Stressed project loans: Will banks have to take a haircut?

By Anjan Dasgupta and Malav K Virani, HSA Advocates

Disclosures by bankers in recent months have highlighted a huge divergence between the quantum of stressed project loans as assessed by the Reserve Bank of India (RBI) and by the banking sector. This divergence can be attributed to differences in interpretation of RBI regulations which for the first time prescribed such disclosures for banks.

Anjan DasguptaPartnerHSA Advocates
Anjan Dasgupta
HSA Advocates

Be that as it may, the problem of stressed loans in the Indian market has clearly reached the tipping point in terms of having an irrevocable effect on the country’s economy. To resolve the situation there is an urgent need to find buyers to fund stressed loan buyouts.

The good news is that an array of international and domestic distressed asset funds – with both buying interest and funding capability – are operating in the Indian market. They include the joint investment platform formed between Infrastructure Leasing & Financial Services and North American private equity fund house Lone Star; the tie-up between Piramal Enterprises and Bain Capital Credit India Investments; and the fund formed by Kotak Mahindra Bank and the Canada Pension Plan Investment Board.

However, the failure to agree on valuation is impeding buyouts of stressed loans. It is universally well understood that stressed assets which are fairly valued will attract buyers at a realistic price. Unfortunately, banks in India have traditionally resisted taking a haircut to settle a loan, as this has a direct impact on their profitability. Against this backdrop, the Insolvency and Bankruptcy Code, 2016 (IBC), brings a glimmer of hope as it is expected to ensure banks come to a realistic valuation of their stressed assets and settle the account in a time-bound manner.

Before the IBC was enacted there was no time-bound resolution mechanism, and hence banks held on to their stressed assets. The RBI came up with a number of schemes to assist in resolution of stressed assets but if these schemes did not succeed there was no clarity as to what would happen after they failed.

Malav K ViraniSenior associateHSA Advocates
Malav K Virani
Senior associate
HSA Advocates

Under the IBC structure, the first step is for the claim of the creditor to be admitted by the National Company Law Tribunal (NCLT) in order to initiate the insolvency proceedings. If the creditor’s application is admitted, a creditors’ committee is constituted and the resolution process, which is conducted by an insolvency resolution professional, commences. The creditors’ committee has to agree, by a 75% majority, to the resolution plan within a period of 180 days from the date of admission of the creditor’s application, extendable by an additional period of 90 days. If the creditors’ committee does not agree on a resolution plan, liquidation of the debtor company is the final step.

Now banks no longer have the leeway to hold on to their stressed assets. If the banks do not come to realistic valuations of their stressed assets, they run the risk of liquidation of the debtor company, in which case recovery of their loans becomes extremely difficult. Banks will have to take large haircuts, taking into account the underlying value of the asset, as buyers during the resolution process will only come at the enterprise value that makes sense to them.

Though the actual quantum of haircut to be taken by banks will depend on the particular case in hand, industry experts expect a significant portion of the loan liability to be extinguished as part of the resolution. The average haircut banks would have to take could be as high as 60% to 65% of the outstanding amounts. The NCLT passed an order in August approving the first resolution plan under the IBC, for Synergies-Dooray Automotive, an auto ancillary company. In this case the creditors will now get back only about ₹500 million (US$7.8 million) out of the total debt of ₹9.72 billion – a haircut of about 94%.

It is still early days for the IBC, which came into effect from December 2016. We do not know how many resolution plans will be agreed by the lenders which will result in turning around debt-ridden companies. Also, only time will tell if banks start to fundamentally take a relook at the quantum of haircut they are willing to take. However, one thing is for sure: there is already a battery of distressed asset funds looking to invest in stressed assets in India and there is a lot of regulatory pressure on the banks to clean up their balance sheets before it gets too late.

Anjan Dasgupta is a partner and Malav K Virani is a senior associate at HSA Advocates. HSA is a full-service firm with offices in New Delhi, Mumbai, Bengaluru and Kolkata.

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