One-Time Loan Restructuring Dilemma

24th September 2020

Author: Sarath Reddy, Principal - Customer Success

The Supreme court directions on NPA classification post moratorium is a new challenge before lenders, while we await the final hearing on this. How can lender decide, which borrower to extend the facility, the one’s in stress need most help, but for lender there is the highest risk – can lender make big leap of faith, rely on past performance of the borrower than the current aberrations. 

For the lenders, the loan recast will require immediate action of assessing the borrower’s current business health and beyond that they will need to start monitoring these borrower’s, this is not an easy path to traverse.

 

Scope and Assessment of Recast

The Supreme Court on September 3rd 2020 had directed that any account which was standard until March 31st 2020 shall not be declared NPA, till further orders in the hearing of the COVID-19 moratorium issue of interest being charged on instalments which were deferred.

While one can argue who they think is correct – the Apex Court or lenders – and how the outcome of the case will impact the lending ecosystem and borrower behaviour is a discussion for a later day – what is imminent is the restructuring of the loans in the system across lenders, public and private.

As per reports, banks are likely to restructure up to Rs 8.4 lakh crore of loans, or 7.7 per cent of the overall system's credit under the one-time loan restructuring program allowed by RBI recently. About Rs 2.1 lakh crore of the above is estimated to be non-corporate which includes loans to MSMEs, agriculture and retail segments.

The KV Kamath committee tasked with suggesting the recommendations on the parameters to be considered for restructuring had identified 26 sectors and also recommended categorizing the accounts into mild, moderate, and severe to ensure speedy action.

The five major ratios along with sector-specific thresholds recommended by the committee for recast include – 

1. Outside liability to Adjusted Tangible Net Worth

2. Debt to EBITDA

3. Current Ratio 

4. Debt Service Coverage Ratio

5. Average Debt Service Coverage Ratio

Banks have their task cut out in analyzing the accounts for this one-time exercise and this cannot be done entirely by traditional methods of crunching audited financials, stock statements and Bureau reports. More reliance should be on cashflow analysis which can be done through bank statement and GST filings data points like:-

• Cash flows in terms of Credits and Debits,

• Quality of Clients/Suppliers,

• Fixed expenses – Salaries paid and/or Utilities, 

• Limit Utilization Analysis, 

• Borrowings from informal channels,

• Arm’s length/related party transactions,

This data gives lenders a clear picture of what was happening with the accounts from Mar ‘20 onwards for which the lenders may not get audited/provisional financials, and gives them better insight to make restructuring decisions.

The lenders will have to incur a significant effort of managing and executing this restructuring.  Though the Loan restructuring is one-time exercise for the lenders, it is an long-term opportunity for the lenders to strengthen their relationship with the borrower(s) and helping them in their financial recovery.

 

Post Recast

With significant % of companies availing moratorium currently are sub-investment grade, for the lender it is important to periodically review these recast accounts to assess the recovery of the business. 

The lenders have a challenge in getting timely information/documentation once the loan is disbursed.

Every major crisis offers an opportunity to make things right and better.

While SMEs provide all the requisite documentation at the time of eligibility assessment, the same is not the case during the tenure of the loan. One can’t squarely blame small businesses either as documentation involves costs and time of running around putting the same together, making it a chore the SMEs don’t actively engage in.

Times have been tiring and everybody is taking a beating.

Lenders can use this one-time recast exercise to deepen their relationship with their customers as they can show what they are putting on the line and get the borrowers to share periodic information on the ongoing business – Bank statements, GST filings et al.

With the Account Aggregator ecosystem just round the corner, monitoring concern is going to be the norm in every product type. This may will be the preparation that lenders can start for the new times where everyone gets to benefit – No sudden surprises for the lenders on the quality of assets which ultimately reduces the costs and the benefits that could be passed to borrowers in terms of lower rates.

Finally, Is this an instance of statesmanship for the society at large? The lenders need to make the leap of the faith in current times and trust in borrower’s financial recovery, at the same time the borrower need to be alleviate the risk of the lender by openly sharing as much information as possible, so that there is true partnership established.

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