Monday, August 17, 2015

Prudential Guidelines on Restructuring of Advances

PART B


Background

The guidelines on restructuring of advances (other than restructuring due to natural calamities) are divided into the following four categories :

(i)           Restructuring of advances to industrial units.
(ii)         Restructuring of advances to industrial units under the CDR Mechanism
(iii)       Restructuring of advances extended to SME
(iv)       Restructuring of all other advances.

The details of the institutional / organizational framework for CDR Mechanism and SME Debt Restructuring Mechanism are given in Annex – 4. The CDR Mechanism (Annex - 4) will also be available to the corporates engaged in non-industrial activities.
( In order to understand it better, Annex-4 has been taken up as a separate chapter in the blog).

General Principles and Prudential Norms for Restructured Advances

The principles and norms are applicable to all advances including the borrowers.

Eligibility criteria for restructuring of advances

Banks may restructure accounts classified under 'standard', 'sub-standard' and 'doubtful' categories.

Banks cannot restructure accounts with retrospective effect. While a proposal is under consideration, the usual asset classification would apply. The status as on the date of approval would be relevant to decide the asset classification after restructuring.

Normally, restructuring cannot take place unless changes in the original loan agreement are made with the formal application of the debtor. However, restructuring can be initiated by the bank in deserving cases subject to consent of the customer.

No account will be taken up for restructuring unless the financial viability is established and there is a reasonable certainty of repayment or else it will be treated as an attempt at ever greening a weak credit facility.
The viability should be determined based on parameters such as Return on Capital Employed, Debt Service Coverage Ratio, Gap between the Internal Rate of Return and Cost of Funds and the amount of provision required in lieu of the diminution in the fair value of the restructured advance.  

Cases of frauds and malfeasance will be ineligible for restructuring. The restructuring of willful Defaulter cases may be done with Board's approval. The restructuring under the CDR Mechanism may be carried out with the approval of the Core Group only.

BIFR cases are not eligible for restructuring without their approval. The CDR Core Group in case of CDR, the lead bank in the case of SME Debt Restructuring and the individual banks in other cases, may consider the proposals for restructuring.

Asset classification norms

Restructuring could take place in the following stages:

(a)                   before commencement of commercial production / operation;
(b)                   after commencement but before the asset becomes 'sub-standard';
(c)                   after commencement and the asset has been classified as 'sub-standard' or 'doubtful'.

The accounts classified as 'standard assets' should be re-classified as 'sub-standard assets' upon restructuring.

The NPAs would continue to follow the normal asset classification norms with reference to the pre-restructuring repayment schedule.

NPA accounts post restructure, should be upgraded only when all the facilities in the account perform satisfactorily during the ‘specified period’ (One year from the commencement of the first repayment, on the credit facility with longest period of moratorium).

Any additional finance may be treated as 'standard asset' during the specified period. However, in pre-restructuring 'sub-standard' and 'doubtful' accounts, interest on the additional finance should be recognised only on cash basis. At the end of the specified period, if the asset does not qualify for upgradation, it shall be placed in the same category as the restructured debt.


Income recognition norms
Interest in respect of restructured 'standard’ assets will be recognized on accrual basis and that in case of 'NPAs', it will be recognized on cash basis.

Provisioning norms

Provision on restructured advances

(i)   Banks will hold provision against restructured advances as per provisioning norms.

(ii)    Restructured ‘standard’ accounts will attract a higher provision in the first two years from the date of restructuring. Where moratorium is allowed, the provisioning will be for the period of moratorium and two years thereafter.

(iii)  Restructured NPAs, when upgraded will attract a higher provision in the first year from the date of upgradation.

(iv)    The higher provision on restructured standard advances:

·      3.50 %- with effect from March 31, 2014 (spread over the four quarters of 2013-14)
·      4.25 %- with effect from March 31, 2015 (spread over the four quarters of 2014-15)
·      5.00 %- - with effect from March 31, 2016 (spread over the four quarters of 2015-16)

Provision for diminution in the fair value of restructured advances

(i) Banks should measure diminution in fair value on account of restructuring and make special provisions in addition to existing norms of provisioning, and in an account distinct from that of normal provisions.

ii) It was observed that, there were divergences in the calculation of diminution of fair value of accounts by banks. Banks are advised that they should correctly capture the diminution in fair value as it will have a bearing not only on the provisioning but also on the amount of sacrifice required from the promoters.

(iii) In the case of working capital facilities, the diminution in the fair value of the CC / OD component may be computed, considering the higher of the balance outstanding or sanctioned limit as the principal amount and taking the tenor as one year. The term premium in the discount factor would be as applicable for one year. The fair value of the term loan components would be computed as per actual cash flows and taking the term premium in the discount factor as applicable for the maturity of the respective term loan components.

(iv) Where security is taken in lieu of the diminution in the fair value, it should be valued at Re.1/- till maturity of the security..

(v)      The diminution in the fair value may be re-computed on each balance sheet date till full repayment, so as to capture the changes on account of changes in BPLR or base rate, term premium and the credit category of the borrower. Consequently, banks may provide for the shortfall in provision or reverse the amount of excess provision held in the distinct account.

(vi)  If a bank finds it difficult to ensure computation of diminution in the fair value, it will have the option of notionally computing the amount and providing therefor, at 5% of the total exposure, in respect of all restructured accounts of less than Rupees one crore.

The total provisions required against an account are capped at 100% of the outstanding debt amount.


Risk-Weights

a.   Restructured housing loans should be risk weighted with an additional risk weight of 25% age points.

b.   The unrated standard dues of corporates should be assigned a higher risk weight of 125% until satisfactory performance under the revised terms has been established in the specific period.


Prudential Norms for Conversion of Principal into Debt / Equity

Asset classification norms
A part of the principal amount can be converted into debt or equity instruments as part of restructuring.  These instruments  will  be classified in the same category as that of the restructured asset.

Income recognition norms
Standard Accounts
In the case of restructured accounts classified as 'standard', the income generated by these instruments may be recognised on accrual basis.

Non- Performing Accounts
In the case of restructured accounts classified as NPAs, the income, generated by these instruments may be recognised only on cash basis.

Valuation and provisioning norms
These instruments should be held under AFS and valued as per usual valuation norms. Equity classified as standard asset should be valued either at market value where quoted or at break-up value, based on the company's latest balance sheet. In case the latest balance sheet is not available, the shares are to be valued at Re. 1. Equity instrument classified as NPA should be valued at market value, if quoted, otherwise it should be valued at Re. 1. Depreciation on these instruments should not be offset against the appreciation in any other securities held under the AFS category.


Prudential Norms for Conversion of Unpaid Interest into 'Funded Interest Term Loan' (FITL), Debt or Equity Instruments

Asset classification norms
The FITL, debt or equity instrument created by conversion of unpaid interest will be classified in the same category as that of the restructured advance.


Income recognition norms
The income generated by instruments classified as standard may be recognised on accrual basis, and on cash basis in case of instruments classified as NPA.

The unrealised income represented by such instruments should have a corresponding credit in an account styled as "Sundry Liabilities Account (Interest Capitalization)".

In the case of conversion of unrealised interest into quoted equities, interest income can be recognised after the account is upgraded to standard category at market value of equity, as on the date of upgradation, not exceeding the amount of interest converted into equity.

Upon realization of these instruments, the amount received will be recognized in the P&L Account, while simultaneously reducing the balance in the "Sundry Liabilities Account (Interest Capitalisation)".

Valuation & Provisioning norms
The depreciation, if any, on valuation may be charged to the Sundry Liabilities (Interest Capitalisation) Account.


With effect from April 1, 2015, a standard account on restructuring (for reasons other than change in DCCO) would be immediately classified as sub-standard. NPAs, upon restructuring, would continue to have the same asset classification as prior to restructuring and slip into lower categories as per the asset classification norms with reference to the pre-restructuring repayment schedule.

Miscellaneous

The banks should decide on the issue regarding convertibility (into equity) option as a part of restructuring exercise keeping in view the statutory requirement under Section 19 of the Banking Regulation Act, 1949, and relevant SEBI regulations.

Conversion of debt into preference shares should be done only as a last resort and should be restricted to a cap. Any conversion to equity should be done only in the case of listed companies.

Acquisition of equity shares / convertible bonds / convertible debentures by way of conversion of debt can be done without seeking prior approval from RBI, even if by such acquisition the prudential capital market exposure limit is breached. However, this will be subject to reporting to RBI every month along with the regular DSB Return on Asset Quality. Nonetheless, banks will have to comply with the provisions of Section 19(2) of the Banking Regulation Act, 1949.

Acquisition of non-SLR securities by way of conversion of debt is exempted from the mandatory rating requirement and the prudential limit on investment in unlisted non-SLR securities, subject to periodical reporting to the RBI in the aforesaid DSB return.

Banks may consider incorporating creditor’s rights to accelerate repayment and the borrower’s right to pre pay, in the package. Further, all restructuring packages must incorporate ‘Right to recompense’ clause and it should be based on certain performance criteria of the borrower. In any case, minimum 75% of the recompense amount should be recovered by the lenders and in cases where some facility under restructuring has been extended below base rate, 100% of the recompense amount should be recovered.

Promoters’ personal guarantee should be obtained in all cases of restructuring and corporate guarantee cannot be accepted as a substitute for personal guarantee. However, corporate guarantee can be accepted in those cases where the promoters of a company are not individuals but other corporate bodies or where the individual promoters cannot be clearly identified.

Disclosures

With effect from 2012-13, banks should disclose information relating to number and amount of advances restructured, and the amount of diminution in the fair value of the restructured advances under CDR Mechanism, SME Debt Restructuring Mechanism and other categories separately. Even if only one of the facilities has been restructured, the bank should disclose the entire outstanding amount pertaining to all the facilities of that particular borrower. The disclosure format includes the following:

i.    details of accounts restructured on a cumulative basis excluding the standard restructured accounts which cease to attract higher provision and risk weight;
ii.  provisions made on restructured accounts under various categories; and
iii.  details of movement of restructured accounts.

The disclosure is no longer required, once the higher provisions and risk weights on restructured advances revert to the normal level. However, the provision for diminution in the fair value should continue to be maintained.

It has been reiterated that the basic objective of restructuring is to preserve economic value of units, not ever-greening of problem accounts. This can be achieved by banks and the borrowers only by careful assessment of the viability, quick detection of weaknesses in accounts and a time-bound implementation of restructuring packages.



Appendix


Broad benchmarks for the viability parameters

i.            Return on capital employed should be at least equivalent to 5 year Government security yield plus 2 per cent.

ii.           The debt service coverage ratio should be greater than 1.25 within the 5 years period in which the unit should become viable and on year to year basis the ratio should be above 1. The normal debt service coverage ratio for 10 years repayment period should be around 1.33.

iii.           The benchmark gap between internal rate of return and cost of capital should be at least 1 per cent.

iv.           Operating and cash break even points should be worked out and they should be comparable with the industry norms.

v.            Trends of the company based on historical data and future projections should be comparable with the industry. Thus behaviour of past and future EBIDTA should be studied and compared with industry average.

vi.           Loan life ratio (LLR), as defined below should be 1.4, which would give a cushion of 40% to the amount of loan to be serviced.


Present value of total available cash flow (ACF) during the loan life period
(including interest and principal)
LLR= ----------------------------------------------------------------------------------------------
Maximum amount of loan


Based on the Master Circular of 1/7/15.
Please visit www.rbi.org.in  for any further clarification if required…………….. Poppy