Restructuring 2.0: Expert committee leaves little wiggle room for banks, poses challenges

Recognizing that the Covid-19 pandemic has affected the best of companies and that the impact has been pervasive across sectors, the expert committee constituted by the RBI to make recommendations on the resolution framework to deal with Covid-led stress, has set out five financial metrics, covering 26 sectors. Sectors such as Agri, IT, food processing, have been excluded from the list of sectors. But with 72 per cent of the banking sector debt (analysed by the committee)--about ₹37.7 lakh crore-- affected by the Covid pandemic, the list covers a comprehensive set of sectors.

While the committee’s recommendations ensure uniformity by putting forth specific thresholds for specific sectors, excessive standardization may prove counter-productive. After all, within each sector, companies operate in different sub-segments, across different markets and are vastly diverse in size and structure. Hence the one-size fits all approach may make it difficult to arrive at a resolution plan. Also, it could be a herculean task to project financial performance and cash flows to prepare the resolution plan, as laid down by the committee, in many cases.

Giving more freedom to banks to set out internal policies and parameters, while deciding on the resolution plan, would have been welcome.

Key recommendations

To ensure that the restructuring is made available particularly to those borrowers who have been hit by the pandemic (and not perennial stressed accounts), the RBI had mandated that only those borrowers that were ‘standard’, and not in default for more than 30 days with the bank as on March 1, 2020, will be eligible for restructuring.

The expert committee was to recommend a list of financial parameters which would need to be factored into the assumptions for each resolution plan, and sector specific benchmark ranges for such parameters.

The panel has selected five financial parameters--total outside liability / adjusted tangible net worth (TOL / ATNW, essentially debt to equity), total debt / EBIDTA, current ratio (current assets by current liabilities), debt service coverage ratio (for the relevant year) and average debt service coverage ratio (for period of the loan)---covering key aspects of leverage, liquidity and debt serviceability.

Given that the ideal levels of these ratios would vary across sectors, the committee has set different thresholds for each of the 26 sectors. For instance, while TOL/ATNW threshold for auto and auto components is fixed at <=4 and <=4.5 respectively, for aviation and real estate (commercial) which use more debt financing the limit has been set at a higher <=6 and <=10 respectively. For total debt/ EBIDTA the threshold ranges between <=4 to <=12.

Current ratio for all sectors has to be >=1, barring aviation (set at lower 0.4) because of its cash and carry model for revenue purpose.

Apparent hitches

While the committee has recognized sector-specific disparities, it has failed to take cognizance of distinctions within a sector across companies. This could pose challenges in arriving at resolution plans in many of the cases. For instance, within the auto components space, there are players that differ vastly in size, in the products they manufacture and the sub-segments (cars, CVs, or two-wheelers etc.) they cater to. It would be difficult to arrive at a resolution plan based on fixed parameters, in many cases.

To meet the set of five financial metrics itself may be difficult, as in certain cases, many of these metrics may not be relevant or difficult to assess. For instance in case of roads sector, the committee has itself stated that given that the financing is cash flow based and at SPV level, ratios like TOL / ATNW, Debt/EBITDA and current ratio may not be relevant at the time of restructuring. There could be other companies in other sectors which have a negative working capital cycle, which may not be able to meet the panel’s threshold limits on current ratio.

Projections difficult

The panel has stated that the sector specific parameters are to be considered as guidance for preparation of resolution plan for a borrower in the specified sector. The plan should be prepared based on the pre-Covid-19 performance of the borrower and impact of Covid-19 in the June and September quarter, to assess cash-flows for FY21 / FY22 and subsequent years. In these financial projections, the threshold set for TOL/Adjusted TNW and debt/ EBIDTA ratios should be met by FY23. The other three threshold ratios should be met for each year of the projections starting from FY22.

In many businesses, it may be difficult to arrive at cash flow projections. The pandemic led lockdowns and restrictions have only made the task more difficult. Taking a view on the long term operational and financial performance of companies, particularly cash flows would be no mean task, given the prolonged uncertainty.

Given that lenders have made the initial assessment while sanctioning loans, more leeway and flexibility should have been given to banks to arrive at parameters, while deciding the restructuring, but with reasonable caveats.