viability study has to be much more rigorous, considering the stakes are much higher — a freshly sanctioned loan to stem the rot could go down the drain. The RBI, too, has pointed out the pitfall of Type I and Type II errors of statistics creeping in viability studies under CDR, resulting in an unscrupulous borrower with an unviable account availing the benefit of restructuring, while a genuine borrower with a viable account may be denied the opportunity.  

Big is not beautiful

The big accounts that have been restructured of late under CDR include those of wind turbine manufacturer Suzlon, Bharati Shipyard, Hindustan Construction and Jindal Stainless (See: For all the talk...). Other prominent names are of Varun Industries, Hotel Leela, Kamat Hotel and KS Oils. But to believe that all borrowers are victims of an economic slowdown and, hence, need a helping hand is preposterous. It also stretches credibility to think that lenders have seen viability in each and every case. But Mr Banker is far from wary. Shyamal Acharya, deputy managing director (mid-corporate) at SBI, has this to say: “Time is of essence in restructuring. If you wait for a detailed study akin to a Nobel research, the operation may be successful but the patient will be dead. You need to have some gut feeling as well. The problem with bankers is that we did too little, too late. So, one of the reasons we are seeing an increase in the numbers [in CDR] is because banks are becoming more proactive than reactive.”

For all the talk of having promoter’s skin in the game, lenders still bear the maximum risk

That being the case, take a look at Suzlon, which has managed to restructure its loan of ₹9,500 crore. The TEV study in this case was done by Lahmeyer International (India), which did not to respond to queries on the viability study. The promoters have been asked to bring in their share of the sacrifice upfront, which works out to around ₹250 crore, and also raise ₹6,000 crore by March 2016. To begin with, the company is looking to raise money by selling its non-core assets: wind farms in India, and Suzlon Energy (Tianjin) for $36 million, but the very acquisition that landed Suzlon in trouble — REPower — has been kept out of the sale, barring the pledge created on Suzlon’s holding. Though Suzlon owns 95% of REPower, it cannot dig into its coffers since German banks have ring-fenced the same. The other option would be to raise fresh capital, which seems unlikely given the headwind Suzlon faces. The promoters have already pledged 91% of their holding with lenders, leaving little room to offload their stake.

Though it has an order book of ₹37,000 crore, half of that (57%) is accounted for by REPower, which faces growth challenges in the key American and European markets. The Indian business accounts for 27% of the order book, but simultaneous withdrawal of two incentives — the generation-based incentive and accelerated depreciation — has taken the wind out of domestic market sails. As for future visibility, the management has stopped giving guidance. 

“We are working on various levers to address our capital structure. These include securing receivables from sticky debtors, divesting non-critical assets, balancing debt across our subsidiaries, releasing cash by reducing our working capital intensity and raising funds via appropriate instruments. But the key here is that the CDR gives us adequate time to balance our capital structure and focus on stabilising the business,” says Kirti Vagadia, group CFO, Suzlon Energy. The comments have to be seen in light of the fact that the lenders are committing themselves to over ₹5,000 crore under the package. For now, it’s not the promoter but the lenders who have skin in the game.

Similarly, in the case of Bharati Shipyard, which has been weighed down by the Great Offshore buyout, the TEV study was carried out by I-Maritime Consultancy and the financial feasibility by PricewaterhouseCoopers (remember Satyam?), based on which the lenders’ exposure over the 10-year package has increased by a little over ₹3,000 crore.

Coming to construction major Hindustan Construction (HCC), which faced environmental issues with its Lavasa township, the lenders have agreed to a 10-year package where their exposure has increased by ₹2,067 crore. Revenue and profitability declined at HCC owing to slow order inflows in the last few quarters, execution bottlenecks, rising interest cost and payment delays by clients. In FY12, the company incurred a loss of ₹222 crore on revenues of around ₹4,000 crore. According to reports, HCC expects sales to remain flat in FY13 as well. The management refused to participate in the story. With the RBI not granting infra status to Lavasa, the debt recast of ₹850 crore too has proved to be a challenge.

Given that the equity market outlook for infra and real estate projects is bleak, the prospects of reviving the Lavasa IPO, too, appear dim. Incidentally, the lenders have not sought divestment of assets in HCC’s case, considering that it has a 26% stake in an IT park in Mumbai, land parcels in Thane, Nashik and Pune, and owns Steiner AG, a Swiss construction firm acquired in 2010, and six road projects.  

Small is ugly

While visibility (viability) of big accounts is in question, it’s surprising to see borrowers such as Varun Industries and KS Oils, too, finding favour with lenders. In the case of KS Oils, either lenders did not hear the buzz of the promoter punting heavily in mustard futures by pledging his holdings or they chose to ignore it. While the markets have given up on the stock, which is now quoting at ₹3, lenders have reposed their faith in the management. They have been issued 1% cumulative redeemable preference shares worth ₹298 crore to be redeemed after seven years at a premium of 64%. In FY12, KS Oils’ losses more than doubled to ₹744 crore against ₹354 crore in FY11. 

What beats them all is Varun Industries. The little-known kitchenware maker, on the back of strong PR machinery, hogged the market’s attention over claims of finding rare earth ore in Madagascar and entering an agreement to sell its entire 500,000 tonne production to a PSU. Not just that, the company claimed to have discovered 10 heavy mineral sand mining blocks and gas blocks measuring 13,200 sq km. There’s more: it claimed wind farms, carbon credits and even the discovery of large reserves of gold in Madagascar, where it planned to extract around 200 kg of gold.

Perhaps so much good news was too much to handle for the directors in the company: four of them resigned in early 2012. And so did the stock, from its peak of ₹290 in February 2012 to its current levels of  ₹16.50. Attempts to get through to chairman Kiran Kumar Mehta proved futile. Eleven banks, including Indian Bank, United Bank of India, Central Bank of India and Bank of Baroda, collectively have an exposure of over ₹1,600 crore to the company. In FY12, the company incurred a loss of ₹158 crore on sales of ₹3,177 crore.

In both cases, the promoters don’t seem to be victims of an economic slowdown. So that begs the question: why are lenders throwing good money after bad?

On the way out

As on date, around 221 cases cumulatively worth ₹1.4 lakh crore are operational under the CDR package and since 2001, while 62 companies, involving advances worth ₹49,000 crore, have exited. 

Among the notable exits are Wockhardt and Essar Oil. Wockhardt, which had restructured its ₹1,300-crore debt in 2009, had to resort to asset sales under pressure from bondholders and the High Court breathing down its neck. It sold its nutrition business for ₹1,576 crore to Danone in 2011, largely paving the way for its exit. The management of Wockhardt refused to participate in the story. 

The notable exception is Essar Oil, which is in the last leg of negotiations for exiting the CDR, since its entry back in 2004. “Had it not been for the collective wisdom of lenders, we wouldn’t have achieved what we have today,” admits Lalit Kumar Gupta, MD and CEO. The refinery, which commenced commercial production in May 2008 initially with a 10.5 million metric tonnes per year, was upgraded to a capacity of 20 mmtpa with an increased complexity to process various grade of crude.

Suresh Jain, chief financial officer, credits the bankers for their foresight. “Refineries had to scale up their operations to meet the new environmental standards and just processing light crude wouldn’t have ensured long-term viability of a refinery. The lenders invested an additional ₹4,600 crore in tranches during the course of the restructuring and that ensured long-term viability in the project,” he points out. 

The company is now looking to replace its rupee borrowings, currently over ₹16,000 crore, with cheaper dollar loans. “Since we are largely a dollarised business, given that our products are sold on import parity prices, it’s necessary to derisk the balance sheet of rupee borrowings,” explains Gupta. The company, which has got both the Reserve Bank of India and shareholders’ approval to raise $2.27 billion in foreign currency borrowings, is negotiating with bankers over the recompense payable on exit. While the management chose to remain tight-lipped on the details, recompense could be a ruse for companies not wanting to exit a CDR. Interestingly, while the recompense clause always existed it was never impressed upon by bankers. Prior to Wockhardt’s ₹210 crore, the maximum recompense under CDR had never exceeded ₹20 crore — which means either that the bankers were more than eager to see the borrower’s back or big exits had yet to happen. 

Exit blues

Under CDR, the company has to pay the entire recompense amount before it can exit but people in the know of the process hint at a possible collusion between bankers and borrowers. “If the borrower is genuine and wants to expand his business and has other avenues to raise money, he will pay the amount in full and exit. But companies that are happy with the debt choose to hang around and the banker, too, doesn’t complain as long as the borrower is servicing the debt,” says a person familiar with the working of the forum. After all, under CDR, you get concessional rates, and unless you want to expand or raise additional capital, it works fine for the borrower.

But to ensure a smoother exit, the RBI has suggested that the forum settle for 75% of the recompense amount if all the lenders agree. “In case of bilateral restructuring, banks don’t force borrowers to sign in blood that they have to pay 100% recompense amount; there they choose to be flexible. But under CDR, they are inflexible,” says the person mentioned earlier. 

The SBI chairman, however, reasons, “If we don’t seek recompense, people will say we are playing ball with the promoter. Also, tomorrow a normal borrower will say that under CDR not only does a borrower gets cheap interest rates but can also exit without paying up the dues in full.”

It will be interesting to see what kind of settlement Essar Oil works out with its 22 lenders, led by SBI, IDBI Bank and ICICI Bank, given that the quantum of loan has been the biggest — ₹9,400 crore.

Coming to exits, around 76 companies (advances involving ₹11,000 crore) have moved out of the forum but after proving to be duds — Alps Industries (₹946 crore), Mysore Cement (₹330 crore), Vidarbha Power (₹275 crore) and Remi Metals (₹422 crore), to name but a few. Attempts to get in touch with the Alps management proved futile. It is now a BIFR case as its net worth has been wiped out; as for the lenders, they have been saddled with 128,487,790 optionally convertible cumulative preference shares to be converted into equity shares at ₹10.82 a share on or before February 18, 2013. It is clear the bankers have to take a hit on conversion as the stock is quoting at ₹1.74.

Interestingly, while CDR data shows 62 successful exits, the figure is over-stated to the extent that, of these, 20 are one-time settlement (OTS) cases (See: Devil in the detail). In other words, they too were failures. OTS is another avenue under which companies can exit the CDR and this scheme, also prevalent under bilateral restructuring, has come in for flak from none other than the Supreme Court (SC). Raising the issue through public interest litigation (PIL) is Shoaib Richie Sequeira from Mumbai. “In the absence of regulations there is rampant misuse of the provision by banks as it is left entirely to the discretion of boards,” says the 51-year-old rights activist.

Devil in the detail

Of the 62 exits, 20 were one-time-settlements. In other words, were failures

In response to the PIL, the RBI had stated that it was not practically feasible to micro-manage and scrutinise every settlement of loans and, thus, ‘specific guidelines’ were framed to regulate the process. Surprisingly, no monetary penalty was ever imposed on any bank for non-compliance as the central bank felt the “violations or irregularities were neither serious nor material in the overall context”. Against such a backdrop, the fact that write-offs and compromises amounted to over ₹87,339 crore between FY07 and FY11, as per the finance ministry’s counter affidavit filed in response to the PIL, raises a red flag.

Incidentally, lawyer Prashant Bhushan, who is fighting the case on behalf of Sequeira in the SC, had also filed a PIL over the menace of rising NPAs. But after fighting the case for 10 long years, the SC had ruled that the subject, being technical in nature, was best left for the government to address. 

However, in this case, the SC has asked the central bank to provide details of bank loans written off or one-time-settlements exceeding ₹10 crore. “I believe, in the first place, the RBI guidelines themselves are inadequate. Besides, the regulator should ensure that not just the concerned company but also other group companies should not be lent funds in the event of a wilful default,” says Bhushan. 

The last resort

While OTS is one route for unsuccessful borrowers to exit, the last resort for a bank is to push for an asset sale. Here again, the picture is far from encouraging. In 2008, banks were able to recover 61% of the ₹7,300 crore under the Sarfesi Act, but the recovery rate dropped sharply to 28% of ₹35,300 crore in 2012. It is here that the Kingfisher case gets interesting. 

Kingfisher, which owes over ₹7,000 crore to PSU lenders, has been a non-performing asset since end-2011, including for SBI, which has the maximum exposure of ₹1,500 crore and has since fully provided for the exposure. Yet, the bankers, 17 in all, are shy of forcing a recovery and are sympathetic in their view. Says Chaudhuri, “Mallya was a successful businessman who ran the spirits business, a successful airline in Kingfisher and had also bought Air Deccan. There was a time people quit their jobs to join the airline. Did they do that knowing it would fold up? It’s only in hindsight that we are talking about the woes of the airline. He [Mallya] has gone through enough ridicule and media trial. However, we are not lending him anymore funds.”

While the last line may sound prudent what bankers are not mentioning is the quality of collateral available in the case of Kingfisher. A chunk of the exposure is tied down to an intangible asset: the brand value of Kingfisher. Though they have shares of United Spirits and Kingfisher Airlines, physical assets such as Kingfisher House and a villa in Goa, besides Mallya’s personal guarantee and corporate guarantee given by United Spirits won’t be enough to make up for Kingfisher’s debt as well as accumulated losses. 

Bankers believe Mallya needs to bring around ₹2,000 crore to revive the airline and are hoping that it will happen sooner than later. MV Tanksale, chairman of Central Bank of India, which has an exposure of over ₹350 crore to the airline and has the second-largest restructured book after SBI, says, “The government has done its part by allowing FDI in domestic airlines….we expect some strategic partner to come in.” 

But what if Mallya is unsuccessful in getting a strategic investor? “He can’t go far defaulting. If he is declared a defaulter he won’t be even eligible for a ₹30,000 credit card… it’s not that he is getting away scot free,” quips Chaudhuri. 

Whose money is it, anyway?

Even as banks are hoping against hope that their loans don’t go down under, they are happy playing the ‘best man’ to the hilt: that is, escorting borrowers down the CDR aisle. At last count (as on January 28), an additional eight cases worth ₹3,339 crore were lined up for restructuring. 

Their generosity doesn’t end there. Hemendra Hazari of Nirmal Bang Institutional Equities points out that Indian banks, through their overseas branches, have funded stressed domestic corporate accounts by replacing rupee loans with loans from their foreign branches (See: The foreign hand). The borrowers, on their part, use their foreign subsidiaries to transfer assets to the bank to receive the required funding. “Such practice allows banks’ stressed corporate asset exposure to be shown as ‘standard’ without any disclosure as a restructured standard asset,” states Hazari in his report. The other route to help out corporates is by financing their overseas acquisitions. “Indian companies inflated the cost of acquisition of foreign entities and the banks financed these inflated acquisitions without any vigorous scrutiny,” points out Hazari. 

The foreign hand

Indian banks have used their overseas branches as a

conduit to fund stressed Indian corporate borrowers

Back home too, the credit growth numbers seem suspect. At a time when cumulative IIP growth for the fiscal stood at a paltry 1%, credit growth stood at 15% and for some banks at over 20%. It can’t be just vehicle and home loans. In fact, loans worth ₹65,000 crore were disbursed in the last fortnight of December alone.

So why are PSU banks playing ball with borrowers? Is it to show robust quarter-on-quarter growth? Are they working towards the larger cause of creating ‘feel-good factor’ in the run-up to the general elections? Or is there something more than meets the eye? In the current year a number of PSU bank chairmen are stepping down and it’s quite possible that the outgoing incumbent wants to exit on a clean slate (See: Passing the parcel). In other words, leave the clean-up job for the successor. That being the case, pardon the cliché, the worst is not yet over.

Passing the parcel

Looks like most incumbent bank chairmen want to step down on a ‘clean’ note

Meanwhile, last heard, Mallya has made a spirited offering of 3 kg gold bricks at the Tirupati shrine of Lord Venkateswara to gild the doors of the sanctum sanctorum. As for Pravin, he is busy winding down his business to pursue opportunities outside of Indian shores. So much so for the spirit of a bank which claims to “being a banker to every Indian.”