ICRA has assigned a rating of Provisional [ICRA]A1+(SO) [pronounced Provisional ICRA A one plus (Structured Obligation)] to the proposed Rs. 100.0 crore commercial paper (CP) programme of Centrum Financial Services Limited (‘CFSL/ Issuer’). The letters SO, in parenthesis, suffixed to the rating symbol stand for structured obligation. An SO rating is specific to the rated issue, its terms and structure. SO ratings do not represent ICRA’s opinion on the general credit quality of the issuers concerned. The provisional ratings are subject to the fulfillment of all conditions under the structure, review by ICRA of the documentation pertaining to the transaction, and Issuer furnishing a legal opinion and tax opinion on the transaction to ICRA. CFSL’s proposed CP programme shall be a covered instrument. Commenting on the development, Mr. Vibhor Mittal, Group Head – Structured Finance, ICRA Limited, said “The proposed CP Programme of Centrum Financial Services Limited shall be the second covered instrument issuance in the country after the Rs. 25.0 crore NCDs issued by Kogta Financial Services Limited (rated [ICRA]AA-(SO)) in January 2019. The CP investors shall have the benefit of dual recourse – recourse on the Issuer, and recourse on the bankruptcy remote Cover Pool assets (i.e. payments due from Larsen & Toubro Limited against invoices raised by its vendors) if the Issuer does not pay. This ensures that the instrument carries the highest credit rating on the short-term scale.”
Mrs. Bumble had broken some trinkets but it was her husband who was held guilty... “Indeed, You are the more guilty of the two, in the eye of the law; for the law supposes that your wife acts under your direction.”
“If the law supposes that," said Mr. Bumble, squeezing his hat emphatically in both hands, "the law is an ass — an idiot. If that's the eye of the law, the law is a bachelor; and the worst I wish the law is, that his eye may be opened by experience” — Charles Dickens in Oliver Twist
Two hundred years have passed. Laws have changed but the process of lawmaking and the end result seem much the same. When Parliament passed the Insolvency and Bankruptcy Code (IBC) in 2017, it was intended to herald a new era for banking. Assets — steel mills, power plants, telecom towers languishing in the never-never land of corporate debt restructuring would be auctioned and put back into use. Banks would take a hair cut but would emerge healthier. Or so it was thought.
The government, in its anxiety to help banks, passed a law which gives seniority to bondholders and lenders over suppliers of goods and services. The Indian constitution provides for equality under the law. This is a fundamental right and a basic feature of the constitution.
It cannot be legislated away. By taking the ground that the act can pay certain types of creditors ahead of others, the IBC opens up a basic question. Can a credit card company claim precedence over the Kirana Store in a bankruptcy?
A company could source equipment from two suppliers. One supplier insists on a Letter of credit from a bank. The other would provide it without a letter of credit. The buyer would have to pay that bank ahead of the supplier who did not ask for a letter of credit.
The mere involvement of a bank or financial institution would seem to be adequate for achieving this priority. Ericsson and L&T, to name but two, have taken recourse to the courts in their recoveries from RCom and Bhushan. Banks take over assets deemed to be charged under an umbrella “present and future assets” clause. When neither the company nor the banks have parted with cash for assets, why would the principles of natural justice allow banks to get the assets for free? Should not the supplier at least be deemed to be a secured creditor with a collateral of the goods supplied?
Even if the Act was just, would it apply to supplies made and debt incurred before the Act was passed? The Vodafone case brought the spotlight on the legality of retrospective taxation.
The law had to be amended to provide for the retrospective effect. The tax involved was a fraction of the amounts at stake in the resolution of the top 25 NPAs alone. The IBC is silent on its applicability in relation to debt incurred prior to its promulgation.
The one certainty is that this legal tangle will be many years into resolution. The RBI provides for a 50% provision for secured assets which are referred to NCLT.
Provisions rise to 100% if the company is insolvent or the asset is an NPA for three years. All other ways of resolutions have been dispensed with in RBI’s February circular. As time elapses, it looks like the IBC will result in a hit to the networth of the banks. May be this dawning realisation is why the RBI allowed banks to reduce provisions to 40% for NCLT cases in late March.
Conventional wisdom is that equity ranks last — below all financial debt, trade credits and even preference shares. In India, banks can use “strategic debt resolution” by which they convert part of their debt to equity.
The devolution of powers to the committee of creditors, which comprises only secured financial lenders, has resulted in strange antics where equity gets paid before debt.
Witness that so far many offers for assets are targeted solely at the interest of the secured financial lenders by giving a repayment of secured loans in cash as well as an offer to buy out outstanding equity.
The real problem stems from moral hazard. Legislators should have aimed for fairness to all creditors and equality under law not merely because they are high-sounding moral principles, but because people can accept a sacrifice if every one else sacrifices too.
Its difficult to avoid the impression that the IBC’s legal sleight of hand is an attempt to avoid a second recapitalisation bill.
NBFCs today hold about a fifth of the entire credit market in India growing at pace of 19% CAGR since 2008, 5% higher than banks. This growth has been aided by various factors like ability to reach under-served segments, receding PSU bank competition, ample liquidity ( albeit till recently) etc. This blitzkrieg in asset growth was primarily funded through market instruments and bank borrowing given NBFCs’ limitation to tap depositors directly. What is important though is the liability mix of the NBFCs viz long-term v/s short-term. As on FY18, NBFCs raised about 15% of their liabilities through Commercial Papers (CP) up from 7% in FY14. While this helped them in reducing Cost of Funds( CoF) but exposed them to liquidity shocks post “IL&FS crisis”. Coupled with the above, Banks pulled back lines and Mutual Funds stopped rolling-over NCDs/Bonds citing redemption pressure. Thus putting the entire NBFC sector in jeopardy. Situation as it stands today, many NBFCs are avoiding default by desperately trying to sell assets or raise long-term funding. Meanwhile, Government has taken few steps in the right direction by providing additional liquidity support ( read HFCs) and partial credit guarantee scheme for asset pool securitization.
So what can be done to alleviate the situation? Howsoever clichéd it might sound, the whole approach towards asset built-up as well as liability mix has to change. Firstly Assets; large balance sheet is desirable but might not be ideal. NBFCs have advantage of reach, flexibility (due to lesser restrictions) and faster TAT. Therefore, they can play a key role for banking sector (esp PSU Banks) in sales, marketing and recoveries. Concepts like Co-origination and Banking Correspondents is in the right direction. Recent announcement of India’s largest lender SBI to tie-up with 4-5 NBFCs is encouraging. This would diversify NBFCs’ revenue stream without stretching their balance sheets.
Second, Liability Management; It has to be approached both from product and investor segment perspective, though both are to some extent intertwined. From product point of view, not-so-new liability generation tools like Direct Assignment and Pool Securitization have to be given impetus. As mentioned above, government has taken some positive steps but Indian markets have lot of catching-up to do when compared to developed markets. However, these products have nuances like minimum holding period, minimum retention ratio, restrictions on credit enhancement etc. To overcome some of these nuances, our firm Artfine Advisory LLP has structured a covered bond for a supply-chain portfolio, a first in India. It has a dual advantage of double recourse and ability of NBFC for retaining the asset in its books, making it hugely popular in the developed markets. Similarly other structured products involving insurance, loss default guarantees can be explored for wider investor coverage. That brings us to the second piece of this conundrum, Investors. Traditionally all debt capital instruments issued by this sector have been placed with Mutual Funds, FIs or Banks thus leaving two large segments of potential investors viz Corporates and HNIs untouched. Many of the corporate treasuries have enough understanding of these complex instruments to take an informed call. Similarly, wealth management teams facilitate distribution in the HNI segment. Last but not the least, technology will play a very important part in bringing transparency and scalability to the above. Tech intervention is another enabler which need thorough discussion, may be in our next article..
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