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Corporates taking undue advantage of corporate debt restructuring mechanism

Anand Adhikari     November 30, 2012
For the last two years, ferro alloys maker Balasore Alloys Ltd, an Ispat Group company, has been trying to get out of the corporate debt restructuring (CDR) package it agreed to in 2009. It maintains it has better financials now than were projected when the package was finalised, and says the terms of the package should be reconsidered. After a 14-year hiatus it even declared a dividend in 2010/11.

If only it could exit the bank-monitored CDR process , it claims, it could raise funds from private equity players and even the overseas market.

The CDR package of 2009 was the second that Balasore Alloys sought - there was an earlier one in 2006. So far the company's bankers - State Bank of India, State Bank of Hyderabad and Allahabad Bank - have resisted. The hitch is a sum of Rs 30 crore related to the first CDR exercise.

But the company's auditor, S.R. Batliboi and Co, has also pointed out that Balasore Alloys did not make any provisioning for its bank dues while calculating its 2011/12 profit. Had it done so, profits would have fallen from Rs 31.93, as shown in its books, to Rs 1.73 crore. Balasore Alloys refused to comment on the matter.


The Balasore Alloys case is a typical example of the problems that have dogged the CDR mechanism, ever since it was instituted in 2001 to help out ailing companies.

{blurb}Lately, hit either by the persisting economic downturn, the high interest rates or their own over-leveraging, a number of high-profile companies have sought to restructure their loans - from engineering major Hindustan Construction Co (HCC) to one-time wind energy poster boy Suzlon to leading hospitality chain Hotel Leelaventure Ltd. Many of them have been obliged.

Is it getting too much? While loans and advances of banks saw a 20 per cent compound annual growth rate (CAGR) between 2008/09 and 2011/12, restructured loans rose by 40 per cent in the same period.

Curiously, public sector banks have been far more amenable to loan restructuring than private ones. Chennai's Indian Overseas Bank has the highest percentage of restructured assets, 9.7 per cent, followed by Mumbai-based Central Bank of India, 8.39 per cent. In comparison, the restructured assets of ICICI Bank, HDFC Bank and Axis Bank, are all below two per cent.

"If the reason for the recent increase in restructured accounts is indeed the economic downturn, it should have been reflected across all bank groups and not just public sector banks," said K.C. Chakrabarty, Deputy Governor, Reserve Bank of India (RBI) at a seminar last August.


If a company is unable to meet the new demands it has agreed to under CDR, or wriggles out of them, the restructured assets turn into non-performing ones. This is precisely what is happening.

"The banks have put non-performing as sets (NPAs) worth Rs 15,000 crore up for sale," says Devendra Jain, founder of, a company that facilitates sale of NPAs. "What we are seeing today is not-so-credible-cases getting approved by the CDR cell of banks," says a company CEO on condition of anonymity. Banks are keen to approve CDR packages, because they know if they do not, the loans in question will promptly turn into NPAs.

But this may merely be postponing the inevitable.

"The cardinal principle while agreeing to a CDR should be preservation of economic value, which requires looking closely at the cash flows of the company concerned, since the primary source of repayment is always cash flows," says a private banker asking his name not be taken. "If this methodology is followed, restructuring will be successful. But often it is not."

The biggest anomaly in the CDR process relates to the promoters' contribution to the restructuring: they usually avoid personal guarantees. "There has to be more skin to the game if the existing promoters or existing management has to continue," says Rana Kapoor, CEO, YES Bank. At present, most companies see CDR as a means to get easy terms or undue concessions after they have messed up.

Earlier this year, a committee headed by B. Mahapatra, Executive Director, RBI, submitted a report which among other matters, reviewed the CDR mechanism. The report held that the current terms - by which a company's promoters agree to 'sacrifice' 15 per cent of what the bank does - allow them to get away too easily. It recommended that promoters sacrifice 15 per cent of the 'diminution in fair value' of the company, without linking it to what the bank sacrifices.

Another major questionable practice is the indiscriminate conversion of debt - or the funded interest component of the debt - into equity. Conversion of part of the debt into preference shares, which often have zero value or a very low coupon rate, gains the banks nothing.

Recently, for instance, banks okayed a CDR package for Bheema Cement, which included funding its loan interest from July 1, 2010 to December 31, 2011, and rescheduling its repayment of loans, in return for shares of the company and zero interest preference shares.

The banks are acquiring equity shares at a very high premium of Rs 70 per share against a market price of Rs 16. The Mahapatra committee has suggested that conversion of debt into preference shares should be only a last resort. It also wants a cap on preference shares at 10 per cent of the restructured debt.


Many small and mid-sized banks also complain that, when they are part of a group of banks deciding the CDR package for a company, they are hardly listened to. A CDR needs only the approval of three-fourths of the total number of banks which have lent the company money, the rest have to fall in line.

Early this year, for instance, a mid-sized bank from South India, which had given a shortterm loan, redeemable in 24 months, was approached by the concerned company seeking CDR. Other bigger banks which had also lent to the same company readily agreed to it - and the small bank's loan was clubbed with theirs.

The small bank "should have got repayment next year, but now the loan has been extended to 10 years," says a rating agency executive, asking he and his employer not be named.

What should banks do to arrest the trend?

"They should develop specialised risk architecture with such competencies. They should not be general physicians but specialist surgeons," says YES Bank's Kapoor. The message is clear: if banks want to have good money, they should learn to catch what is wrong early and prescribe the right cures.

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