Corporates beware ! SDR comes knocking, courtesy RBI

The conventional thinking in corporate lending went that the power of the bank over the borrower was inversely proportional to the size of the loan. Hobbled by laws that made loan recovery a chore, a promoter lobby determined to protect their interests and political masters who prioritized the next election to prudential norms, PSU banks seemed resigned to loan waivers and NPAs. While the 5/25 plan appeared to give banks some leverage, too often the general public has seen the banks fight shy of targeting large corporates (and their nabob promoters).

The current mood in the RBI seems determined to consign this behaviour into the dustbin. First, a tough-talking governor has finally stood up and castigated the “sweep-under-the-carpet” mentality on several occasions. This has been supplemented by a far-sighted government that has been taking bold economic decisions to ease the bureaucratic gridlock and resource constraints, coal and gas being good examples. Equally important, unlike previous administrations the government has largely refrained from second-guessing the RBI’s policy stance. This has helped restore investor confidence and manage the eventual capital flows when the US Fed raises interest rates.

But the significant (and yet largely under-reported) change has been in the RBI’s policy framework for managing bad loans. Through the establishment of the Joint Lender Forum (JLF) and the recent policy directive on Strategic Debt Restructuring (SDR), the RBI has delivered some sophisticated artillery capabilities to banks. The SDR allows lenders with the capability to convert their debt into equity and acquire management control over the firm by wiping out the promoter’s stake. Supported by generous (interim) dispensations on prudential norms and SEBI takeover codes, the SDR mechanism allows lenders to form a united front to force recalcitrant lenders into taking the tough economic decisions necessary for the firm’s survival. This is a massive change as much in the psychology of corporate lending as it is about actual policy. The RBI deserves to be richly commended for taking up such innovative approaches to structural issues, which is fast emerging as a hallmark of Dr. Rajan’s tenure, such as with payment and small finance banks.

It appears that banks are taking tentative steps along this path. On 27^th July, the first SDR “workout” was undertaken on ElectroSteel Steels’s loan of INR 9600 crores. This was followed, on August 10^th, by an INR 500 crores SDR on Lanco Infratech’s project. On 20^th August, the JLF of Jyoti Structures decided to implement the SDR to convert an INR 2,178 crore debt into equity, wiping out the promoter’s stake. So far, the market seems to be pessimistic of the economic prospects for these companies that are trading down 17%, 12%, and 11% from the time of their respective SDR announcement (all data as of 23^rd Aug, 2015).

Exiting the Chakravyuh

Anyone acquainted with Hindu mythology is aware that it was the prospect of exiting the maelstrom that made the hearts of the stoutest warriors tremble. While the SDR exhorts the JLF to keep out the past promoter and work quickly to undertake a sale of the company it is sketchy on the actual details of managing the company in the interim period. This silence extends to communicating the plan and its progress with wider stakeholders. As a consequence, the market has been largely in the dark regarding the improvement in operational parameters.

Corporate Affairs recommends the following tactical inclusions to navigate a smoother exit from the SDR –

a.     

•         Establish a stakeholder engagement plan

A financial restructuring plan spells uncertainty for employees, customers and the authorities such as the sales tax and excise departments of individual states. Often companies also have litigations that are pending at various levels of the judiciary that requires a pro-active outreach.  Employees and customers are in the dark as to the motives of the JLF, which need to be clearly conveyed and fit into the strategic initiatives of the firm. Assuming a “BAU” approach is clearly a recipe for low all-round morale, negatively impacting share prices and negotiating power for the JLF.

•  Strengthen and co-opt the executive management

It seems a naïve to expect that the removal of the promoter could somehow enthuse the firm’s prospects and the contributions of the executive management. Often where the sector itself is in the doldrums, the promoter’s actions might have precipitated the eventual collapse. Several economic sectors continue to remain in oligopolistic cliques, the resolution of which is an element of policy detail. In such a case, the management might require re-skilling and familiarization in the usage of cost management tools to improve [productivity. Management reporting, which might have been given a go-by in the previous dispensation will need to be rigorously implemented to instill operational discipline. This could assist in cost simplification and raising morale as the effect of the “quick-wins” kicks in. 

•       Involve specialist support

It is understandable to see nervousness amongst JLF constituents for incremental funding of their NPAs in SDR. However, there could be strategic investments that might be justified through improvements in capital structure, process, technological and sales effectiveness that could enhance the attractiveness of the account for a potential bidder. Specialist shops, both merchant banking and consulting arms exist within PSU banks themselves. In addition, there are a plethora of outfits that could provide turnkey support to the company which should look to outsource non-core activities. It is not clear whether these are being actively planned for the SDR accounts, but these should be considered too. The incremental expenditure might well be worth it in the asking price and the management time that it saves of the JLF team.

The path less travelled

At the risk of spouting clichés, it is very clear that banks are in uncharted territory with the use of SDR as a tool for tackling NPAs. Notwithstanding the solid support (read ear-wringing) of the RBI, it is up to the banks to embrace bold, innovative solutions. This should also serve as a recurring reminder to the other silent stakeholders – domestic financial institutions and the retail investor community.

The hubris of the promoters is as much a cause of NPAs as is the meekness of their shareholders. Participants need to take a more active interest in the functioning of the companies that they own. Selling out of companies that they don’t like is understandable, but the hero worship of the companies that they like is unpardonable. Investors should understand that today’s heroes could easily turn in to tomorrow’s zeroes. 

Much ado about nothing - Mr. Sathe's appointment to SEBI

The recent appointment of noted jurist Mr. Arun Sathe as a part-time member of SEBI should raise eyebrows, but only due to the partisan reporting that has surrounded its notification.  This episode is yet another indication that in an era of non-stop reportage and TRP pressures the notions of reasoned debate and a respect for process are being given short shrift. The charge against Mr. Sathe is essentially that as a “political man” (whatever this means) of a right-wing persuasion, he is somehow ineligible to hold any responsible office, including the role of a part-time member of SEBI. This kind of assertion is astounding in modern India that aspires to be a superpower in a culture of meritocracy and equality.

Are Mr. Sathe’s critics confident that every official in high office who is in the executive branch of government is completely apolitical? Is it correct to expect that people in public life will not hold an ideological preference in their personal lives? Should the focus not instead be on the individual’s actions prior to an appointment or even after he/she assumes the post under question?

The sad consequence of the brouhaha in this episode is that the facts are being conveniently buried. First, Mr. Sathe is a noted jurist in tax matters. The constitution of the current SEBI board (see here) is without any legal representation and hence it can be argued that he is suited to making valid contributions to SEBI’s board, especially in an era of increasing global regulation of the financial sector. Second, he has been transparent in stating his personal involvement with the RSS and the BJP, neither of which are organizations whose members are debarred from public office.  Third, the government is well within its rights to nominate part-time members to the board. In fact, this prerogative extends even in the appointment of the Chairman of the Board. Fourth, the code of conduct of the SEBI board has explicit provisions that require members to declare conflict of interest. Further, the Board also entertains unsolicited submissions from the public on conflict of interest matters, provided they are backed by material facts. If indeed Mr. Sathe is not “fit and proper” to be on SEBI’s Board, pray where is the smoking gun?

Such protest from within certain quarters is in stark contrast to the situation in countries like the USA. Here, people in high office are often noted members of the industry that is being regulated by the entity. Instances like that of Mr. Robert Rubin (Treasury Secretary and co-head of Goldman Sachs), Mr. Hank Paulson (same as Mr. Rubin), Mr. Robert Khuzami (General Counsel, Deutsche Bank and SEC) are but a few instances of a well-established system. This allows the regulator to implement policy decisions that incorporate the market realities. Closer home, the appointment of Dr. Raghuram Rajan as RBI governor helped to assure global markets and also steer the Indian economy adroitly. This government’s continuing support has helped the RBI to proceed on the path of financial inclusion with confidence.

This government has refrained from over-commenting on this case, beyond stating that due consideration has been exercised in proposing Mr. Sathe to the Board. This is in stark contrast to the unsavoury situation that SEBI found itself a few years back when Mr. C B Bhave, former Chairman and Mr. K M Abraham were “honoured” with a preliminary enquiry (PE) from the CBI for their role in providing a license to MCX-SX. Mr. Abraham had even alleged that there was undue pressure on SEBI from the Finance Ministry (headed then by Mr. Pranab Mukherjee) on this and other cases. In the face of a public backlash, and importantly with no evidence of any wrong-doing, CBI had closed the PE.