Has the strategic debt restructuring experiment run aground?

In the 14 months since SDR was introduced, banks have invoked it in at least 21 cases but closed out only two


While difficulties in finding buyers, disagreement over valuations and even the choice of merchant bankers used in the SDR process seem to be impeding closure, the central bank has moved on to other measures such as S4A (Scheme for Sustainable Structuring of Stressed Assets) for stressed asset resolution. Photo: Aniruddha Chowdhury/Mint
While difficulties in finding buyers, disagreement over valuations and even the choice of merchant bankers used in the SDR process seem to be impeding closure, the central bank has moved on to other measures such as S4A (Scheme for Sustainable Structuring of Stressed Assets) for stressed asset resolution. Photo: Aniruddha Chowdhury/Mint

Mumbai: It was billed as a powerful tool in the clean-up of bank balance sheets laden with bad loans, but has proved to be a bit of a dud.

The strategic debt restructuring (SDR) initiative, which allowed creditors to convert debt into equity and take over the management of defaulting companies, could well end up in failure judging by the experience so far, said officials at three large banks.

In the 14 months since it has been introduced, banks have invoked the provisions of SDR in at least 21 cases.

Of these, they have closed out only two.

Difficulties in finding buyers, disagreement over valuations and even the choice of merchant bankers used in the SDR process seem to be impeding closure. And the central bank has moved on to other measures such as S4A (Scheme for Sustainable Structuring of Stressed Assets) for stressed asset resolution.

In June, the Reserve Bank of India introduced S4A as another option for banks to tackle stressed assets. Under S4A, banks can convert up to 50% of a company’s loans into equity or equity-like instruments without the need to find buyers immediately.

“SDR looked quite exciting to begin with, but soon it was evident that there are no buyers in cases where it was being invoked. Even the buyers that actually turned up were demanding prices that were completely unacceptable,” said the first of the three people cited above, a senior official at a public sector bank, on condition of anonymity.

According to the banker quoted above, most lenders have already started looking at bad-loan resolution options outside the SDR initiative, as there is no clarity on whether changing management is realistically possible in these cases.

At the end of June, Indian banks were sitting on Rs.6.3 trillion of bad loans—the legacy of an economic downturn, coupled with regulatory delays and difficulties in completing land acquisition, that stranded many ambitious industrial projects and made it difficult for their promoters to repay debt.

SDR was meant to ease the clean-up of bad loans. But the lack of trust in the mechanism is evident from the fact that even though banks have invoked the SDR provisions in at least 21 cases, they have converted debt to equity in only four cases.

Under the SDR mechanism, banks can convert a part of the debt in a company to majority equity, taking over operational control.

Banks would have to find a buyer in 18 months, during which the underlying debt would not attract any negative asset classification and thus, additional provisions.

In the event that creditors fail to locate a buyer within 18 months, banks would have to classify the account as a non-performing asset (NPA) and set aside all pending provisions against the asset.

Announcing State Bank of India’s (SBI’s) June quarter results on 12 August, chairman Arundhati Bhattacharya said loans in the 21 cases where the lender has invoked SDR totalled Rs.18,000 crore. Of this, the bank has already classified Rs.10,000 crore of loans as NPAs.

“The banks wouldn’t like to hold these assets indefinitely and therefore just conversion (of debt to equity) doesn’t make sense. Unless and until you are very clear as to what is going to happen immediately thereafter so that you give over the ownership to whoever else comes in, it doesn’t make much sense to do the conversion,” she said.

While this strategy was part of the thought process before the actual invocation of SDR, some of the probable buyers that came on board eventually exited due to creditors’ concerns around their genuineness and source of funding, among others, added Bhattacharya.

So far, banks have converted debt in select borrowers such as Electrosteel Steels Ltd, Gammon India Ltd and IVRCL Ltd but they haven’t been successful in finding buyers.

Another issue was the lack of adequate support from investment bankers involved in the case, said bankers.

By virtue of SBI being the lead lender in a majority of SDR cases, its unit SBI Capital Markets Ltd became the default and sole investment banker appointed in these cases, said four bankers, including the three quoted earlier.

The investment banker’s role in this entire scheme was to locate financial and strategic investors locally and internationally so that deals could be struck.

While the investment banker conducted bidding for a number of cases including Monnet Ispat and Energy Ltd and Adhunik Power and Natural Resources Ltd, it has not been able to zero in on good deals yet.

“In most of these deals, the banks are required to take a serious haircut, which is something that they are not interested in. However, the slow pace of the overall process has also led to deals not going through. That is the responsibility of the investment banker involved,” said a second public sector bank official, the second of the three cited above, also speaking on condition of anonymity. A haircut is the discount that a creditor accepts in the sale of a sticky asset.

SBI Capital did not respond to queries sent on Thursday.

Experts say the main problem is still the valuation difference—something that cannot be glossed over.

“In the infrastructure companies where banks had invoked SDR, there has been a serious erosion of economic value over the last two-three years. This has negatively impacted the valuation of the entire company, which has directly led to a diversion in expectation between the buyers and the banks,” according to Dinkar V., partner (restructuring) at EY.

SDR was mainly invoked in the case of metal, power and infrastructure companies such as Electrosteel Steels, Ankit Metal and Power Ltd, Rohit Ferro-Tech Ltd, IVRCL, Gammon India, Monnet Ispat and Energy, VISA Steel Ltd, Lanco Teesta Hydro Power Pvt. Ltd, Lanco Infratech Ltd, Jyoti Structures Ltd and Alok Industries Ltd.

So far, lenders have been able to find takers only for the businesses of Lanco Infratech and Gammon India.

To be sure, the SDR mechanism can effect a turnaround in stressed cases if there is a strong economic recovery and revival in investment demand.

In the meantime, a quick resolution to these pending cases is necessary because bad loans continue to attract higher provisioning as they age on bank books.

Unless there is clarity of resolution in these cases, bank profits will continue to get hit in the quarters to come.

“The introduction of S4A was proof enough that the system believes that the SDR mechanism hasn’t really worked. While the intent behind SDR was to expedite the system, issues like restructuring routes available and the absence of senior members in the SDR forums have always come up. These problems are yet to be dealt with and continue to slow down the process,” said Saswata Guha, director (financial institutions) at Fitch Ratings.

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