Strategic debt restructuring an introduction

STRATEGIC DEBT RESTRUCTURING- AN INTRODUCTION
Sumat Singhal
(B.Com, CAIIB, DTIRM,ACA,ACS,CWA(F)
1. PREAMBLE: The concept of Strategic Debt Restructuring ("SDR") has been introduced by the
Reserve Bank of India (the "RBI") in the SDR Scheme (the "Scheme") to help banks recover their
loans by taking control of the distressed listed companies.The Scheme has been enacted with a
view to revive stressed companies and provide lending institutions with a way to initiate
change of management in companies which fail to achieve the milestones under Corporate Debt
Restructuring ("CDR").The Scheme is subsequent to CDR or any other restructuring exercise
undertaken by the companies.
2. STATUS OF CORPORATE DEBT RESTRUCTURING (CDR) AND NON PERFORMING
ASSETS (NPAS)
Worrying Signs* Estimated as on March 2015 Projected by March 2016
Gross NPAs Rs.3.1 lakh crore (4.4% of total
loans)
Rs.4.2-4.7 lakh crore (5.-5.9%
of total loans)
Standard Restructured
Advances
Rs.4.3 lakh crore (6.2% of total
loans)
-
Gross NPAs + Standard
Restructured Advances
Rs.7.4 lakh crore (10.6% of
total loans)
Rs.7.4-8 lakh crore (9.5-10.5%
of total loans
*ICRA estimate on banks’ gross NPAs and restructured advances (PSBs+ Private Banks)
3. ELIGIBILITY
 Conversion of outstanding debts can be done by a consortium of lending institutions.
Such a consortium is known as the Joint Lenders Forum ("JLF").
 The JLF may include banks and other financial institutions such as NBFCs.
 The Scheme will not be applicable to a single lender.
“It will be useful in cases where the borrower has been non-compliant and the bank is confident
that a new promoter or buyer can turn things around. In other cases, the existing managements
are better equipped to grapple with the situation” - Jaideep Iyer, Group President, Financial
Management, YES Bank
4. CONDITIONS
At the time of initial restructuring, the JLF must incorporate an option in the loan agreement to
convert the entire or part of the loan including the unpaid interest into equity shares if the
company fails to achieve the milestones and critical conditions stipulated in the restructuring
package.
a. This option must be corroborated with a special resolution since the debt-equity swap
will result in dilution of existing shareholders.

b. Such a mandate will result in the lenders acquiring a majority (51%) ownership.
c. "If the company fails to achieve the milestones stipulated in the restructuring package,
the decision of invoking the SDR must be taken by the JLF within thirty (30) days of the
review of the account during the restructuring.
d. The JLF must approve the debt to equity conversion under the Scheme within ninety
(90) days of deciding to invoke the SDR.
e. The JLF will get a further ninety (90) days to actually convert the loan into shares.
5. WHAT HAPPENS AFTER THE DEBT-EQUITY SWAP?
a. On completion of conversion of debt to equity as approved under the Scheme, the JLF
shall hold the existing asset status of the loan for another eighteen (18) months.
b. The JLF must divest their holdings in the equity of the Company. If the JLF decide to
divest their stake to another Promoter, the loan will be upgraded to 'Standard'. The 'new
promoter' should not be a person/entity from the existing promoter/promoter group.
“The measure is welcome in so far as it does create a sense of fear amongst borrowers, resulting
in better credit compliance and responsible behavior” - Diwakar Gupta, former MD andCFO of
the State Bank of India.
6. NEED FOR STRATEGIC DEBT RESTRUCTURING
•According to Fitch, stressed assets of Indian lenders set to rise 13% of total advances by March,
2016 from 10.73% as at December, 2014
•CRISIL ratings & S&P’ Indian arm estimates the total bad loans to reach Rs.5.3 trillion by
March, 2016
•Failure of Debt Restructuring package.
7. PROCESS OF SDR
8. VALUATION FOR CONVERSION OF DEBT INTO EQUITY
A decision has to be taken by the lenders within 30 days of the review of the account.
Consent of at least 75% of creditors by value and 60% of creditors by number.
Banks decide whether the entire loan or a part of it can be converted into equity
Joint lender’s forum meet to discuss recovery plans

The conversion price of the equity shall be determined as follows:
a. Conversion of outstanding debt into equity will be treated at a 'Fair Value' which will
not exceed the lowest of :
 Market value, average of the closing pricesduring the10 day average price in the market.
 Book value per share to be calculated from the company's latest audited balance sheet
without considering revaluation resources.
b. In any case, the price cannot be lower than the face value of the share.
9. OPEN OFFER? OR NOT?
a. The pricing formula stated above has been exempted from the Securities and Exchange
Board of India (SEBI) (Issue of Capital and Disclosure Requirements) Regulations, 2009.
b. Further, the acquiring lender on account of conversion of debt into equity will be
exempted from making an open offer under Regulation 3 and Regulation 4 of the
provisions of the Securities and Exchange Board of India (Substantial Acquisition of Shares
and Takeovers) Regulations, 2011.
10. DIFFERENCE BETWEEN CORPORATE DEBT RESTRUCTURING(CDR) AND
STRATEGIC DEBT RESTRUCTURING(SDR)
Sr No. Corporate Debt Restructuring (CDR) Strategic Debt Restructuring (SDR)
1 The reorganization of a company's
outstanding obligations by reducing the
burden of the debts on the company by
decreasing the rates paid and increasing the
time the company has to pay the obligation
back.
SDR scheme allows banks to convert
their outstanding loans into equity in a
company if even restructuring has not
helped.
2 The CDR system got evolved and detailed
guidelines were issued by RBI on August
23, 2001.
SDR was announced on 8th June, 2015
by the RBI
3 It has a three tier structure which includes
CDR Cell, Empowered Group and a
Standing Forum. The Standing Forum is the
top tier which decides on the restructuring.
A consortium of lending institutions
namely Joint Lender’s Forum is formed
which will decide on the conversion of
debt into equity
11. ADVANTAGES TO BANKS
Conversion of debt into equity in an enterprise by a bank may
result in the bank holding more than 20% of voting power,
which will normally result in an investorassociate relationship
under applicable accounting standards. However, as the lender
acquires such voting power in the borrower entity in
satisfaction of its advances under the SDR, and the rights
exercised by the lenders are more protective in nature and not
participative, such investment may not be treated as
investment in associate. On conversion of debt to equity as
“For such companies, the
ability of banks to find
buyers will be critical
because the regulation clearly
states that banks will take
control only to cede control
to another promoter” -
Diwakar Gupta, former MD
and CFO of the State Bank of

approved under SDR Scheme, the existing asset classification
of the account, as on the reference date will continue for a
period of 18 months from the reference date. Acquisition of
shares due to the execution of strategic debt restructuring
scheme will be exempted from regulatory ceilings or
restrictions on capital market exposures, investment in para-
banking activities and intra-group exposure.
India
2. Equity shares acquired and held by banks under the SDR scheme will be exempt from the
requirement of periodic mark-to-market. On divestment of holding of banks in favour of a new
promoter, the asset classification of the account may be upgraded to Standard. Further, at the
time of divestment of their holdings to a new promoter, banks may refinance the existing debt
of the company considering the changed risk profile of the company without treating the
exercise as restructuring subject to banks making provision for any diminution in fair value of
the existing debt on account of the refinance. Advantages for Bankers under the SDR Scheme.
Banks can bring in Foreign Promoters after taking over defaulting companies
3. Banks can convert shares at prices prevailing during time of restructuring,subject to floor of
face value.  New RBI guideline will help banks avoid a “Kingfisher type Situation” where
banks were compelled by the old SEBI pricing formula to convert loans at a 60% premium to
market value although the airline was on the verge of bankruptcy.  New Indian promoters
should hold at least 51%, foreigners can acquire control with 26% as long as they are largest
shareholders.
4.Banks need not mark to market converted shares, nor do they have to follow investor-
associate norms.
12. ISSUES RELATED TO STRATEGIC DEBT RESTRUCTURING SCHEME
Issuesrelatedto
Strategic Debt
Restructuring Scheme
Legal Issues
Since a majorportionof the
SDR scheme depends on the
discretionof the lenders, banks
maybe potentiallymaking
themselves vulnerable to
litigation. Various groups like
minorityshareholders,
promoters, rival companies etc
mayfile multiple cases against
the banks, whichwill be a major
concern for the lenders.
Multiple Claimants
In case there are more than
one potential newowners
with comparable track
records andcompetent
management teams, it will
be difficult for banks to
choose one over the other.
Further, as statedearlier, the
final selection willleave a lot
of room for aggrievedparties
to take the lenders to court.
Structural Issues
Manyaccounts runinto
problems not because of
inefficient managements but
due to structural problems like
weak demand, cheap imports,
overcapacityetc. Insuch
cases, effecting a
management change is not
likelyto substantiallyimprove
the troubledcompany's
performance

13. ANALYSIS
 RBI has recently proposed this concept in India. Although banks would get ownership and
control over these corporates, at this stage, the value of the underlying assets would have
deteriorated substantially. Banks are, in effect, left with a bagful of non-performing assets. It
will be challenging for the lenders to continue to run the business of these companies till the
time a suitable buyer is found and may have to deploy professional management to
efficiently run and manage these companies leading to "putting good (public) money behind
bad money". Until these corporates turn-around and become viable, finding a suitable buyer
for the lenders will be difficult and may take many years. SDR can be considered as a last
resort to revive such companies which have already undergone a long drawn financial
restructuring process.
 One of the critical problems of the Scheme could be the price at which the debt to equity
conversion must take place. The conversion price could be higher than the market price as
the market value of these scrips would have substantially reduced, whereas the lenders as
per the Scheme will be required to convert the debt into equity at a price which shall not
exceed the fair value (i.e. market value or break-up value, whichever is lower subject to the
floor of face value). This may result in further losses to the lenders.
January 2016
Sources: Various Readings from publicly available

Strategic debt restructuring an introduction

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