Friday, October 2, 2015
Guidelines on Partial Credit Enhancement to corporate bonds by banks
The objective is to enhance the credit rating of the bonds issued so as to enable corporates to access the funds from the bond market on better terms.
Banks can provide PCE to a project as a non-funded subordinated facility in the form of an irrevocable contingent line of credit which will be drawn in case of shortfall in cash flows for servicing the bonds and thereby improve the credit rating of the bond issue.
Salient features of the PCE facility
The aggregate PCE provided by all banks for a given bond issue shall be limited to 20 per cent of the bond issue size.
The PCE facility shall be provided at the time of the bond issue and will be irrevocable.
Banks may offer PCE only in respect of bonds whose pre-enhanced rating is BBB minus or better.
Banks cannot provide PCE by way of guarantee.
Banks providing PCE to bonds will not be eligible to invest in those bonds. They can, however, provide other need based credit facilities.
So long as the exposure of a bank to a project loan is classified as standard, providing a commercially priced PCE to enhance the rating of a bond issue, whose proceeds replace the bank's project loan, would not amount to restructuring.
Banks should have a Board approved policy on PCE.
The documentation for the facility must clearly define the circumstances under which the facility would be drawn upon.
The contingent PCE will be available only for servicing the bond, irrespective of the seniority of claims of other creditors in relation to the bond holders. A clear agreement will be signed between the bond issuer, the bank and all other lenders to the project. The operational details are to be decided by the banks.
The unpaid accrued interest on a partly drawn PCE will be excluded from the remaining amount available for drawing.
The contingent facility may be made available as a revolving facility.
In the event of the project failure, the PCE must rank below the claims of the enhanced bond holders.
Balance sheet treatment, capital requirements, exposure and asset classification norms for exposures arising on account of providing PCE
PCE facilities should be treated as an advance in the balance sheet. Undrawn facilities would be reported under ‘Contingent Liability – Others’.
The capital to be maintained by the banks will be computed, as if the entire bond issue was held by banks, as the difference between (a) the capital required on the entire bond amount, corresponding to its pre-credit enhanced rating and (b) the capital required on the bond amount corresponding to its post-credit enhanced rating, as per Basel III.
Where the PCE is provided by more than one bank, each bank will maintain capital as illustrated above in proportion to the quantum of PCE provided by it.
The rating of the bond must be monitored regularly and capital requirement adjusted in the following manner:
(a) The capital calculation must take into account, the difference in rating notches between the pre-enhanced and enhanced rating as arrived at the time of bond issue.
(b) As long as the bond outstanding exceeds the aggregate PCE, the capital held should not be less than the amount required to be held at the time of issuance of the PCE enhanced bond. However, once the bond outstanding has amortised below the aggregate PCE amount, the capital can be computed taking into account the outstanding bond amount.
(c) In situations where the notional pre-enhanced rating of the bond, slips below investment grade (BBB minus), capital must be maintained as per risk weight of 1250% on the amount of PCE provided.
In all circumstances, the capital computed for PCE and required to be maintained by the PCE provider, will be capped by the total amount of credit enhancement provided.
When Credit Enhancement (CE) gets drawn it indicates towards financial distress of the project. Therefore, a drawn tranche of the PCE will be required to be repaid within 30 days from the date of its drawal (due date). The facility will be treated as NPA if it remains outstanding for 90 days or more from the due date and provided for as per the usual asset classification and provisioning norms. In that event, the bank’s other facilities to the borrower will also be classified as NPA.
The PCE providing bank will observe the following exposure limits:
(a) PCE exposure to a single counterparty or group shall not exceed 5% of the bank’s Single / Group limit to the counterparty to whom the PCE is provided,
(b) The aggregate PCE exposure of a bank shall not exceed 20% of its Tier 1 capital.
The effect of the PCE on the bond rating must be disclosed in the bond offer document.
There would be no prohibition in providing the PCE facility even if the issuer is not the regular constituent of the bank.
Banks should ensure that the assets created out of the bond issue, and the cash flows from the project are ring fenced through an escrow account mechanism administered under a bond trustee arrangement. The manner in which security interest would be shared by the lenders, bond holders and banks and the manner in which the project cash flows would be shared for servicing loans and the bonds and PCE, should be decided and agreed upon before the issue of bonds and should be properly documented.
While providing PCE, banks should exercise necessary due diligence and risk appraisal, including making their own internal credit analysis/rating. Banks should strengthen their internal rating systems which should also include building up of a system of regular tracking of the financial position of the issuer.
Banks must honour the full PCE commitment made ab-initio in respect of a bond issue irrespective of the asset classification of the concerned borrower’s credit facilities.
All extant regulatory prescriptions for credit and investment exposures by banks, unless specified otherwise in this circular, will continue to apply.
Based on RBI Circular dt 24/9/15. Please visit www.rbi.org.in for any further clarification if required….. Poppy