Guaranteed Emergency Line of Credit: Understanding and FAQs

-Financial Services Division (finserv@vinodkothari.com)

The Finance Minister has, in the month of May, 2020, announced a slew of measures as a part of the economic stimulus package for self-reliant India. Among various schemes introduced in the package, one was the Emergency Credit Line Guarantee Scheme (ECLGS, ‘Scheme’), which intends to enable the flow of funds to MSMEs. This is the so-called Rs 300000 crore scheme.

Under this Scheme the GoI, through a trust, will guarantee loans provided by banks and Financial Institutions (FIs) to MSMEs and MUDRA borrowers. The Scheme aims to extend additional funding of Rs. 3 lakh crores to eligible borrowers in order to help them through the liquidity crunch faced by them due to the crisis.

Based on the information provided by the Finance Minister about this Scheme, the press release issued in this regard and the scheme documents issued subsequently, we have prepared the below set of FAQs. There is also a set of FAQs prepared by NCGTC – we have relied upon these as well.

In brief, the Guaranteed Emergency Line of Credit [GECL] is a scheme whereby a lender [referred to as Member Lending Institution or MLI in the Scheme] gives a top-up loan of 20% of the outstanding facility as on 29th February, 2020. This top up facility is entirely guaranteed by NCGTC. NCGTC is a special purpose vehicle formed in 2014 for the purpose of acting as a common trustee company to manage and operate various credit guarantee trust funds.

[Vinod Kothari had earlier recommended a “wrap loan” for restarting economic activity – http://vinodkothari.com/2020/04/loan-products-for-tough-times/. The GECL is very close to the idea of the wrap loan.]

Essentially, the GECL will allow lenders to provide additional funding to business entities. The additional funding will run as a separate parallel facility, along with the main facility. The GECL loan will have its own term, moratorium, EMIs, and may be rate of interest as well. Of course, the GECL will share the security interest with the original facility, and will rank pari passu, with the main facility, both in terms of cashflows as in terms of security interest.

The major questions pertaining to the GECL are going to be about the eligible borrowers to whom GECL may be extended, and the allocation of cashflows and collateral with the main facility. Operationally, issues may also centre round the turnaround time, after disbursement, for getting the guarantee cover, and whether the guarantee cover shall be in batch-processed, or processed loan-by-loan. Similarly, there may be lots of questions about how to encash claims on NCGTC.

Eligible Lenders and eligible borrowers

1.      What is the nature of GECL?

The GECL shall be an additional working capital term loan (in case of banks and FIs), and additional term loan (in case of NBFCs) provided by the MLIs to Eligible Borrowers. The GECL facility may run upto 20% of the loan outstanding on 29th February, 2020.

The meaning of “working capital term loan” is that the amount borrowed may be used for general business purposes by the borrower.

2.      Who are the MLIs/eligible lenders under the Scheme?

For the purpose of the Scheme MLIs/eligible lenders include:

I.   All Scheduled Commercial Banks. Other banks such as RRBs, co-operative banks etc. shall not be eligible lenders.

II.   Financial Institutions (FIs), defined under section 45-I(c) of the RBI Act, 1934. The term all-India Financial Institutions” now includes Exim Bank, NABARD, SIDBI and NHB, none of which are extending primary loans. Hence, the term “financial institutions” as per sec. 45I (c) of the RBI Act will essentially refer to NBFCs, covered below..

III.    Non-Banking Financial Companies (NBFCs), registered with the RBI and which have been in operation for a period of 2 years as on 29th February, 2020.

3.      What is the meaning of NBFC having been in operation for 2 years? Are we referring to 2 years from the date of incorporation of the Company, or 2 years from the date of getting registration with the RBI as an NBFC, or 2 financial years?

The language of the scheme indicates that the NBFC must be in operation for 2 years (and not financial years) as on 29th February, 2020. Thus, the period of 2 years shall be counted from the starting of operations after getting registration as an NBFC.

Usually, the RBI while granting registration requires the NBFC to start operations within a period of six months of getting registration. It also requires the NBFC to intimate to RBI that it has commenced operations. Logically, the 2 years’ time for starting of operations should be read from the date of commencement of operations

4.      Does the NBFC have to be a systemically important company? Or any NBFC, whether SI or not, will qualify?

The asset size of the NBFC would not matter. The NBFC must only hold a valid certificate of registration issued by RBI in order to be eligible under the scheme (and in operation for 2 years). Thus, whether SI or not, any NBFC will qualify.

5.      Is it necessary that the NBFC must be registered with the RBI?

Yes, the eligibility criteria specifically requires the NBFC to be registered.

6.      Will the following qualify as MLIs?

  • HFCs: HFCs fall under the definition of financial institutions provided under the eligibility criteria for lenders. While HFCs essentially grant home loans, HFCs are permitted to have other types of loans within a limit of 50% of their assets. Hence, if the HFC has facilities that qualify for the purpose of the Scheme, an HFC will also qualify as MLI. This is further clarified in the FAQs 44 as well.
  • MFIs: MFIs are a class of NBFCs and thus, eligible as MLIs. However, it is to be seen if the nature of loans granted by the MFI will be eligible for the purpose of the Scheme.
  • CICs: CICs again are a class of NBFCs and thus, eligible as MLIs. However, they can grant loans to their group companies only.
  • Companies giving fin-tech credit to consumers: The nature of the loan will mostly be by way of personal loans or consumer credit. While the lender may qualify, but the facility itself may not.
  • Gold loan companies: Mostly, the loan is a personal loan and does not relate to a business purpose. Hence, the loan will not qualify.

7.      Is it possible for a bank to join as co-lender in case of a loan given by an NBFC? To be more precise, the primary loan is on the books of the NBFC. Now, the NBFC wants to give the GECL facility along with a bank as a co-lender. Is that possible?

In our view, that should certainly be possible. However, in our view, in that case, the rate of interest charged to the borrower should be the blended rate considering the interest rate caps for the bank [9.25%] and the NBFC [14%].

8.      Who are the eligible borrowers (Eligible Borrower or Borrower)?

The Eligible Borrowers shall be entities fulfilling each of the following features :

  • Nature of the activity/facility: Our understanding is that Scheme is meant only for business loans. Hence, the nature of activity carried by the entity must be a business, and the facility must be for the purpose of the business.
  • Scale of business: Business enterprises or MSMEs. The term MSME has a wide definition and we are of the view that it is not necessary for the borrower to be registered for the purpose of MSME Development Act. Please see our detailed resources on the meaning of MSMEs here: http://vinodkothari.com/2020/05/resources-on-msme/.In addition, the word “business enterprises” is also a wide term – see below.
  • Existing customer of the MLI: The borrower must be an existing customer of the MLI as on 29th Feb., 2020. That is, there must be an existing facility with the borrower.
  • Size of the existing facility: The size of the existing facility, that is, the POS, as on 29th Feb. 2020, should be upto Rs 25 crores.
  • Turnover for FY 2019-20: The turnover of the Eligible Borrower, for financial year 2019-20, should be upto Rs 100 crores. In most cases, the financial statements for FY 2019-20 would not have been ready at the time of sanctioning the GECL. In that case, the MLI may proceed ahead based on a borrower’s declaration of turnover.
  • GST registration: Wherever GST registration is mandatory, the entity must have GST registration.
  • Performance of the loan: As on 29th Feb., 2020, the existing facility must not be more than 59 DPD.
  • Further, Business Enterprises / MSMEs would include loans covered under Pradhan Mantri Mudra Yojana extended on or before 29.2.2020, and reported on the MUDRA portal. All eligibility conditions including the condition related to Days past due would also apply to PMMY loans.

9.      Who are eligible Mudra borrowers?

Mudra borrowers are micro-finance units who have availed of loans from Banks/NBFCs/MFIs under the Pradhan Mantri Mudra Yojna (PMMY) scheme.

10.   Do Eligible Borrowers have to have any particular organisational form, for example, company, firm, proprietorship, etc?

No. There is no particular organisational form for the Eligible Borrower. It may be a company, firm, LLP, proprietorship, etc.

Note that the Scheme uses the expression: “all Business Enterprises / MSME institution borrower accounts”. From the use of the words “business enterprises” or “institution borrower account”, it may be contended that individuals are excluded. In Para 7 of the Operational Guidelines on the website of NCGTC, it is mentioned that “Loans provided in individual capacity are not covered under the Scheme”. However, the very same para also permits a business run as a proprietorship as an eligible case of business enterprise.

It seems there is a confusion between a business owned/run by an individual, and a loan taken in individual capacity. The latter will presumably mean a loan for personal purposes, such as a home loan, loan against consumer durables, car loan or personal loan. As opposed to that, a loan taken by a business, even though owned by an individual and not having a distinctive name than the individual himself, cannot be regarded as a “loan provided in individual capacity”.

For instance, many SRTOs, local area retail shops etc are run in the name of the proprietor. There is no reason to disregard or disqualify such businesses. It is purpose and usage of the loan for business purposes that matters.

11.   What is the meaning of the term “business enterprise” which is defined as one of the Eligible Borrowers?

The term “ business enterprise” has been used repetitively in the Scheme, and is undefined. In our view, its meaning should be the plain business meaning– enterprises which are engaged in any business activity. The word “business activity” should be taken broadly, so as to give an extensive and purposive interpretation to fulfil the intent of the Scheme. Clearly, the Scheme is intended to encourage small businesses which are the backbone of the economy and which may help create “self reliant” India.

Having said this, it should be clear that the idea of the Scheme is not to give loans for consumer durables, personal use vehicles, consumer loans, personal loans, etc. While taking the benefit of the Scheme, the MLI should bear in mind that the intent of the lending is to spur economic activity. There must be a direct nexus between the granting of the facility and economic/business activity to be carried by the Eligible Borrower.

12.   One of the Eligible Borrowers is an MSME. Is it necessary that the entity is registered i.e. has a valid Udyog Aadhaar Number, as required under the MSMED Act?

The eligibility criteria for borrowers does not specifically require the MSMEs to be registered under the MSMED Act. Thus, an unregistered MSME may also be an Eligible Borrower under the scheme.

13.   For the borrowers to give a self-declaration of turnover for FY 2019-20, is there a particular form of declaration?

There is no particular form. However, we suggest something as simple as this:

To whomsoever it may concern

Sub: Declaration of Turnover

I/ We………………………………….. (Name of Authorized Signatory), being ……………………..(Designation) of …………………………………………………. (Legal Name as per PAN) do hereby state that while the financial statements for the FY 2019-20 have not still been prepared or finalised, based on our records, the turnover of the abovementioned entity/unit during the FY 2019-2 will be within the value of Rs 100 crores.

 

Signed ………….            Date:…………………

14.   One of the important conditions for the Eligible Borrower is that the Borrower must not be an NPA, or SMA 2 borrower. For finding the DPD status of the existing facility, how do we determine the same in the following cases?

●       My EMIs are due on 10th of each month. On 10th Feb., 2020, the borrower had two missing EMIs, viz., the one due on 10th Jan. 2020 and the one due on 10th Feb., 2020. Is the Borrower an Eligible Borrower on 29th Feb., 2020?

The manner of counting DPD is – we need to see the oldest of the instalments/ principal/interest due on the reckoning date. Here, the reckoning date is 29th Feb. On that date, the oldest overdue instalment is that of 10th Jan. This is less than 59 DPD. Hence, the borrower is eligible.

●      My EMIs are due on the 1st of each month. The borrower has not paid the EMIs due on 1st Jan. and 1st Feb., 2020. Is the Borrower an Eligible Borrower on 29th Feb., 2020?

On the reckoning date, the oldest instalment is that of 1st Jan. 2020. Since the reckoning date is 29th Feb., we will be counting only one two dates – 1st Jan and 29th Feb. The time lag between the two adds to exactly 59 days. The borrower becomes ineligible if the DPD status is more than 59 days. Hence, the borrower is eligible.

15.   Is the Scheme restrictive as to the nature of the existing facility? Can the GECL be different from the existing facility?

It does not seem relevant that the GECL should be of the same nature/type or purpose as the primary facility. We have earlier mentioned that the purpose of the GECL is to support the business/economic activity of the borrower.

However, there may be issues where the existing facility itself would not have been eligible for the Scheme. For instance, if the existing facility was a car loan to a business entity (say, an MSME), can the GECL  be eligible if the same is granted for working capital purposes? Intuitively, this does not seem to be covered by the Scheme. Once again, the intent of the Scheme is to provide “further” or additional funding to a business. Usually, the so-called further or additional funding for a business may come from a lender who had facilitated business activity by the primary facility.

Hence, in our view, the primary as well as the GECL facility should be for business purposes.

16.   Is there a relevance of the residual tenure of the primary facility? For example, if the primary facility is maturing within the next 6 months, is it okay for the MLI to grant a GECL for 4 years?

There does not seem to be a correlation between the residual term of the primary facility and the tenure of the GECL facility. The GECL seems to be having a term of 4 years, irrespective of the original or residual term of the primary facility.

Of course, the above should be read with our comments above about the primary facility as well as the GECL to be for business purposes.

17.   A LAP loan was granted to a business entity.  The loan was granted against a self-owned house, but the purpose of the loan was working capital for the retail trade business carried by the borrower. Will this facility be eligible for GECL?

Here, the purpose of the loan, and the nature of collateral supporting the loan, are different, but what matters is the end-use or purpose of the loan. The collateral is a self-occupied house. But that does not change the  purpose of the loan, which is admittedly working capital for the retail trade activity.

Hence, in our view, the facility will be eligible for GECL, subject to other conditions being satisfied.

 18.   I have an existing borrower B, who is a single borrower as on 29th Feb 2020. I now want to grant the GECL loan to C, who would avail the loan as a co-borrower with B. Can I lend to B and C as co-borrowers?

It seems that even loans extended to co-obligors or co-applicants also qualify.

We may envisage the following situations:

  • The primary facility was granted to B and C. B is an Eligible Borrower. The GECL is now being granted to B and C. This is a good case for GECL funding, provided B remains the primary applicant. In co-applications, the co-borrowers have a joint and several obligations, and the loan documentation may not make a distinction between primary and secondary borrower. However, one needs to see the borrower who has utilised the funding.
  • The primary facility was granted to B who is an Eligible Borrower. The GECL is now being granted to B and C. This is a good case for GECL funding if B is the primary applicant. See above for the meaning of “primary” applicant.
  • The primary facility was granted to B, who is a director of a company, where C, the company, joined as a co-applicant. C is an Eligible Borrower. The GECL is now being granted to C. This is a good case for GECL funding since the GECL funding is to Cm and C is an Eligible Borrower.

19.   When can GECL be sanctioned? Is there a time within which the GECL should be sanctioned?

The Scheme shall remain in operation till 31st October, 2020, or till such time as the maximum amount of loans covered by NCGTC reaches Rs 300000 crores. Accordingly, it can be inferred that the GECL must be sanctioned during the period of the operation of Scheme, that is during the period from May 23, 2020 to 31st October, 2020, or till an amount of Rs. 3 lakh crore is sanctioned under GECL, whichever is earlier.

20.   How can an MLI keep track of how much is the total amount of facilities guaranteed by NCGTC?

Understandably, there may be mechanisms of either dissemination of the information by NCGTC, or some sort of a pre-approval of a limit by NCGTC.

21.   Whether the threshold limit of outstanding credit of Rs. 25 crores, will have to be seen across all the lenders, the borrower is currently dealing with, or with one single lender?

The Scheme specifically mentions that the limit of Rs. 25 crores shall be ascertained considering the borrower accounts of the business enterprises/MSMEs with combined outstanding loans across all MLIs. For the purpose of determining whether the combined exposure of all MLIs is Rs 25 crores or not, the willing MLI may seek information about other loans obtained by the borrower.

22.   For the threshold limit of outstanding credit of Rs. 25 crores, are we capturing only eligible borrowings of the borrower, or all debt obligations?

Logically, all business loans, that is, loans/working capital facilities or other funded facilities availed for business purposes should be aggregated. For instance:

  • Unfunded facilities, say, L/Cs or guarantees, do not have to be included.
  • Non-business loans, say, car loans, obtained by the entity do not have to be included as the same are not for business purposes.

23.   What is the meaning of MSME? Is it necessary that the Eligible Borrower should be meeting the definition of MSME as per the Act?

The Scheme uses the term MSME, but nowhere has the Scheme made reference to the definition of MSME under the MSMED Act, 2006. Therefore, it does not seem necessary for the Eligible Borrower to have registration under the MSMED Act. Further, even if the entity in question is not meeting the criteria        of MSME under the Act, it may still be satisfying the criteria of “business enterprise” with reference to turnover and borrowing facilities. Hence, the reference to the MSMED Act seems unimportant.

However, for the purpose of ease of reference, we are giving below the meaning of MSME as per the definition of MSMEs provided in the MSMED Act, 2006 (‘Act’):

Enterprise Manufacturing sector [Investment in plant and machinery (Rs.)] Service sector [Investment in equipment (Rs.)]
Small Not exceeding 25 lakhs Not exceeding 10 lakhs
Micro Exceeding 25 lakhs but does not exceed 5 crores Exceeding 10 lakhs but does not exceed 2 crores
Medium Exceeding 5 crores but not exceeding 10 crores Exceeding 2 crores but does not exceed 5 crores

 

The above definition has been amended by issue of a notification dated June 1, 2020. As per the amendment such revised definition shall be applicable with effect from July 01, 2020. Accordingly, w.e.f. such date, following shall be the definition of MSMEs:

Enterprise Investment in plant and machinery or equipment (in Rs.) Turnover (in Rs.)
Micro Upto 1 crore Upto 5 crores
Small Upto 10 crores Upto 50 crores
Medium Upto 50 crores Upto 250 crores

24.   The existing schemes laid down by the CGTMSE, CGS-I and CGS-II, cover the loans extended to MSE retail traders. Will the retail traders be eligible borrowers for this additional facility?

The Scheme states that a borrower is eligible if the borrower has –

(i) total credit outstanding of Rs. 25 Crore or less as on 29th Feb 2020;

(ii) turnover for 2019-20 was upto Rs. 100 Cr;

(iii) The borrower has a GST registration where mandatory.

Udyog Aadhar Number (UAN) or recognition as MSME is not required under this Scheme.

Hence, even retail traders fulfilling the eligibility criteria above would be eligible under the scheme.

25.   If the borrower does not have any existing credit facility as on 29th February, 2020, will it still be able to avail fresh facility(ies) under this Scheme?

Looking at the clear language of the Scheme, it seems that existence of an outstanding facility is a prerequisite to avail credit facility under the Scheme. The intent of the Scheme is to provide additional credit facility to existing borrowers.

26.   I have a borrower to whom i have provided a sanction before 29th February, 2020; however, no disbursement could actually take place within that date. Will such a borrower qualify for the Scheme?

Since the amount of GECL is related to the POS as on 29th Feb., 2020, there is no question of such a borrower qualifying.

27.   The Scheme seems to refer to the facility as a “working capital term loan” in case of banks/FIs and “additional term loan” in case of NBFCs. Does that mean the MLIs cannot put any end-use restrictions on utilisation of the facility by the Eligible Borrowers?

It is counter-intuitive to think that the MLI cannot put end-use restrictions. Ensuring that the funds lent by the MLI are used for the purpose for which the facility has been extended is an essential prudential safeguard for a lender. It should be clear that the additional facility has been granted for restarting business, following the disruption caused by the COVID crisis. There is no question of the lender permitting the borrower to use the facility for extraneous or irrelevant purposes.

Terms of the GECL Facility

28.   What are the major terms of the GECL Facility?

The major terms are as follows:

  • Amount of the Facility: Up to 20% of the POS as on 29th Feb., 2020. Note that the expression “upto” implies that the MLI/borrower has discretion in determining the actual amount of top up funding, which may go upto 20%.
  • Tenure of the Facility: 4 years. See below about whether the parties have a discretion as to tenure.
  • Moratorium: 12 months. During the moratorium, both interest and principal will not be payable. Hence, the first payment due under the top up facility will be on the anniversary of the facility.
  • Amortisation/repayment term: 36 months.
  • Mode of repayment: While the Scheme says that the principal shall be payable in 36 installments, it should not mean 36 equal instalments of principal. The usual EMI, wherein the instalment inclusive of interest is equated, works well in the financial sector. Hence, EMI structure may be adopted. However, if the parties prefer equated repayment of principal, and the interest on declining balances, the same will also be possible. Note that in such case, the principal at the end of 12 months will have the accreted interest component for 12 months’ moratorium period as well.
  • Collateral: The Scheme says that no additional collateral shall be asked for the purposes of the GECL. In fact, given the sovereign guarantee, it may appear that no additional collateral is actually required. [However, see comment below on dilution of the collateral as a result of the top-up funding].
  • Rate of interest: The rate of interest is capped as follows – In case of banks/ – Base lending rate + 100 bps, subject to cap of 9.25% p.a. In case of NBFCs, 14% p.a.
  • Processing/upfront fees: None

29.   As regards the interest rate, is it possible that the MLI has the benefit under any interest rate subvention scheme as well?

Yes. This scheme may operate in conjunction with any interest rate subvention scheme as well.

30.   Is the tenure of the GECL facility non-negotiably fixed at 4 years or do the parties have discretion with respect to the same? For example, if the borrower agrees to a term of 3 years, is that possible?

It seems that the Scheme has a non-negotiable tenure of 4 years. Of course, the Scheme document does say the parties may agree to a prepayment option, without any prepayment penalty. However, in view of the purpose of the Scheme, that is, to restart business activity in the post-COVID scenario, it does not seem as if the purpose of the Scheme will be accomplished by a shorter loan tenure.

31.   Is it possible for MLI to lend more than 20%, but include only 20% for the benefit of the guarantee?

Minus the Scheme, nothing stopped a lender from giving a top-up lending facility on a loan. Therefore, the wrapped portion of the GECL facility is 20% of the loan, but if the lender so wishes to give further loan, there is nothing that should restrain the lender from doing so.

32.   The Scheme document provides that the collateral for the primary loan shall be shared pari passu with the GECL facility. What does the sharing of the collateral on pari passu basis mean?

Para 11 of the Scheme document says: “…facility granted under GECL shall rank pari passu with the existing credit facilities in terms of cash flows and security”. The concept of pari passu sharing of the security, that is, the collateral, may create substantial difficulties in actual operation, since the terms of repayment of the primary facility and the GECL facility are quite divergent.

To understand the basic meaning of pari passu sharing, assume there is a loan of Rs 100 as on 29th Feb., 2020, and the MLI grants an additional loan of Rs 20 on 1st June, 2020. Assume that the value of the collateral backing the primary loan is Rs 125. As and when the GECL is granted, the value of this collateral will serve the benefit of the primary loan as well as the GECL facility. In that sense, there is a dilution in the value of the security for the primary loan. This, again, is illogical since the primary does not have a sovereign wrap, while the GECL facility has.

What makes the situation even worse is that due to amortizing nature of the primary loan, and the accreting nature of the GECL facility during the moratorium period, the POS of the primary facility will keep going down, while the POS of the GECL facility will keep going up. It may also be common that the primary facility will run down completely in a few months (say 2 years), while the GECL facility is not even half run-down. In such a situation, the benefit of the collateral will serve the GECL loan, in proportion to the amount outstanding of the respective facilities. Obviously, when the primary facility is fully paid down, the collateral serves the benefit of the GECL facility only.

33.   The Scheme provides that the primary facility and the GECL facility shall rank pari passu, in terms of cash flows. What is the meaning of pari passu sharing of cashflows?

The sharing of cashflows on pari passu basis should mean, if there are unappropriated payments made by the borrower, the payment made by the borrower should be split between the primary facility and the GECL facility on proportionate basis, proportional to the respective amounts falling/fallen due.

For instance, in our example taken in Q 15 above, assume the borrower makes a payment in the month of July 2020. The entire payment will be taken to the credit of the primary loan since the GECL loan is still in moratorium.

Say, in the month of July 2021, an aggregate payment is made by the borrower, but not sufficient to discharge the full obligation under the primary facility and the GECL facility. In this case, the payment made by the borrower will be appropriated, in proportion to the respective due amounts (that is, due for the month or past overdues) for the primary facility and the GECL facility.

34.   Given the fact that the payments for the GECL are still being collected by the MLI, who also has a running primary facility with the same borrower, is there any obligation on the part of the MLI to properly appropriate the payments received from the borrower between the primary and the GECL facility?

Indeed there is. The difficulty arises because there are two facilities with the borrower, one is naked, and the other one wrapped. The pari passu sharing of cashflows will raise numerous challenges of appropriation. Since the claim is against the sovereign, there may be a CAG audit of the claims settled by the NCGTC.

35.   The Scheme document says that the charge over the collateral has to be created within 3 months from the date of disbursal. What is the meaning of this?

If the existing loan has a charge securing the loan, and if the same security interest is now serving the benefit of the GECL facility as well, it will be necessary to modify the charge, such that charge now covers the GECL facility as well. As per Companies Act, the time for registration of a modification is thirty days, and there is an additional time of ninety days.

36.   Say the primary loan is a working capital loan given to a business and has a residual tenure of 24 months. The loan is secured by a mortgage of immovable property. Now, GECL facility is granted, and the same has a tenure of 48 months. After 24 months, when the primary loan is fully discharged, can the borrower claim the release of the collateral, that is, the mortgage?

Not at all. The grant of the GECL facility is a grant of an additional facility, with the same collateral. Therefore, until the GECL loan is fully repaid, there is no question of the borrower getting a release of the collateral.

37.   Should there be a cross default clause between the primary loan and the GECL loan?

In our view, the collateral is shared by both the facilities on pari passu basis. Hence, there is no need for a cross default clause.

38.   What are the considerations that should prevail with the borrower/MLI while considering the quantum of the GECL facility?

The fact that the GECL facility is 100% guaranteed by the sovereign may encourage MLIs to consider the GECL facility as risk free, and go aggressively pushing lending to their existing borrowers. However, as we have mentioned above, the pari passu sharing of the collateral results into a dilution of collateral for the primary facility. Hence, MLIs should use the same time-tested principles of lending in case of GECL as well – capacity, collateral, etc.

For the borrower as well, the borrower eventually has to pay back the loan. In case of NBFCs, the loan is not coming cheap – it is coming at a cost of 14%. While for the lender, the risk may be covered by the sovereign guarantee, the risk of credit history impairment for the borrower is still the same.

Hence, we suggest both the parties to take a considered call. For the lender, the consideration should still be the value of the collateral, considering the amount of the top up facility. In essence, the top up facility does not mechanically have to be 20% -the amount may be carefully worked out.

39.   Does the disbursal of the GECL facility have to be all in cash, or can it be adjusted partly against the borrower’s obligations, say for any existing overdues? Can it be partly given to MLI as a security deposit?

While the disbursal should appropriately be made by the MLI upfront, if the borrower uses the money to settle existing obligations with the MLI, that should be perfectly alright.

40.   In case the borrower has multiple loan accounts with multiple eligible lenders, how will such borrower avail facility under GECL?
It is clarified that a borrower having multiple loan accounts with multiple lenders can avail GECL. The GECL will have to be availed either through one lender or each of the current lenders in proportion depending upon the agreement between the borrower and the MLI.

Further, In case the borrower wishes to take from any lender an amount more than the proportional 20% of the outstanding credit that the borrower has with that particular lender, a No Objection Certificate (NOC) would be required from all other lenders.

Lender-Borrower documentation

41.   The Scheme has consistently talked about an opt-out facility for the GECL scheme. What exactly is the meaning of the opt-out facility?

In our understanding, the meaning is, except for those borrowers who opt out of the facility, the lender shall consider the remaining borrowers as opting for the facility. However, there cannot be a case of automatic lending, as a loan, after all, is a mutual obligation of the borrower towards the lender. Hence, there has to be explicit agreement on the part of the borrower with the lender.

Of course, a wise borrower may also want to negotiate a rate of interest with the lender.

42.   What documentation are we envisaging as between the MLI and the borrower?

At least the following:

  1. Additional loan facility documentation, whether by a separate agreement, or annexure to the master facility agreement executed already by the borrower.
  2. Modification of charge.

Income recognition, NPA recognition, risk weighting and ECL computation

43.   During the period of the moratorium on the GECL facility, will income be recognised?

Of course, yes. In case of lenders following IndAD 109, the income will be recognised at the effective interest rate. In case of others too, there will be accrual of income.

44.   Once we give a GECL loan, we will have two parallel facilities to the borrower – the primary loan and the GECL loan. Can it be that one of these may become an NPA?

The GECL loan will have a moratorium of 12 months – hence, nothing is payable for the first 12 months. The primary facility may actually be having upto 59 DPD overdues at the very start of the scheme itself. Hence, it is quite possible that the primary facility slips into an NPA status.

As a rule, if a facility granted to a borrower has become an NPA, then all facilities granted to the same borrower will also be characterised as NPAs.

Therefore, despite the 100% sovereign guarantee, the facility may still be treated as an NPA, unless there is any separate dispensation from the RBI.

45.   If the GECL facility becomes an NPA, whether by virtue of being tainted due to the primary loan or otherwise, does it mean the MLI will have to create a provision?

As regards the GECL facility, any provision is for meeting the anticipated losses/shortfalls on a delinquent loan. As the GECL is fully guaranteed, in our view, there will be no case for creating a provision.

46.   Will there be any expected credit loss [ECL] for the GECL facility?

In view of the 100% sovereign guarantee, this becomes a case of risk mitigation. In our view, this is not a case for providing for any ECL.

47.   Will the 40 bps general loss provision for standard assets have to be created for the GECL loans too?

Here again, our view is that the facility is fully sovereign-guaranteed. Hence, there is no question of a prudential build up of a general loss provision as well. The RBI should come out with specific carve out for GECL loans.

48.   Will capital adequacy have to be created against GECL assets?

The Scheme document says that the RBI will be requested to provide for a 0% risk weight.

Guarantor and the guarantee

49.   Who is the guarantor under the Scheme?

The Guaranteed Emergency Credit Line (GECL) or the guarantee under the Scheme shall be extended by National Credit Guarantee Trustee Company Limited (NCGTC, ‘Trust’).

50.   What is National Credit Guarantee Trustee Company Ltd (NCGTC)?

NCGTC is a trust set up by the Department of Financial Services, Ministry of Finance to act as a common trustee company to manage and operate various credit guarantee trust funds. It is a company incorporated under the Companies Act, 1956.

51.   What is the role of NCGTC?

The role of NCGTC is to serve as a single umbrella organization which handles multiple guarantee programmes of the GoI covering different cross-sections and segments of the economy like students, micro entrepreneurs, women entrepreneurs, SMEs, skill and vocational training needs, etc.

Presently, NCGTC manages 5 credit guarantee schemes that deal with educational loans, skill development, factoring, micro units etc.

52.   To what extent will the guarantee be extended?

The guarantee shall cover 100% of the eligible credit facility.

53.   Whether the guarantee will cover both principal and interest components of the credit facility?

Yes, the Scheme shall cover both the interest as well as the principal amount of the loan.

54.   What will be the guarantee fee?

The NCGTC shall charge no guarantee fee from the Member Lending Institutions (MLIs) in respect of guarantee extended against the loans extended under the Scheme.

55.   Are eligible lenders required to be registered with the NCGTC to become MLIs?

Usually, eligible lenders under such schemes are required to enter into an agreement with the trust extending the guarantee, to become their members. In this scheme, the eligible lenders are required to provide an undertaking to the NCGTC, in the prescribed format, in order to become MLIs.

56.   What is the procedure for obtaining the benefit of guarantee under the Scheme?

The MLI shall, within 90 days from a borrower account under the scheme turning NPA,  inform the date on which such account turned NPA. On such intimation, NCGTC shall pay 75% of the guaranteed amount to the MLI i.e. 75% of the default amount.

The rest 25% shall be paid on conclusion of recovery proceedings or when the decree gets time barred, whichever is earlier.

Securitisation, direct assignment and co-lending

57.   The loan, originated by the NBFC, has been securitised. Is it possible for the NBFC to give a GECL facility based on the POS of the securitised loan?

On the face of it, there is nothing that stops a lender from giving a further facility, in addition to the one that has been securitised. However, in the present case, there will be modification of the existing charge document, whereby the charge will be extended to the top up GECL loan as well. This amounts to a dilution of the security available for the primary loan. In our view, this will require specific consent of the PTC investors, through the trustee.

Note that FAQ 35 by NCGTC seems to be talking about off-balance sheet facility. Many securitisation transactions are actually on the balance sheet.

58.   The loan, originated by the NBFC, has been assigned to the extent of 90% to a bank. Is it possible for the NBFC to give a GECL facility based on the POS of the partly-assigned loan?

Same reasoning as above. Here again, FAQ 40 by NCGTC is talking about the entity on whose books the loan currently is. NCGTC’s view about the loan being on the books of a lender is seemingly overshadowed by accounting concepts which have drastically changed over time. For example, a loan which has been a matter of a DA transaction is actually partly on the books of the original lender, and partly on the books of the assignee. One cannot expect the assignee to be giving the additional line of credit, as the assignee is, practically speaking, a mere passive investor. The assignee does not have the franchise/relation with the borrower, which the originator has. To contend that the assignee bank should extend the additional facility is actually to deny the facility to the borrower completely, for no fault of the borrower and for no gain for the system. Since it is the original lender who maintains the relation with the borrower, it is original lender only who may extend the facility.

59.   Is it possible for the NBFC to originate the GECL facility, and securitise/assign the same? Will the assignee have the benefit of the GoI guarantee?

There is nothing in the Scheme for assignment of the benefit of guarantee. Typically, unless the guarantee agreement says to the contrary, the benefit of a security or guarantee is assignable along with the underlying loan. However, the guarantee agreement between NCGTC and the lender will be critical in determining this.

Our answer as above stands indicated by FAQ no 41 by NCGTC.

[1] https://pib.gov.in/PressReleasePage.aspx?PRID=1625306

[2] http://www.dcmsme.gov.in/publications/circulars/cate-12-6.pdf

[3] https://udyogaadhaar.gov.in/Web/doc/Activities_NIC_CodesNotAllowed.PDF

[4] The scheme earlier required the MSMEs to obtain UAN (i.e. get registered) in order to avail benefit under the same. However the same was recently done away with through a notification issued on February 5, 2020. Link to the notification- https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11803&Mode=0

[5] https://www.cgtmse.in/files/CGS-I.pdf

 

Our related write-ups may be referred here:

 

PCG Scheme 2.0 for NBFC pooled assets, bonds and commercial paper

-Financial Service Division (finserv@vinodkothari.com)

The write-up below covers version 2.0 of the Partial Credit Guarantee Scheme [PCG Scheme, or PCGS, or simply, the Scheme; version 2 is referred to herein as PCG 2.0 for the sake of distinction from its earlier version, which we refer to PCGS 1.0].

PCGS 1.0 was announced by the Finance Minister, during the Union Budget 2019-20, introducing a partial credit guarantee scheme so as to extend relief to NBFCs during the on-going liquidity crisis. The proposal laid down in the Budget was a very broad statement. On 13th August, 2019 the Ministry of Finance came out with a Press Release to announce the notification in this regard, dated 10th August, 2019, laying down specifics of the scheme.

PCGS 1.0 was only a moderate success, as literally no transactions were conducted under the Scheme until November, 2019. Various stakeholders[1] represented to the MOF to remove the bottlenecks in the structure. Subsequently, on 11th December, 2019, the Union Cabinet approved amendments[2] to the Scheme (Amendments).

The scheme,  known as “Partial Credit Guarantee offered by Government of India (GoI) to Public Sector Banks (PSBs) for purchasing high-rated pooled assets from financially sound Non-Banking Financial Companies (NBFCs)/Housing Finance Companies (HFCs)”, is referred to, for the purpose of this write, as  “the Scheme”.

PCGS 2.0 was introduced by the Finance Minister as a part of her Rs 20-lakh Crore stimulus package, announced on 13th May, 2020 to provide liquidity to NBFCs, HFCs and MFIs with low credit rating. The Union Cabinet approved the sovereign portfolio guarantee of up to 20% of first loss for purchase of Bonds or Commercial Papers (CPs) with a rating of AA and below (including unrated paper with original/ initial maturity of up to one year) issued by NBFCs/ MFCs/MFIs, by Public Sector Banks through an extension of the PCGS 1.0. PCGS 2.0 has been put in the form of FAQs as well as press-release on the website of the Ministry of Finance.

While PCGS 1.0 was intended to address the temporary liquidity crunch faced by solvent HFCs/ NBFCs, PCGS 2.0 is premised on the continuing problems faced by NBFCs/HFCs/MFIs. The Press Release of the GoI says: “COVID-19 crisis and consequent lockdown restrictions are likely to have a negative impact on both collections and fresh loan disbursements, besides a deleterious effect on the overall economy. This is anticipated to result not only in asset quality issues for the NBFC/ HFC/ MFI sector, but also low loan growth as well as higher borrowing costs for the sector, with a cascading effect on Micro, Small and Medium Enterprises (MSMEs) which borrow from them. While the RBI moratorium provides some relief on the assets side, it is on the liabilities side that the sector is likely to face increasing challenges. The extension of the existing Scheme will address the liability side concerns. In addition, modifications in the existing PCGS will enable wider coverage of the Scheme on the asset side also. Since NBFCs, HFCs and MFIs play a crucial role in sustaining consumption demand as well as capital formation in small and medium segment, it is essential that they continue to get funding without disruption, and the extended PCGS is expected to systematically enable the same.”

 PCGS 2.0 covers both the asset side as well as the liability side. PCGS 1.0 was limited to the asset side, for guaranteeing the purchase of “pooled assets” from NBFCs. PCGS 2.0 covers the liability side as well – permitting banks to purchase CPs/ bonds issued by NBFCs/HFCs/MFIs (Finance Companies). Therefore, both the banks as well as Finance Companies will have to make a careful comparison between pool assignments, versus liability issuance. We intend to provide a comparative view of the same in our analysis below.

In this write-up we have tried to answer some obvious questions that could arise along with potential answers. This write-up should be read in conjunction with our earlier write ups on the PCGS 1.0 here.

Scope of applicability

  1. When does this scheme come into force?

The Scheme was originally introduced on 10th August, 2019 and has been put to effect immediately. The modifications in the Scheme were made applicable with effect from 11th December, 2019.

PCGS 2.0 was announced by the GoI vide a note dated 20th May, 2020.

  1. Currently, the Scheme has two distinct elements – purchase of asset pools, and purchase of CPs/bonds issued by finance companies. How do these different funding options compare for both the finance companies, and the investing banks?

PCGS 2.0 has added the CP/bond element into the Scheme basically for providing short-term, sovereign-guaranteed liquidity support for redeeming liabilities maturing within 6 months from the date of issue of the CP/bonds. Therefore, the CP/bond guarantee is essentially a liability management option.

On the other hand, the asset pool purchase gives ability to NBFCs to release liquidity locked in assets, and gives them long-term resources for on-lending.

CP is typically issued for a tenure upto 12 months. Bonds for the purpose of the Scheme are also short-term bonds, with a maturity of 9 to 18 months. Hence, in either case, the finance company is simply shifting its existing redemption liability by 9 to 18 months.

Asset pools will have a minimum rating requirement, whereas in case of short-term paper issuance, there is a maximum rating requirement. In fact, PSBs are allowed to purchase unrated paper as well, if the tenure is within 12 months.

A tabular comparison between pool purchases and paper purchase may run as follows:

Pool Purchases Paper Purchases
Nature of the transaction Sale of pool of loans by finance companies to PSBs. PSBs get a first loss guarantee from GoI Acquisition of a pool of CP/bonds (paper) by PSBs, issued by finance companies. PSBs get a first loss guarantee from GoI
Eligible finance companies NBFCs and HFCs. MFIs are not eligible MFIs are also eligible
Purpose/purport of the transaction The finance company refinances its pool, thereby releasing liquidity. The liquidity can be used for on-lending The purported use of the funding is for meeting an imminent liability redemption. The issuance of the paper is connected with liabilities maturing within next 6 months.

The liability itself may be either repayment of a term loan, redemption of any debt security, or otherwise.

Rating requirement Minimum rating of BBB+ Maximum rating of AA. Unrated paper also qualifies
Tenure of the loans/paper There is no stipulation of the tenure of the underlying loans. The guarantee is valid for a period of 24 months only. Paper should have maturity of 9 to 18 months.
Extent of cover by GoI 10% of the pool purchased by PSBs 20% of the portfolio of paper purchased by the PSBs
Ramp up period Loan pools may be acquired upto 31st March, 2021 Paper may be acquired within 3 months
Impact on asset liability mismatch Repayment of the pool is on a pass-through basis to the PSB. Hence, there is no ALM Repayment will be on a bullet maturity basis. Hence, there will be an ALM issue.
Bankruptcy remoteness Pool purchases take exposure on the underlying pool, and are therefore, bankruptcy-remote qua the NBFC. Paper purchase is paper issued by the NBFC and hence, the PSB takes exposure in the issuer.
  1. How long will this Scheme continue to be in force?

Originally, PCGS 1.0 was supposed to remain open for 6 months from the date of issuance of this Scheme or when the maximum commitment of the Government, under this Scheme, is achieved, whichever is earlier. However, basis the Amendments discussed above, the Scheme was extended till 20th June, 2020. The Amendments also bestowed  upon the Finance Minister power to extend the tenure by upto 3 months.

PCGS 2.0 has two distinct elements – (a) Purchase of Pooled assets; (b) Purchase of bonds/CPs issued by Finance companies. For Part (a), that is, purchase of pooled assets, the Scheme is now extended to 31st March, 2021. For purchase of paper by the PSBs, the PSB has to acquire the paper within 3 months of the announcement. Taking the announcement date of the Scheme to be 20th May, the paper should be acquired by the PSBs within 20th August, 2020.

  1. Who is the beneficiary of the guarantee under the Scheme – the bank or the NBFC?

The bank (and that too, PSB only) is the beneficiary. The NBFC is not a party to the transaction of guarantee. This is true both for pool purchases as well as paper purchases.

  1. Does a bank buying pools from NBFCs/HFCs (Financial Entities) automatically get covered under the Scheme?

No. Since a bank/ Financial Entities may not want to avail of the benefit of the Scheme, the Parties will have to opt for the benefit of the guarantee. The bank will have to enter into specific documentation, following the procedure discussed below.

  1. In case of Paper Purchases, is the guarantee applicable to paper issued by different finance companies?

Yes. The guarantee is for a portfolio of finance company paper acquired by the PSB. For example, a PSB buys the following paper issued by different finance companies:

X Ltd    bonds with maturity of 18 months      Rs 200 crores

Y Ltd    CP having maturity of 9 moths           Rs 100 crores

C Ltd   bonds having maturity of 12 moths    Rs 450 crores

D Ltd   CP having maturity of 6 months         Rs 50 crores

Total portfolio                                                  Rs 800 crores

The bank may get the entire paper, adding to Rs 800 crores, guaranteed by GoI. The guaranteed amount is Rs 800 crores, and the maximum loss payable by the GoI is 20%, that is, Rs 160 crores.

  1. What is the relevance of pooling of paper, in case of paper purchases?

In case of paper purchases, the guarantee is on a pool of paper, that is, on an aggregate basis. In all such aggregation transactions, unless the pool becomes granular, the first loss guarantee may become highly inadequate.

For example, in the illustration taken in Q5 above, the loss is limited to Rs 160 crores, being 20% of the guaranteed amount. If the bonds issued by C Ltd default, Rs 450 crores would be in default, while the guarantee by the GoI will be only upto Rs 160 crores.

In the same case, had the total portfolio of Rs 800 crores were, say, to consist of 10 issuances of Rs 80 crores each, 2 out of the 10 issuers will be fully covered by the guarantee. Though the conditions of a binomial distribution are inapplicable in the present case (as the pool has a high level of correlation risk), but the probability of more than 2 defaults in a pool of 10 issues seems much lower than the probability of a major issuer out of a non-granular pool defaulting. Hence, PSBs, in their own interest, may want to build up a granular pool consisting of several issuers.

Of course, the ramp up time for all that is highly inadequate – only 3 months from the scheme announcement. From past experience, it should be clear that that much time is lost even in dissemination of understanding  – from MOF to SIDBI to the PSBs, and more so because of communication difficulties in the present situation.

  1. What does the Bank have to do to get covered by the benefit of guarantee under the Scheme?

The procedural aspects of the guarantee under the Scheme are discussed below.

  1. Is the guarantee specifically to be sought for each of the asset pools acquired by the Bank or is it going to be an umbrella coverage for all the eligible pools acquired by the Bank?

The operational mechanism requires that there will be separate documentation every time the bank wants to acquire a pool from a financial entity in accordance with the Scheme. Hence it appears that the guarantee is for a pool from a specific finance company.

In case of paper purchases, the situation is different – there, the guarantee is for a pool of paper issued by different finance companies.

  1. How does this Scheme, relating to asset pool purchases, rank/compare with other schemes whereby banks may participate in originations done by NBFCs/HFCs?

The RBI has lately taken various initiatives to promote participation by banks in the originations done by NBFCs/ HFCs. The following are the available ways of participation:

  • Direct assignments
  • Co-lending
  • Loans for on-lending
  • Securitisation

Direct assignments and securitisation have been there in the market since 2012, however, recently, once the liquidity crisis came into surface, the RBI relaxed the minimum holding period norms in order to promote the products.

Co-lending is also an alternative product for the co-origination by banks and NBFCs. In 2018, the RBI also released the guidelines on co-origination of priority sector loans by banks and NBFCs. The guidelines provide for the modalities of such originations and also provide on risk sharing, pricing etc. The difficulty in case of co-origination is that the turnaround time and the flexibility that the NBFCs claimed, which was one of their primary reasons for a competitive edge, get compromised.

The third product, that is, loans for on-lending for a specific purpose, has been in existence for long. However, recent efforts of RBI to allow loans for on-lending for PSL assets have increased the scope of this product.

This Scheme, though, is meant to boost specific direct assignment transactions, but is unique in its own way. This Scheme deviates from various principles from the DA guidelines and is, accordingly, intended to be an independent scheme by itself.

The basic use of the Scheme is to be able to conduct assignment of pools, without having to get into the complexity of involving special purpose vehicles, setting enhancement levels only so as to reach the desired ratings as per the Scheme. The effective cost of the Financial Entities doing assignments under the Scheme will be (a) the return expected by the Bank for a GoI-guaranteed pool; plus (b) 25 bps. If this effectively works cheaper than opting for a similar rated pool on a standalone basis, the Scheme may be economically effective.

  1. How does this Scheme, relating to paper purchases, rank/compare with other schemes whereby PSBs may provide liquidity to NBFCs/HFCs/MFIs?

The Scheme should be compared with Special Liquidity Scheme for NBFCs/HFCs. From the skeletal details available [https://pib.gov.in/PressReleasePage.aspx?PRID=1625310], the Special Liquidity Scheme may allow an NBFC/HFC to issue debt instruments by a rating notch-up, based on partial guarantee given by the SPV to be set up for this purpose.

It may seem that the formation of the SPV as well as implementation of the Special Liquidity Scheme may take some time. In the meantime, if a finance company has immediate liquidity concerns for some maturing debt securities, it may use the PCG scheme.

However, a fair assessment may be that the PCGS 2.0 will be largely useful for pool purchases, rather than paper purchases. This is so because in case of paper purchases, the ramp up period of 3 months will elapse very soon, giving PSBs very little time to approach SIDBI for getting limits. In any case, the ramp up of the pool of paper has to happen first, before the PSB can get the guarantee. This may demotivate PSBs from committing to buy the paper issued by finance companies.

  1. Is the Scheme for Pool Purchases an alternative to direct assignment covered by Part B of the 2012 Guidelines, or is it by itself an independent option?

While intuitively one would have thought that the Scheme is a just a method of risk mitigation/facilitation of the DA transactions which commonly happen between banks and Financial Entities, there are several reasons based on which it appears that this Scheme should be construed as an independent option to banks/ Financial Entities:

  • This Scheme is limited to acquisition of pools by PSBs only whereas direct assignment is not limited to either PSBs or banks.
  • This Scheme envisages that the pool sold to the banks has attained a BBB+ rating at the least. As discussed below, that is not possible without a pool-level credit enhancement. In case of direct assignments, credit enhancement is not permissible.
  • Investments in direct assignment are to be done by the acquirer based on the acquirer’s own credit evaluation. In case of the Scheme, the acquisition is obviously based on the guarantee given by the GoI.
  • There is no question of an agreement or option to acquire the pool back after its transfer by the originator. The Scheme talks about the right of first refusal by the NBFC if the purchasing bank decides to further sell down the assets at any point of time.

Therefore, it should be construed that the Scheme is completely carved out from the DA Guidelines, and is an alternative to DA or securitisation. The issue was clarified by the Reserve Bank of India vide its FAQs on the issue[3].

  1. Is this Scheme applicable to Securitisation transactions as well?

Assignment of pool of assets can be happen in case of both direct assignment as well as securitisation transaction. However, the intention of the present scheme is to provide credit enhancements to direct assignment transactions only. The Scheme does not intend to apply to securitisation transactions; however, the credit enhancement methodology to be deployed to make the Scheme work may involve several structured finance principles akin to securitisation.

  1. In case of Paper Purchases, does the PSB have the benefit of security from underlying assets?

In case of CP, the same is unsecured; hence, the question of any security does not arise. In case of bonds, security may be obtained, but given the short-term nature of the instrument, and the fact that the security is mostly by way of a floating charge, the security creation may not have much relevance.

  1. Between a bond and a CP, what should a PSB/finance company prefer?

The obvious perspective of the finance company as well as the bank may be to go for the maximum tenure permissible, viz., 18 months. CP has a maturity limitation. Hence, the obvious choice will be to go for bonds.

  1. A finance company has maturity liabilities over the next few months. However, it has sufficient free assets also. Should it prefer to sell a pool of assets, or for a short-term paper issuance?

The question does not have a straight answer. In case the finance company goes for paper issuance, it keeps its assets still available, may be for using the same for a DA/securitisation transaction. However, from the viewpoint of flexibility in use of the funds, as also the elimination of ALM risk, a finance company should consider opting for the pool sale option.

16A. As per the Scheme documents pertaining to Paper Purchase, the issuance of Paper may be done for repaying liabilities. What is the construct of the term “liability”? Can it, for example, include payment to securitisation investors?

Securitisation is a self-liquidating liability which liquidates based on the pool cashflows. The issuer does not repay securitisation liability. However, the facility may otherwise be used for payment of any of the financial obligations of the issuer.

Risk transfer

  1. The essence of a guarantee is risk transfer. So how exactly is the process of risk transfer happening in case of pool purchases?

The risk is originated at the time of loan origination by the Financial Entities. The risk is integrated into a pool. Since the transaction is a direct assignment (see discussion below), the risk transfer from the NBFC to the bank may happen either based on a pari passu risk sharing, or based on a tranched risk transfer.

The question of a pari passu risk transfer will arise only if the pool itself, without any credit enhancement, can be rated BBB+. Again, there could be a requirement of a certain level of credit enhancements as well, say through over-collateralisation or subordination.

Based on whether the share of the bank is pari passu or senior, there may be a risk transfer to the bank. Once there is a risk transfer on account of a default to the bank, the bank now transfers the risk on a first-loss basis to the GoI within the pool-based limit of 10%.

  1. How does the risk transfer happen in case of paper purchase?

In case of paper purchase, the risk will arise in case of “failure to service on maturity”. As we discussed earlier, it is presumed that the paper will have a bullet maturity. Hence, if the finance entity is not able to redeem the paper on maturity, the PSB may claim the money from the GoI, upto a limit of 20% for the whole of the pool.

  1. Let us say, at the time of original guarantee for Paper Purchase, the Pool of paper had a total exposure of Rs 800 crores. Out of the same, Rs 100 crores has successfully been redeemed by the issuer. Is it proper to say that the guarantee now stands reduced to 20% of Rs 700 crores?

No. The guarantee is on a first loss basis for the whole pool, amounting to Rs 800 crores. Hence, the guaranteed amount will remain 20% of Rs 800 crores.

  1. What is the maximum amount of exposure, the Government of India is willing to take through this Scheme?

Under this Scheme, the Government has agreed to provide (a) 10% first loss guarantee to pool purchase; and (b) 20% guarantee for paper purchases. The total exposure of the Govt has been fixed at a cap of ₹ 10,000 crores.

With the 20% first loss cover in case of paper, it may be seem that the paper will eat the up the total capacity under the Scheme fast. However, as we have discussed above, we do not expect the paper purchases will materalise to a lot of extent in view of the ramp up time of 3 months.

  1. What does 10% first loss guarantee in case of Pool Purchase signify?

Let us first understand the meaning for first loss guarantee. As the name suggests, the guarantor promises to replenish the first losses of the financier upto a certain level. Therefore, a 10% first loss guarantee would signify that any loss upto 10% of the total exposure of the acquirer in a particular pool will be compensated by the guarantor.

Say for example, if the size of pool originated by NBFC N is Rs. 1000 crores, consisting of 1000 borrowers of Rs. 1 crore each. The terms of the guarantee say that the PSB may make a claim against the GoI once the PSB suffers a loss on account of the loan being 91 DPD or more.

Since the GoI is guaranteeing the losses suffered by the PSB, one first needs to understand the terms between the PSB and the finance company. Quite likely, the finance company will have to provide at least 2 pool level enhancements to lift the rating of the pool sold to the bank to the BBB+ level – excess spread, and some degree of over-collateralisation or first loss support. Hence, to the extent the loans in the pool go delinquent, but are taken care of by the excess spread present in the pool, or the over-collateralisation/first loss support available in the pool, there is no question of any loss being transferred to the PSB. If there is no loss taken by the PSB, there is no question of reaching out to the GoI for the guarantee. It is only when the PSB suffers a loss that the PSB will reach out to the GoI for making payment, in terms of the guarantee.

  1. When is a loan taken to have defaulted, in case of Pool Purchases, for the purpose of the Scheme?

Para D of the Scheme suggests that the loan will be taken as defaulted when the interest and/or principal is overdue by more than 90 days. It further goes to refer to crystallisation of liability on the underlying borrower. The meaning of “crystallisation of liability” is not at all clear, and is, regrettably, inappropriate. The word “crystallisation” is commonly used in context of floating charges, where the charge gets crystallised on account of default. It is also sometimes used in context of guarantees where the liability is said to crystallise on the guarantor following the debtor’s default. The word “underlying borrower” should obviously mean the borrower included in the pool of loans, who always had a crystallised liability. In context, however, this may mean declaration of an event of default, recall of the loan, and thereby, requiring the borrower to repay the entire defaulted loan. 

  1. On occurrence of “default” as above, will be the Bank be able to claim the entire outstanding from the underlying borrower, or the amount of defaulted interest/principal?

The general principle in such cases is that the liability of the guarantor should crystallise on declaration of an event of default on the underlying loan. Hence, the whole of the outstanding from the borrower should be claimed from the guarantor, so as to indemnify the bank fully. As regards subsequent recoveries from the borrower, see later.

  1. Does the recognition of loss by the bank on a defaulted loan have anything to do with the excess spreads/interest on the other performing loans? That is to say, is the loss with respect to a defaulted loan to be computed on pool basis, or loan-by-loan basis?

A reading of para D would suggest that the claiming of compensation is on default of a loan. Hence, the compensation to be claimed by the bank is not to be computed on pool basis. However, any pool-level enhancement, such as excess spread or over-collateralisation, will have to be exhausted first.

  1. Can the guarantee be applicable to a revolving purchase of loans by the bank from the NBFC, that is, purchase of loans on a continuing basis?

No. The intent seems clearly to apply the Scheme only to a static pool.

  1. If a bank buys several pools from the same NBFC, is the extent of first loss cover, that is, 10%, fungible across all pools?

No. The very meaning of a first loss cover is that the protection is limited to a single, static pool.

  1. What will the 20% first loss guarantee in case of Paper Purchase signify?

The meaning of first loss guarantee will be the same in case of Paper Purchases, as in case of Pool Purchases. The difference is clearly the lack of granularity in case of Paper purchases, as the exposure is on the issuer NBFC, and not the underlying borrower.

Hence, if the issuer NBFC fails to redeem the paper on maturity, the PSB shall be entitled to claim payment from the guarantor.

  1. From the viewpoint of maximising the benefit of the guarantee in case of Pool Purchase, should a bank try and achieve maximum diversification in a pool, or keep the pool concentric?

The time-tested rule of tranching of risks in static pools is that in case of concentric, that is, correlated pools, the limit of first loss will be reached very soon. Hence, the benefit of the guarantee is maximised when the pool is diversified. This will mean both granularity of the pool, as also diversification by all the underlying risk variables – geography, industry or occupation type, type of property, etc.

  1. Is the same principle of pool diversification applicable to a Paper purchase also?

Yes, absolutely. The guarantee is a tranched-risk cover, upto a first loss piece of 20%. In case of all tranched risk cover, the benefit can be maximised only if the risk is spread across a granular pool.

  1. Can or should the Scheme be deployed for buying a single loan, or a few corporate loans?

First, the reference to pools obviously means diversified pools. As regards pools consisting of a few corporate loans, as mentioned above, the first loss cover will get exhausted very soon. The principle of tranching is that as correlation/concentricity in a pool increases, the risk shifts from lower tranches to senior tranches. Hence, one must not target using the Scheme for concentric or correlated pools.

  1. In case of Pool Purchases, on what amount should the first loss guarantee be calculated – on the total pool size or the total amount of assets assigned?

While, as we discussed earlier, there is no applicability of the DA Guidelines in the present case, there needs to be a minimum skin in the game for the selling Financial Entity. Whether that skin in the game is by way of a pari passu vertical tranche, or a subordinated horizontal tranche, is a question of the rating required for attaining the benefit of the guarantee. Therefore, if we are considering a pool of say ₹ 1000 crores, the originator should retain at least ₹ 100 crores (applying a 10% rule – which, of course, will depend on the rating considerations) of the total assets in the pool and only to the extent the ₹ 900 crores can be assigned to the purchasing bank.

The question here is whether the first loss guarantee will be calculated on the entire ₹ 1000 crores or ₹ 900 crores. The intention is guarantee the purchasing banks’ share of cash flows and not that retained by the originator. Therefore, the first loss guarantee will be calculated on ₹ 900 crores in the present case.

Scope of the GoI Guarantee

  1. In case of Pool Purchases, does the guarantee cover both principal and interest on the underlying loan?

The guarantee is supposed to indemnify the losses of the beneficiary, in this case, the bank. Hence, the guarantee should presumably cover both interest and principal.

  1. Does the guarantee cove additional interest, penalties, etc.?

Going by Rule 277 (vi) of the GFR, the benefit of the guarantee will be limited to normal interest only. All other charges – additional interest, penal interest, etc., will not be covered by the guarantee.

  1. In case of Paper Purchases, what all does the guarantee cover?

Once again, the guarantee seems to be for the maturiing amount, as also the accumulated interest.

  1. How do the General Financial Rules of the Government of India affect/limit the scope of the guarantee?

Para 281 of the GFR provides for annual review of the guarantees extended by the Government. The concerned department, DFS in the present case, will conduct review of the guarantees extended and forward the report to the Budget Division. However, if the Government can take any actions based on the outcome of the review is unclear.

Bankruptcy remoteness

  1. Does the transaction of assignment of pool from the Financial Entity to the bank have to adhere to any true sale/bankruptcy remoteness conditions?

The transaction must be a proper assignment, and should achieve bankruptcy remoteness in relation to the Financial Entity. Therefore, all regular true sale conditions should be satisfied.

  1. Can a Financial Entity sell the pool to the bank with the understanding that after 2 years, that is, at the end of the guarantee period, the pool will be sold back to the NBFCs?

Any sale with either an obligation to buyback, or an option to buy back, generally conflicts with the true sale requirement. Therefore, the sale should be a sale without recourse. However, retention of a right of first refusal, or right of pre-emption, is not equivalent to option to buy back. For instance, if, after 2 years, the bank is desirous of selling the pool at its fair value, the NBFC may have the first right of buying the same. This is regarded as consistent with true sale conditions.

  1. If off-balance sheet treatment from IFRS/Ind-AS viewpoint at all relevant for the purpose of this transaction?

No. Off balance sheet treatment is not relevant for bankruptcy remoteness.

  1. Is the Pool Purchase transaction subject to bankruptcy risk of the issuer finance company?

Yes, absolutely. There is no bankruptcy remoteness in case of paper purchases.

Short term bond instrument regulations

  1. What are the specific regulations to be complied with in case of PAPER issuance?

The issuing NBFC/HFC will have to comply with the provisions of Companies Act, 2013. Additionally, depending on the tenure and nature of the PAPER, the regulations issued by RBI for money market instruments shall also be applicable.

  1. Given the current regulatory framework for short term instruments, is it possible to issue unrated instruments with maturity less than 12 months?

As per the RBI Master Directions for Money Market Instruments, the issuers is required to obtain credit rating for issuance of CP from any one of the SEBI registered CRAs. Further, it is prescribed that the minimum credit rating shall be ‘A3’ as per rating symbol and definition prescribed by SEBI.

Similarly, in case of NCD issuance with tenure upto one year, there is a requirement to obtain credit rating from one of the rating agencies. Further, the minimum credit rating shall be ‘A2’ as per rating symbol and definition prescribed by SEBI.

Buyers and sellers

  1. Who are eligible buyers under this Scheme?

Both in case of Pool Purchases as also Paper Purchases, only Public Sector Banks are eligible buyers of assets under this Scheme. Therefore, even if a Private Sector Bank acquires eligible assets from eligible sellers, guarantee under this Scheme will still not be available.

This may be keeping in view two points – first, the intent of the Scheme, that is, to nudge PSBs to buy pools from Financial Entities. It is a well-known fact that private sector banks are, as it is, actively engaged in buying pools. Secondly, in terms of GFR of the GoI, the benefit of Government guarantee cannot go to the private sector. [Rule 277 (vii)] Hence, the Scheme is restricted to PSBs only.

  1. Who are eligible sellers under the Scheme in case of Pool purchases?

The intention of the Scheme is to provide relief from the stress caused due to the ongoing liquidity crisis, to sound HFCs/ NBFCs who are otherwise financially stable. The Scheme has very clearly laid screening parameters to decide the eligibility of the seller. The qualifying criteria laid down therein are:

  • NBFCs registered with the RBI, except Micro Financial Institutions or Core Investment Companies
  • HFCs registered with the NHB
  • The NBFC/ HFC must have been able to maintain the minimum regulatory capital as on 31st March, 2019, that is –
    • For NBFCs – 15%
    • For HFCs – 12%
  • The net NPA of the NBFC/HFC must not have exceeded 6% as on 31st March, 2019
  • The NBFC/ HFC must have reported net profit in at least one out of the last two preceding financial years, that is, FY 2017-18 and FY 2018-19.
  • The Original Scheme stated that the NBFC/ HFC must not have been reported as a Special Mention Account (SMA) by any bank during the year prior to 1st August, 2018. However, the Amendment even allows NBFC/HFC which may have slipped during one year prior to 1st August, 2018 shall also be allowed to sell their portfolios under the Scheme.
  1. Who are eligible issuers under the Scheme in case of PAPER purchases?

The intention of the Scheme is to provide relief from the stress caused due to the ongoing liquidity crisis, the eligible issuers are as follow:

  • NBFCs registered with the RBI except Government owned NBFCs
  • All MFIs which are members of a Self-Regulatory Organisation (SRO) recognized by RBI shall be eligible for purchase of Bonds/ CPs.
  • HFCs registered with the NHB except Government owned HFCs.
  1. In case of pool purchases, can NBFCs of any asset size avail this benefit?

Apparently, the Scheme does not provide for any asset size requirement for an NBFC to be qualified for this Scheme, however, one of the requirements is that the financial institution must have maintained the minimum regulatory capital requirement as on 31st March, 2019. Here it is important to note that the requirement to maintain regulatory capital, that is capital risk adequacy ratio (CRAR), applies only to systemically important NBFCs.

Only those NBFCs whose asset size exceeds ₹ 500 crores singly or jointly with assets of other NBFCs in the group are treated as systemically important NBFCs. Therefore, it is safe to assume that the benefits under this Scheme can be availed only by those NBFCs which – a) are required to maintain CRAR, and b) have maintained the required amount of capital as on 31st March, 2019, subject to the fulfillment of other conditions.

  1. In case of issuance of bonds/commercial papers, is there a similar capital requirement?

There is no such condition in case of bond and CP issuance.

  1. In case of pool purchases, the eligibility criteria for sellers state that the financial institution must not have been reported as SMA-1 or SMA-2 by any bank any time during 1 year prior to 1st August, 2018– what does this signify?

As per the prudential norms for banks, an account has to be declared as SMA, if it shows signs of distress without slipping into the category of an NPA. The requirement states that the originator must not have been reported as an SMA-1 or SMA-2 any time during 1 year prior to 1st August, 2018, and nothing has been mentioned regarding the period thereafter.

Therefore, if a financial institution satisfies the condition before 1st August, 2018 but becomes SMA-1 or SMA-2 thereafter, it will still be eligible as per the Scheme. The whole intention of the Scheme is to eliminate the liquidity squeeze due to the ILFS crisis. Therefore, if a financial institution turns SMA after the said date, it will be presumed the financial institution has fallen into a distressed situation as a fallout of the ILFS crisis.

Eligible assets

  1. What are the eligible assets for the Scheme in case of Pool Purchases?

The Scheme has explicitly laid down qualifying criteria for eligible assets and they are:

  • The asset must have originated on or before 31st March, 2019.
  • The asset must be classified as standard in the books of the NBFC/ HFC as on the date of the sale.
  • The original Scheme stated that the pool of assets should have a minimum rating of “AA” or equivalent at fair value without the credit guarantee from the Government. However, through the Amendment, the rating requirement has been brought down to BBB+.
  • Each account under the pooled assets should have been fully disbursed and security charges should have been created in favour of the originating NBFCs/ HFCs.
  • The individual asset size in the pool must not exceed ₹ 5 crore.
  • The following types of loans are not eligible for assignment for the purposes of this Scheme:
    • Revolving credit facilities;
    • Assets purchased from other entities; and
    • Assets with bullet repayment of both principal and interest
    • Pools consisting of assets satisfying the above criteria qualify for the benefit of the guarantee. Hence, the pool may consist of retail loans, wholesale loans, corporate loans, loans against property, or any other loans, as long as the qualifying conditions above are satisfied.
  1. Should the Scheme be deployed for assets for longer maturity or shorter maturity?

Utilising the Scheme for pools of lower weighted average maturity will result into very high costs – as the cost of the guarantee is computed on the original purchase price.

Using the Scheme for pools of longer maturity – for example, LAP loans or corporate loans, may be lucrative because the amortisation of the pool is slower. However, it is notable that the benefit of the guarantee is available only for 2 years. After 2 years, the bank will not have the protection of the Government’s guarantee.

  1. If there are corporate loans in the pool, where there is payment of interest on regular basis, but the principal is paid by way of a bullet repayment, will such loans qualify for the benefit of the Scheme?

The reference to bullet repaying loans in the Scheme seems similar to those in DA guidelines. In our view, if there is evidence/track record of servicing, in form of interest, such that the principal comes by way of a bullet repayment (commonly called IO loans), the loan should still qualify for the Scheme. However, negatively amortising loans should not qualify.

  1. Is there any implication of keeping the cut-off date for originations of loans to be 31st March, 2019?

This Scheme came into force with effect from 10th August, 2019 and remained open till 30th June, 2020. The original Scheme also had this cut-off of 31st March, 2019.

Due to the extension, though the timelines have been extended by one year till 31st March, 2021, however, the cut off date has not changed. Therefore, in our view, this scheme will hold good only for long tenure loans, such as mortgage loans.

  1. Is there any maximum limit on the amount of loans that can be assigned under this Scheme?

Yes, the Scheme has put a maximum cap on the amount of assets that can be assigned and that is an amount equal to 20% of the outstanding standard assets as on 31st March, 2019, however, the same is capped to ₹ 5000 crores.

  1. Is there a scope for assigning assets beyond the maximum limits prescribed in the Scheme?

Yes, the Scheme states that any additional amount above the cap of ₹ 5,000 crore will be considered on pro rata basis, subject to availability of headroom. However, from the language, it seems that there is a scope for sell down beyond the prescribed limit, only if the eligible maximum permissible limit gets capped to ₹ 5,000 crores and not if the maximum permissible limit is less than ₹ 5000 crores.

The following numerical examples will help us to understand this better:

Total outstanding standard assets as on 31st March, 2019 ₹ 20,000 crores ₹ 25,000 crores ₹ 30,000 crores
Maximum permissible limit @ 20% ₹ 4,000 crores ₹ 5,000 crores ₹ 6,000 crores
Maximum cap for assignment under this Scheme ₹ 5,000 crores ₹ 5,000 crores ₹ 5,000 crores
Amount that can be assigned under this Scheme ₹ 4,000 crores ₹ 5,000 crores ₹ 5,000 crores
Scope for further sell down? No No Yes, upto a maximum of ₹ 1,000 crores

 

  1. When will it be decided whether the Financial Entity can sell down receivables beyond the maximum cap?

Nothing has been mentioned regarding when and how will it be decided whether a financial institution can sell down receivables beyond the maximum cap, under this Scheme. However, logically, the decision should be taken by the Government of India of whether to allow further sell down and closer towards the end of the Scheme. However, we will have to wait and see how this unfolds practically.

  1. What are the permissible terms of transfer under this Scheme?

The Scheme allows the assignment agreement to contain the following:

  • Servicing rights – It allows the originator to retain the servicing function, including administrative function, in the transaction.
  • Buy back right – It allows the originator to retain an option to buy back its assets after a specified period of 12 months as a repurchase transaction, on a right of first refusal basis. Actually, this is not a right to buy back, it is a right of first refusal which the NBFC/ HFC may exercise if the purchasing bank further sells down the assets. See elsewhere for detailed discussion

Rating of the Pool in case of Pool Purchases

  1. The Scheme requires that the pool must have a rating of BBB+ before its transfer to the bank. Does that mean there be a formal rating agency opinion on the rating of the pool?

Yes. It will be logical to assume that SIDBI or DFS will expect a formal rating agency opinion before agreeing to extend the guarantee. 

  1. The Scheme requires the pool of assets to be rated at least BBB+, what does this signify?

As per the conditions for eligible assets, the pool of assets to be assigned under this Scheme must have a minimum rating of “BBB+” or equivalent at fair value prior to the guarantee from the Government.

There may be a question of expected loss assessment of a pool. Initially, the rating requirement was pegged at “AA” or higher and there was an apprehension that the originators might have to provide a substantial amount of credit enhancement in order to the make the assets eligible for assignment under the Scheme. Subsequently, vide the Amendments, the rating has been brought down to BBB+. The originators may also be required to provide some level of credit enhancements in order to achieve the BBB+ rating.

Unlike under the original Scheme, where the rating requirement was as high as AA, the intent is to provide guarantee only at AA level, then the thickness of the guarantee, that is, 10%, and the cost of the guarantee, viz., 25 bps, both became questionable. The thickness of support required for moving a AA rated pool to a AAA level mostly is not as high as 10%. Also, the cost of 25 bps for guaranteeing a AA-rated pool implied that the credit spreads between AA and a AAA-rated pool were at least good enough to absorb a cost of 25 bps. All these did not seemed and hence, there was not even a single transaction so far.

But now that the rating requirement has been brought down to BBB+, it makes a lot of sense. The credit enhancement level required to achieve BBB+ will be at least 4%-5% lower than what would have been required for AA pool. Further, the spread between a BBB+ and AAA rated pool would be sufficient to cover up the guarantee commission of 25 bps to be incurred by the seller in the transaction.

Here it is important to note that though the rating required is as low as BBB+, but there is nothing which stops the originator in providing a better quality pool. In fact, by providing a better quality pool, the originator will be able to fetch a much lower cost. Further, since, the guarantee on the pool will be available for only first two years of the transaction, the buyers will be more interested in acquiring higher quality pools, as there could be possibilities of default after the first two years, which is usually the case – the defaults increase towards the end of the tenure.

Risk weight and capital requirements

  1. Can the bank, having got the Pool guaranteed by the GoI, treat the Pool has zero% risk weighted, or risk-weighted at par with sovereign risk weights?

No. for two reasons –one the guarantee is only partial and not full. Number two, the guarantee is only for losses upto first 2 years. So it is not that the credit exposure of the bank is fully guaranteed 

  1. What will be the risk weight once the guarantee is removed, after expiry of 2 years?

The risk weight should be based on the rating of the tranche/pool, say, BBB+ or better.

Guarantee commission

  1. Is there a guarantee commission? If yes, who will bear the liability to pay the commission?

As already discussed in one of the questions above, the Scheme requires the originators to pay guarantee commission of 25 basis points on the amount of guarantee extended by the Government. Though the originator will pay the fee, but the same will be routed through purchasing bank.

  1. The pool is amortising pool. Is the cost of 25 bps to be paid on the original purchase price?

From the operational details, it is clear that the cost of 25 bps is, in the first instance, payable on the original fair value, that is, the purchase price.

Invocation of guarantee and refund

  1. When can the guarantee be invoked in case of Pool Purchases?

The guarantee can be invoked any time during the first 24 months from the date of assignment, if the interest/ principal has remained overdue for a period of more than 90 days.

  1. When can the guarantee be invoked in the case of Paper Purchases?

There is no maximum time limit in case of Paper Purchases. Hence, the guarantee can be invoked upto maturity. The maximum maturity, of course, is limited to 18 months. 

  1. In case of Pool Purchases, can the purchasing bank invoke the guarantee as and when the default occurs in each account?

Yes. The purchasing bank can invoke the guarantee as and when any instalment of interest/ principal/ both remains overdue for a period of more than 90 days. 

  1. In case of PAPER Purchases, can the purchasing bank invoke the guarantee as and when the default occurs?

Assuming the instruments will have bullet repayment of principal, the answer is yes. 

  1. To what extent can the purchasing bank recover its losses through invocation of guarantee?

When a loan goes bad, the purchasing bank can invoke the guarantee and recover its entire exposure from the Government. It can continue to recover its losses from the Government, until the upper cap of 10% of the total portfolio is reached. However, the purchasing bank will not be able to recover the losses if – (a) the pooled assets are bought back by the concerned NBFCs/HFCs or (b) sold by the purchasing bank to other entities. 

  1. Within how many days will the purchasing bank be able to recover its losses from the Government?

As stated in the Scheme, the claims will be settled within 5 working days. 

  1. In case of pool purchase, what will happen if the purchasing bank recovers the amount lost, subsequent to the invocation of guarantee?

If the purchasing bank, by any means, recovers the amount subsequent to the invocation of the guarantee, it will have to refund the amount recovered or the amount received against the guarantee to the Government within 5 working days from the date of recovery. However, if the amount recovered is more than the amount received as guarantee, the excess collection will be retained by the purchasing bank. 

  1. In case of PAPER Purchase, what will happen if the purchasing bank recovers the amount lost, subsequent to the invocation of guarantee?

If the purchasing bank, by any means, recovers the amount subsequent to the invocation of the guarantee, it will have to refund the amount recovered or the amount received against the guarantee to the Government within 5 working days from the date of recovery. However, if the amount recovered is more than the amount received as guarantee, the excess collection will be retained by the purchasing bank.

Modus operandi

  1. What will be the process for a bank to obtain the benefit of the guarantee?

While the Department of Financial Services (DFS) is made the administrative ministry for the purpose of the guarantee under the Scheme, the Scheme involves the role of SIDBI as the interface between the banks and the GoI. Therefore, any bank intending to avail of the guarantee has to approach SIDBI.

  1. Can you elaborate on the various procedural steps to be taken to take the benefit of the guarantee?

The modus operandi of the Scheme is likely to be as follows:

  • An NBFC approaches a bank with a static pool, which, based on credit enhancements, or otherwise, has already been uplifted to a rating of BBB+ or above level.
  • The NBFC negotiates and finalises its commercials with the bank.
  • The bank then approaches SIDBI with a proposal to obtain the guarantee of the GOI. At this stage, the bank provides (a) details of the transaction; and (b) a certificate that the requirements of Chapter 11 of General Financial Rules, and in particular, those of para 280, have been complied with.
  • SIDBI does its own evaluation of the proposal, from the viewpoint of adherence to Chapter 11 of GFR and para 280 in particular, and whether the proposal is in compliance with the provisions of the Scheme. SIDBI shall accordingly forward the proposal to DFS along with a specific recommendation to either provide the guarantee, or otherwise.
  • DFS shall then make its decision. Once the decision of DFS is made, it shall be communicated to SIDBI and PSB.
  • At this stage, PSB may consummate its transaction with the NBFC, after collecting the guarantee fees of 25 bps.
  • In case of PAPER Purchase, the NBFC/HFC shall have to comply with the extant regulations for issuance of bonds/CPs, under Companies Act, 2013 and as issued by the regulators- RBI or NHB, as the case may be.
  • PSB shall then execute its guarantee documentation with DFS and pay the money by way of guarantee commission.
  1. Para 280(i)(a) of the GFR states that there should be back-to-back agreements between the Government and Borrower to effect to the transaction – will this rule be applicable in case of this Scheme?

Para 280 has been drawn up based on the understanding that guarantee extended is for a loan where the borrower is known by the Government. In the present case, the guarantee is extended in order to partially support a sale of assets and not for a specific loan, therefore, this will not apply.

Miscellaneous

  1. Is there any reporting requirement?

The Scheme does provide for a real-time reporting mechanism for the purchasing banks to understand the remaining headroom for purchase of such pooled assets. The Department of Financial Services (DFS), Ministry of Finance would obtain the requisite information in a prescribed format from the PSBs and send a copy to the budget division of DEA, however, the manner and format of reporting has not been notified yet. 

  1. What are to-do activities for the sellers to avail benefits under this Scheme?

Besides conforming to the eligibility criteria laid down in the Scheme, the sellers will also have to carry out the following in order to avail the benefits:

  • The Asset Liability structure should restructured within three months to have positive ALM in each bucket for the first three months and on cumulative basis for the remaining period;
  • At no time during the period for exercise of the option to buy back the assets, should the CRAR go below the regulatory minimum. The promoters shall have to ensure this by infusing equity, where required.

 

Other related articles-

Government Credit enhancement scheme for NBFC Pools: A win-win for all

GOI’s attempt to ease out liquidity stress of NBFCs and HFCs: Ministry of Finance launches Scheme for Partial Credit Guarantee to PSBs for acquisition of financial assets

Government credit enhancement for NBFC pools: A Guide to Rating agencies

http://vinodkothari.com/2019/09/partial-credit-guarantee-scheme/

 

[1] Including Indian Securitisation Foundation

[2] https://pib.gov.in/PressReleseDetailm.aspx?PRID=1595952

[3] https://www.rbi.org.in/Scripts/FAQView.aspx?Id=131

 

Regulator’s move to repair the NBFC sector

-Mridula Tripathi

(finserv@vinodkothari.com)

The evolving impact on people’s health has casted a threat on their livelihoods, the businesses in which they work, the wider economy, and therefore the financial system. The outbreak of this pandemic is nothing like the crisis faced by the economies in the year 2007-08 and imperils the stability of the financial system. The market conditions have forced traders to take aggressive steps exposing the system to great volatility thereby resulting in crashing asset values. Combating the pandemic and safeguarding the economy, the financial sectors across the globe have witnessed numerous reforms to hammer the aftermaths of the global crisis. Read more

Restructuring of bonds during COVID-19 crisis

This presentation covers the procedural requirements for restructuring of bonds/debentures during COVID-19 crisis.

Please click below for the presentation:

Part-1:

Please click here for the PPT used in the presentation.

 

The Rise of Stablecoins amidst Instability

-Megha Mittal

(mittal@vinodkothari.com

The past few years have witnessed an array of technological developments and innovations, especially in Fintech; and while the world focused on Bitcoins and other cryptos, a new entrant ‘Stablecoin’ slowly crept its way into the limelight. With the primary motive of shielding its users from the high volatility associated with cryptos, and promises of boosting cross-border payments and remittance, ‘Stablecoins’ emerged in 2018, and now have become the focal point of discussion of several international bodies including the Financial Standards Board (FSB), G20, Financial Action Task Force (FATF) and International Organization of Securities Commission (IOSCO).

Additionally, the widespread notion that the desperate need of cross-border payments and remittances during the ongoing COVID-crisis may prove to be a defining moment for stablecoins, has drawn all the more attention towards the need of establishing regulations and legal framework pertaining to Stablecoins.

In this article, we shall have an insight as to what Stablecoins, (Global Stable Coinss) are, its modality, its current status of acceptance by the international bodies, and how the ongoing COVID crisis, may act as a catalyst for its rise.

Read more

Australia’s unique Structured Finance Support Fund (SFSF)

– A $15 billion stimulus package for securitisation transactions

Timothy Lopes, Executive, Vinod Kothari Consultants

finserv@vinodkothari.com

Background

COVID-19 has pushed the global economy into recession. Many countries have made several policy reforms to address and mitigate the impact of the pandemic. Several countries have provided ‘moratorium’, ‘loan modification’ or ‘forbearance’ on scheduled loan obligations of borrowers.

There is no doubt that this deferment of payment by borrowers of principal and interest cause by moratorium in several countries, will have an impact on the cash flows in securitisation transactions.

Australia is one of the major economies that has provided relief to borrowers in the form of a six month moratorium for small business. Due to the relief provided, the country has also recognized the need for providing support to securitisation transactions which will be affected by the moratorium and has enacted a new legislation, thereby constituting a fund for structured finance.

In this write up we discuss the details of this seemingly new and innovative support mechanism for securitisation transactions.

Moratorium on loans in Australia

The Australian Banking Association (ABA)[1] has provided a moratorium package which extends to all small business loans as well as mortgages. There will be deferment of principal as well as interest for a period of six months. Interest will continue to be accrued, it can then be paid off over the life of the loan once repayments begin again, or the length of the loan can be extended.

In order to be eligible for the same, one must have less than $10 million total debt to all credit providers and needs to be current, and not in arrears as of 1 January 2020.

The Australian Structured Finance Support Fund (SFSF)

On 24th March, 2020, Australia enacted a new law called the Structured Finance Support (Coronavirus Economic Response Package) Act 2020[2] (‘Act’). The Act was supported with the Structured Finance Support (Coronavirus Economic Response Package) Rules 2020[3] (‘Rules’) as well as the Structured Finance Support (Coronavirus Economic Response Package) (Delegation) Direction 2020[4] (‘Delegation’).

The move was part of an announcement made by the Australian Government in this regard to provide continued access to funding markets for small and medium enterprises (SMEs) impacted by the economic effects of the Coronavirus, and to mitigate impacts on competition in consumer and business lending markets.

Pursuant to the Act, a Structured Finance Support Fund has been established with an initial corpus of A$15 billion. The said fund is managed by the Australian Office of Financial Management (AOFM)[5].

Purpose of the Fund

The fund is set up with the purpose of making investment in RMBS, ABS and warehousing facilities to compensate for cashflows deferred as a result of COVID-19 hardship payment holidays being granted to borrowers.

The idea is to invest in securities issued by SPVs who wish to be compensated for the missed interest component of scheduled payments not received from the borrower as a result of the payment holiday granted due to the impact of COVID-19.

This will provide a source of liquidity to securitisation transactions to mitigate the impact of non-payment of interest on account of the moratorium.

Inner mechanics of the fund

Eligible lenders who can access the fund are the following –

  1. A non-ADI lender, (regardless of size); or
  2. An ADI (Authorised Deposit-taking Institution) that does not have the capacity to provide the collateral that is acceptable to the Reserve Bank of Australia (RBA) under a term funding facility (and is not a subsidiary of another ADI that does have access to such a facility).

Authorised Debt Securities –

As per the Act, the fund is permitted to invest in only in ‘authorised debt securities’. As per Section 12 of the Act, –

An authorised debt security is a debt security that:

  • is issued by:
  • a trustee of a trust; or
  • a body corporate that is a special purpose vehicle; and
  • is expressed in Australian dollars; and
  • relates to one or more amounts of credit; and
  • complies with the requirements or restrictions (if any) prescribed by the rules.

The Rules go on to prescribe that for the purpose of Section 12, an authorised debt security must not be a first loss security.

Thus, we are looking at investments made by the fund in the senior most securities issued by an SPV or other securities, which must not be a first loss security.

Investment priority/ decision making –

The Delegation issued, sets out the investment strategies/policies, decision-making criteria and appetite for risk and return for the SFSF. These are designed to assist the fund to prioritise between investments.

As per the Delegation, priority must be given to investments which provide support to smaller lenders.

Setting up a “Forbearance” SPV

The Australian Securitisation Forum (ASF) and AOFM are developing a structure that will enable the SFSF to invest in new senior ranking debt securities issued by a newly constituted “Forbearance” SPV.

That SPV will then advance funds to securitisation trusts and warehouses who wish to draw liquidity advances to compensate for the missed interest component of scheduled payments not received as a result of the borrower being granted a payment holiday or moratorium due to the impact of COVID-19.

The plan of the ASF is to appoint legal counsel to develop a detailed term sheet to describe how an industry wide “Forbearance” SPV can operate subject to the terms of the SFSF legislation and the operational guidelines of the SFSF.  Once established eligible issuers and lenders can be registered to access the “Forbearance” SPV.  It is expected that eligible participants will need to subscribe for junior notes in the “Forbearance” SPV in proportion to their participation and these notes will not cross collateralise the obligations of the other participants.

The ASF expects that the “Forbearance” SPV will appoint an independent party to verify the transfer of eligible COVID-19 receivables to the SPV and reconcile drawdowns and repayments under the liquidity facility, amongst other things.

This is an innovative structure which would identify lenders in need, particularly small lenders and provide the required liquidity by advancing funds to compensate for the impact of the moratorium.

Conclusion

The structured finance industry world over is seen to impacted by payment holidays provided. While in most cases, there would have to be modification in the pay-outs of the securitisation transaction, Australia has recognised the need to support securitisation structures by setting up a Fund with a seemingly large corpus to deal with the issue of moratorium.

So far, the SFSF has announced two investments to date, the first in Firstmac’s 2019-1 RMBS and the second in a Judo Bank warehouse facility. This move along with several other policy measures taken by the Reserve Bank of Australia can only help mitigate the impact of COVID-19 on securitisation structures.

[1] https://www.ausbanking.org.au/covid-19/the-business-relief-package/

[2] https://www.legislation.gov.au/Details/C2020A00027

[3] https://www.legislation.gov.au/Details/F2020L00309

[4] https://www.legislation.gov.au/Details/F2020N00034

[5] https://www.aofm.gov.au/

Asset classification standstill and other liquidity support measures- RBI Governor’s Statement of 17th April, 2020

Team Financial Services, Vinod Kothari Consultants P Ltd. 

finserv@vinodkothari.com 

[Published on April 17, 2020 and updated as on May 6, 2020]

The nationwide lockdown was imposed by the Government of India from March 25, 2020. Since then, the RBI has taken a number of steps to ensure normal business functioning by the entire banking sector. The first address by the RBI governor on March 27, 2020[1] introduced several measures to deal with the disruption including, grant of a three months moratorium on term loans and the infusion of liquidity by way of TLTRO scheme.

The RBI Governor’s address on April 17, 2020[2] is intended to introduce further measures to maintain adequate liquidity in the financial system, facilitate and incentivise bank credit flows and ease financial stress. Subsequently, the RBI has issued a Notification on the issue.

Below is an analysis of the second round of regulatory relief granted by the RBI. As for the moratorium on loan payments provided by the March 27 notification, we have covered the same at length- see write-up here

For the ease of reading we have divided the FAQs into broad categories. We shall keep on updating the FAQs based on the detailed guidelines and clarifications issued by RBI in this regard, from time to time.

Liquidity Measures

Targeted Long Term Operations (TLTRO) 2.0

1. What is TLTRO?

Targeted Long Term Repo Operations or TLTRO, is a variation of LTRO, launched by the RBI in order to manage the liquidity in the financial sector. The TLTRO is a much refined version of LTRO, through which the RBI attempts to extend liquidity in targeted segments, in this case, the NBFCs. TLTRO was introduced first time on February 27, 2020[3] by the RBI, where it had promised repo auctions worth Rs. 1 lakh crore. Until this press release, RBI has already conducted three repo auctions injecting a total Rs. 75,041 crores worth to ease liquidity constraints in the banking system and de-stress financial markets.

Our detailed write up on the subject can be read here.

2a. What are the avenues in which the funds availed by banks under TLTRO 2.0 can be invested?

As stated above, the main intention behind TLTRO is to inject liquidity in the financial system. As per the notification[4] issued by the RBI for TLTRO 2.0 the funds raised through TLTRO have to be invested in investment grade bonds, commercial paper, and non-convertible debentures of NBFCs. Further, the funds raised through these auctions have to be deployed within a maximum period of 1 month.

2b. What is the prescribed timeline for deployment of funds under the scheme?

Based on the feedback received from banks and taking into account the disruptions caused by COVID-19, the time available for deployment of funds under the TLTRO 2.0 scheme has been extended from 30 working days to 45 working days from the date of the operation.

2c. What happens if a bank fails to deploy the funds availed under the TLTRO 2.0 scheme in specified securities within the stipulated timeframe?

Funds that are not deployed within this extended time frame will be charged interest at the prevailing policy repo rate plus 200 bps for the number of days such funds remain un-deployed. The incremental interest liability will have to be paid along with regular interest at the time of maturity.

3a. Is there a minimum investment limit for small and medium NBFCs?

At least 50 per cent of the total amount availed must be invested in small and mid-sized NBFCs and MFIs.

3b. Will the specified eligible instruments have to be acquired up to fifty per cent from primary market issuances and the remaining fifty per cent from the secondary market?

There is no such condition applicable for funds availed under TLTRO 2.0.

4. What is the criteria to be classified as a small or medium sized NBFC?

Small NBFCs: NBFCs having an asset size of Rs. 500 crore or below

Medium sized NBFCs: NBFCs having asset size between Rs. 500 crores and Rs. 5,000 crores.

5. For the purpose of determining the aforesaid asset based criteria, the asset size shall be considered as on  which date?

The asset size shall be determined as per the latest audited balance sheet of the investee institution/company.

6. How will the 50% be appropriated among small NBFCs, medium NBFCs and NBFC MFIs?

The 50% shall be apportioned as given below:

  • 10% – securities/instruments issued by Micro Finance Institutions (MFIs);
  • 15% – securities/instruments issued by NBFCs with asset size of Rs.500 crore and below;
  • 25% – securities/instruments issued by NBFCs with assets size between Rs.500 crores and Rs.5,000 crores.

7. How will the asset size be determined for the purpose of the aforesaid limits?

The asset size shall be determined as per the latest audited balance sheet of the NBFC.

8. When will the first auction under TLTRO 2.0 be conducted?

The first auction under TLTRO 2.0 will be conducted on April 23, 2020. The auction window will open for a period of one hour from 10:30 am to 11:30 am.

9a. How will the Investments made by the banks, under this scheme be classified?

Investments made under this facility will be classified as held to maturity (HTM) even in excess of 25 percent of total investment permitted to be included in the HTM portfolio. Exposures under this facility will not be reckoned under the Large Exposure Framework (LEF).

9b. Will the specified securities acquired from TLTRO funds and kept in HTM category be included in computation of Adjusted Net Bank Credit (ANBC) for the purpose of determining priority sector targets/sub-targets?

In order to incentivise banks’ investment in the specified securities of these entities, it has been decided that a bank can exclude the face value of such securities kept in the HTM category from computation of adjusted non-food bank credit (ANBC) for the purpose of determining priority sector targets/sub-targets. This exemption is only applicable to the funds availed under TLTRO 2.0.

10. What is the maturity restriction on the securities to be acquired under the scheme?

As per the FAQs released by the RBI for TLTROs[5], there is no maturity restriction on the securities. However, the outstanding amount of securities purchased using the funds availed under TLTRO should not fall below the amount availed under TLTRO scheme. This implies that the securities purchased should be maintained in the bank’s HTM portfolio at all times till maturity of TLTR.

11. How can an NBFC apply to avail the benefit under the scheme?

The funds injected through these auctions are ultimately meant for the NBFCs. NBFCs intending to utilise the benefits of this scheme will have to apply to banks, participating in these auctions, with their proposal to subscribe to the permitted instruments issued by them.

Refinancing Facilities

12. From where can an NBFC avail the refinancing facility?

RBI has provided special refinance facilities for an amount of Rs. 15,000 crore to SIDBI for on-lending/refinancing.

13. Is there anything earmarked for HFCs?

Yes, the RBI has announced a special refinancing facility of Rs. 10000 crores for the National Housing Bank which will be used only to refinance the housing finance companies.

14a. What will be the lending rate for such a refinance facility?

Advances under this facility will be charged at the RBI’s policy repo rate at the time of availment.

14b. Can all NBFCs avail the finance under the Special Liquidity Support Scheme?

The Scheme has three segments, out of which, two segments are for NBFCs and one for SCBs and SFBs.

The first part of the Scheme is for NBFC-ICCs and the second part of the Scheme is for NBFC-MFIs. The eligibility criteria for these two categories of NBFCs have been discussed below:

  • NBFC-ICC or NBFC-MFI ( In case of MFIs, they may be registered as society, trust or section-8 company)
  • Carrying on the business of an NBFC for the past 3 years;
  • Minimum NOF- 20 crores;
  • Minimum Asset size- 50 crores;
  • Minimum investment grade rating (BBB- or above); In case of MFI, also have minimum MFI grading of “MfR5”
  • Compliance with all regulatory requirements;
  • NBFC/ any of its promoters must not be in RBI’s defaulter/blacklist list;
  • Statutory CRAR is maintained at all times during the past 24 months.

14c. For what purpose, the finance availed from such scheme can be used?

The funds availed can be used for on-lending to MSMEs by the NBFCs and microfinance borrowers by NBFC-MFIs.

14d. What will be the tenor of such facility?

The tenor for such facility shall be 90 days,with a bullet repaymentat the end. Usually, the loans to MSMEs are more than 90 days tenor, therefore, the question is – if the tenor of the loans extended by the NBFCs are more than 90 days, how will the funds obtained under this Scheme be refunded timely. The logical answer to this question is that the NBFCs will have to arrange for alternative financing sources during these 90 days and use the funds to repay the facility under this Scheme. Therefore, it seems that the intent is to provide a bridge funding facility to the NBFCs for the time being.

Further, SIDBI has vide circular dated April 24, 2020, extended the repayment period of loans to NBFCs and MFIs, to one year from the 90-day period.

14e. Whether such facility will be secured?

The nature of the loans shall be based on the existing norms of SIDBI.

14f. Is there any cap on processing fee?

The processing fee shall be 0.10 % of the sanctioned loan amount subject to a maximum of Rs. 5 lakhs (including GST).

14g. How can NBFCs apply to avail benefit of such scheme?

There is no prescribed procedure for making application to SIDBI for availing funds under such scheme. Eligible NBFCs may apply to SIDBI to avail funds from the scheme.

Regulatory Measures

Asset Classification

15. What is meant by asset classification standstill?

Asset classification standstill means there will be no movement, deterioration or upgradation, in the asset classification during a given period of time. In the given context, the ageing of the loan default, that is, the days past due (DPD) status, will remain on a standstill mode, as if the time clock has stopped running during the period of the moratorium.

Our detailed write up on the issue can be read here.

Our analysis of the Delhi HC and Bombay HC ruling in this regard may also be read here.

16. How to determine the qualifying loan accounts for relaxation under this circular?

All loan accounts for which lending institutions decide to grant moratorium or deferment, and which were standard as on March 1, 2020.

17. The loan moratorium notification came on 27th March. For many companies, the payment for March was, say, due on 5th March. Therefore, the moratorium was effectively granted only for the payments due on 5th April and 5th May. Does such NBFC still have the right to keep the NPA clock on hold for accounts which were in default on 1st March, 2020?

In our view, the moratorium period uniformly began for all financial institutions on 1st March and continues upto 31st May. The moratorium is the result of an external event – hence, it is not something which is based on entity-level payment schedules. That the borrowers have paid the instalments due on 5th March does not impact the moratorium – moratorium simply implies the customer has the option of not paying, but he has chosen to pay, that is his discretion.

Therefore, in this case in point, the NPA clock will still be on hold from 1st March to 31st May.

18. How will the asset classification be carried out?

As per the guidelines[6] provided by the RBI, the asset classification relaxation is provided only if the account was to move from standard to sub-standard category during the moratorium period from March 1, 2020 to May 31, 2020. However, if the account was within the NPA category already, the benefit of the relaxation will not be available.

Effectively the circular stalls the dip in the asset classification by 3 months.

19. To what installment dues does the relaxation apply?

The relaxation applies to:

  1. Dues payable between 1st March, 2020 and 31st May, 2020
  2. Dues payable before 1st March that are classified as standard as on 1st March
  3. Dues payable after 31st May, will be covered by the existing instructions with regard to NPA recognition unless the lender grants a voluntary relaxation in accordance with the RBI Guidelines

20. Does a standard loan account as on March 1, 2020 include SMA classified accounts?

In case of assets showing signs of distress as on March 1, 2020, such as SMA1 and SMA2, the relaxation will still be available since they are classified as standard assets.

 21. Will the standstill be applicable in case of extension of the EMI dates for installments falling due after May 31, 2020?

The standstill will be applicable for all accounts for which lending institutions decide to grant moratorium or deferment, and which were standard as on March 1, 2020.

Considering the disruption caused across the globe, the Company may consider extension of the EMI dates for installments falling due after May 31, 2020.

The reason for granting such relaxation is not related to any specific borrower’s financial difficulty because of any economic or legal reasons. The reason for such relaxation would be the disruption caused across an entire class of borrowers and not any individual borrower. Hence, this would not be considered as “restructuring” and will not require any asset classification downgrade merely because of restructuring. However, if the borrower does not pay the “restructured debt” as well, then asset classification norms will apply.

22. An NBFC has the following borrower accounts with DPDs marked, how will the NPA classification be impacted in case of non-payment

DPD as on March 01, 2020 NPA declaration (in case moratorium has been granted) NPA declaration (in case moratorium has not been granted)
0 31st August, 2020 31st May, 2020
30 31st July, 2020 30th April, 2020
60 30th June, 2020 31st March, 2020
90 1st March, 2020 1st March, 2020
120 Already NPA Already NPA

 23. Will the delayed instalments accrue in the books of accounts?

The accounting entries with regard to accrual of the instalments will depend on the grant of moratorium, that is, accrual will happen as per the modified contractual terms. However, as regards income recognition, NBFCs that have moved to IndAS recognise income based on the “effective interest rate” method. As long as the effective interest rate has been maintained after restructuring, income recognition will continue at that rate, even during the moratorium period.

24. Can a lender take enforcement action on account of non-payments during the breather period?

In case there was a default, and there were remedies available to the lender as on 1st March already, the same will not be affected.

As regards the period of moratorium, since the contractual obligation of the borrower has been modified, there is no default unless the borrower defaults on the restructured obligations.

As regards the use of powers under SARFAESI, the same depends on “NPA classification” in books of account. Since the loan will not be classified as NPA, there will be a bar on SARFAESI action as well.

Provisioning requirement

25. Para 5 of the RBI Notification talks about a provisioning requirement. This, on first reading, seems to suggest that the provisioning requirement will be applicable to all the loans which have been given the benefit of moratorium. Is this understanding correct?

No, this understanding is not correct. Note the words “In respect of accounts in default but standard where provisions of paragraphs (2) and (3) above are applicable, and asset classification benefit is extended, lending institutions shall make general provisions of not less than 10 per cent of the total outstanding of such accounts.. [Emphasis supplied].

The meaning of this is not to include every loan which was >0 DPD on 1st March. The intent of this is only such loans, which, but for the standstill of the asset classification, would have turned into NPA.

In case of March 31, 2020 quarter, only loans which were at least 60 DPD on 1st March would have become NPA. Therefore, 5% general provisioning will be required only for such loans as were >59 DPD on 1st March, 2020.

26. There are some who have argued that the 10% general provision (spread over two quarters) will be applicable to both SMA1 as well as SMA2. Do you agree with this view?

Respectfully, we do not agree with this view. This view will be counter-intuitive. There is no provisioning required until the asset reaches substandard status. An account which was SMA1 (>30 days on 1st March) would not have become NPA on 31st March. Hence, the question of any degradation to NPA would not have arisen. Nor would there have been any provisioning requirement (except for the 0.40% required for all assets). The moratorium has not made the SMA1 loans worse in any manner. Therefore, there is no question of the RBI obliging banks to make a provision, which was not required before the 17th April Notification.

The 5% provision (for Q4 of 2020) may only be applicable where, but for the 17th April notification, the account would have become NPA. That would be the case in case of those accounts which were SMA2 on 1st March, 2020.

Note: A substantial confusion was prevailing on this issue. We had given a precise reasoning for our view above. As per a Report, the RBI also eventually seems to have agreed to our view above. That is, the general provisioning requirement is applicable, as on 31st March, 2020, only to those accounts which were SMA2 on 1st March, 2020.

27. What about the quarter of 30th June, 2020?

The quarter of June 30 may be a tough one. The general provisioning requirement is to be spread over 2 quarters. Hence, the situation may be illustrated in the Table below:

Position as on 31st March, 2020

DPD as on March 01, 2020 DPD on 31st March, 2020 Whether 5% general loss provision in the Q4, 2020 required?
0 31 No question
30 61 No, because there would have been no slippage of asset classification, even in absence of the Notification
60 91 Yes, 5% general loss provision required
90 121 Account was an NPA; 10% provision required

 

Position as on 30th June, 2020

DPD as on March 01, 2020 DPD on 30th June, 2020 Explanation Whether 5% general loss provision in the Q4, 2020 required?
0 91 During the moratorium, from 1st March to 31st May, customer paid nothing. In June, customer pays one months’ payment There was no payment obligation during the moratorium since there was a loan modification. There was no default on 1st March. The customer has cleared his obligations of June. Hence, the account is completely in order – the 90 DPD is actually the obligations during moratorium, which has been deferred. No provisioning at all
30 121 The customer did not clear his default of 30 days which was past due on 1st March. When the moratorium is over, he pays one single instalment of loan. Based on FIFO principle, the obligation that was past due on 1st March has been cleared on 30th June. Nothing became due during March, April and May. Hence, this loan has not taken the benefit of standstill. Hence, no general provision required.
60 151 The customer has paid only one instalment in June, whereas, on 1st March, he has obligation to pay for 2 months. Therefore, obligation as on 1st March achieves a vintage of at least 120 days on 30th June. There was a provision of 5% already made in Q4, 2020. An additional 5% general loss provision will be required in Q1, 2021.
90 181 The account was already an NPA Not covered by general loss provisions.

 28. What is the meaning of general loss provision? How is it different from a provision for NPAs?

General loss provision is a general prudential provision. It does not cause the value of gross assets to be reduced. It does not require the asset to be classified as an NPA. The general loss provision will be treated as a part of Tier 2 capital.

29. Is it proper to say that the general provisioning requirement of the 17th April notification creates a pressure on the regulatory capital of banks?

The general loss requirement certainly hits the revenues of the banks, but it is treated as a part of Tier 2. Hence, essentially, what is happening is, the provision eats into Tier 1 capital, but fills the same in Tier 2. If the bank had inadequate or potentially weak Tier 1, the general loss provision will create an issue.

30. Will there be any impact on the provision for accounts already classified as NPA as on February 29, 2020?

The provisions for accounts already classified as NPA as on February 29, 2020 as well as subsequent ageing in these accounts, shall continue to be made in the usual manner.

31. Will the reporting to CICs also come to a standstill due to the standstill of asset classification?

There will be no reporting to CICs since the SMA status, where applicable, as on March 1, 2020 will remain unchanged till May 31, 2020.

32. What are the disclosure requirements to be ensured by the lender?

The lending institutions shall suitably disclose the following in the ‘Notes to Accounts’ while preparing their financial statements for the half year ending September 30, 2020 as well as for FY 2019-20 and 2020-2021:

(i) Respective amounts in SMA/overdue categories, where the moratorium/deferment was extended;

(ii) Respective amount where asset classification benefits is extended;

(iii) Provisions made during the Q4FY2020 and Q1FY2021;

(iv) Provisions adjusted during the respective accounting periods against slippages and the residual provisions.

Impairment requirement for NBFCs

33. What is the relevance of para 17 of the Governor’s statement as regards NBFCs? Is it giving discretion to NBFCs regarding how much moratorium can they offer?

Para 17 of the Governor’s statement (relevant part) reads:

“NBFCs, which are required to comply with Indian Accounting Standards (IndAS), may be guided by the guidelines duly approved by their boards and as per advisories of the Institute of Chartered Accountants of India (ICAI) in recognition of impairments. In other words, NBFCs have flexibility under the prescribed accounting standards to consider such relief to their borrowers.”

In our view, this has nothing to do with the grant of the moratorium or the standstill on asset classification.This para deals with the recognition of impairment losses, that is, ECL provisions, in the books of those NBFCs which have adopted IndAS 109.

So, to summarise:

  • Moratorium period, 1st March to 31st May, is consistent for all financial entities, including banks.
  • The standstill provisions are also the same for NBFCs.
  • As regards ECL provisions, NBFCs may be guided by accounting guidance.

34. What are the guidelines for recognition of impairments/ECL?

IFRS Foundation has given the following guidance on computation of ECL due to impact of the coronavirus:

“Entities should not continue to apply their existing ECL methodology mechanically. For example, the extension of payment holidays to all borrowers in particular classes of financial instruments should not automatically result in all those instruments being considered to have suffered an SICR”[7] (SICR stands for significant increase in credit risk).”

There have been similar statements from the Basel Committee of Banking Supervision[8] (BCBS) where they have stated the following:

“Banks should use the flexibility inherent in these frameworks to take account of the mitigating effect of the extraordinary support measures related to Covid-19.”

“Regarding the SICR assessment, relief measures to respond to the adverse economic impact of COVID-19 such as public guarantees or payment moratoriums, granted either by public authorities, or by banks on a voluntary basis, should not automatically result in exposures moving from a 12-month ECL to a lifetime ECL measurement.”

As regards ICAI, ICAI has given a common guidance on impact of the pandemic on IFRS[9]. This states: “As a guidance from Appendix A of Ind AS 109: Borrower specific concession(s) given by lenders, on account of economic or contractual reasons relating to the borrower’s financial difficulty, which the lenders would not have otherwise considered. Such a condition to be considered as evidence that a financial asset is credit-impaired.”

The restructuring as permitted by the regulators is not a case of borrower-specific concession. It is given to all borrowers across.

Hence, this by itself cannot be a reason for any movement in the DPD bucket.

Extension of Resolution Timeline

35. What are the existing timelines for resolution of stressed assets?

As per the prudential framework for resolution of stressed assets[10], once an account defaults, a Review Period[11] of 30 days becomes operational. The resolution plan is to be implemented within 180 days after the Review Period. In case of failure to implement the resolution plan within the said 180 days, an additional provision of 20% of the amount outstanding in the account has to be maintained by the lender.

36. Will there be any impact on the Review Period?

The notification[12] issued by the RBI providing extension of 90 days for implementation of resolution plan also provides for a stay on the Review Period. Accordingly, if an account was under review period on March 1, 2020, the Review Period of 30 days shall freeze until May 31, 2020. The calculation of residual Review period shall start from June 01, 2020.

Further, through another notification on May 23, 2020 the RBI extended the period of stay to August 31, 2020. Accordingly, the review period shall resume from September 01, 2020.

 37. What will happen to the accounts whose Review Period has expired but the resolution plan has not been implemented?

For accounts whose Review Period has expired, but the timeline of 180 days for implementing the resolution plan has not expired as on March 1, 2020, the timeline shall be further extended by 90 days.

 38. What will be the implication of extending the period for the resolution plan by 90 days?

Given the current circumstances, delay in implementation of the resolution plan may be due to factors beyond control of the lender. Hence, due to the extension of the said timeline by 90 days, the requirement of maintaining additional provision of 20% gets delayed.

39. Will the deferment of creation of this provision aid the liquidity position of the lenders?

Since, the requirement of maintaining additional provision of 20% gets delayed, the lenders will have relatively more liquidity in hand at this time when liquidity is needed the most.

 40. Will the lender be required to hold an additional provision of 20 per cent if a resolution plan has not been implemented within 210 days from the date of such default?

No, the lender would not be required to hold additional provision of 20% if the resolution plan is not implemented within 210 days.

However, if the resolution plan is not implemented within 210+90= 300 days, an additional provision of 20% would have to be maintained.

41. Are there any disclosure requirements in this regard?

The notification requires the NBFCs to make relevant disclosures in respect of accounts where the resolution period was extended, in the ‘Notes to Accounts’ while preparing their financial statements for the half year ending September 30, 2020 as well as for FY2020 and FY2021.

NBFC Loans to Commercial Real Estate Projects

42.Which loans are defined as loans to Commercial Real Estate Projects?

The definition of loans to Commercial Real Estate has been aligned to Basel II norms, which is based on the source of loan repayment. As per the definition, if the repayment primarily depends on other factors such as operating profit from business operations, quality of goods and services, tourist arrivals etc., the exposure would not be counted as Commercial Real Estate (CRE).

Thus, whether a loan can be defined as a loan to CRE is a subjective matter and would require understanding of the business of the borrower, use of the loan proceeds etc.

43. What are the existing parameters for considering a loan to the commercial real estate sector as restructured?

As per the existing norms, the Date of Commencement of Commercial Operations (DCCO) shall be clearly spelt out at the time of financial closure of the project and the same shall be formally documented. In case the DCCO is extended beyond a period of one year from the predetermined DCCO or the terms of the loan are revised with a motive to provide the borrower with some relief during times of stress, the account is said to be restructured.

Upon restructuring, an account classified as standard would immediately become sub-standard i.e. the asset classification of the account has to be downgraded on restructuring.

44.What do the revised guidelines propose?

In line with the guidelines for banks, the NBFCs are now allowed to extend the DCCO for reasons beyond the control of promoters by an additional one year, over and above the one-year extension permitted in normal course, provided the revised repayment schedule is not extended more than the extension in DCCO .

45. What would be the impact of such an extension?

Considering the current situation, many of the commercial real estate projects may fail to initiate operations for a while. Due to this, the DCCO is likely to extend. As per the existing guidelines, if the DCCO extends for a period above 1 year, the account would become restructured and thus the asset classification would degrade. This would result in accumulation of lower grade assets into the books of NBFCs.

Allowing a time period of 2 years from the predetermined DCCO would provide the borrower with enough time to get back into operations and at the same time the asset classification would not be downgraded in the books of the NBFC.


[1] https://www.rbi.org.in/Scripts/bs_viewcontent.aspx?Id=3847

[2] https://rbidocs.rbi.org.in/rdocs/Content/PDFs/GOVERNORSTATEMENTF22E618703AE48A4B2F6EC4A8003F88D.PDF

[3] https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=49360

[4] https://rbidocs.rbi.org.in/rdocs/PressRelease/PDFs/PR2237379D65C898244520B79D8889EE42888E.PDF

[5] https://www.rbi.org.in/Scripts/FAQView.aspx?Id=134

[6] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11872&Mode=0

[7] https://cdn.ifrs.org/-/media/feature/supporting-implementation/ifrs-9/ifrs-9-ecl-and-coronavirus.pdf?la=en

[8] https://www.bis.org/press/p200403.htm

[9] https://resource.cdn.icai.org/58829icai47941.pdf

[10] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11580&Mode=0

[11] During this Review Period of thirty days, lenders may decide on the resolution strategy, including the nature of the RP, the approach for implementation of the RP, etc.

[12] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11871&Mode=0

The Great Lockdown: Standstill on asset classification

– RBI Governor’s Statement settles an unwarranted confusion

Timothy Lopes, Executive, Vinod Kothari Consultants

finserv@vinodkothari.com

Background

In the wake of the disruption caused by the global pandemic, now pitted against the Great Depression of 1930s and hence called The Great Lockdown[1], several countries have taken measures to try and provide stimulus packages to mitigate the impact of COVID-19[2]. Several countries, including India, provided or permitted financial institutions to grant ‘moratorium’, ‘loan modification’ or ‘forbearance’ on scheduled payments of their loan obligations being impacted by the financial hardship caused by the pandemic.

The RBI had announced the COVID-19 Regulatory Package[3] on 27th March, 2020. This package permitted banks and other financial institutions to grant moratorium up to 3 months beginning from 1st March, 2020. We have covered this elaborately in form of FAQs.[4]

However, there was ambiguity on the ageing provisions during the period of moratorium. That is to say,  if an account had a default on 29th February, 2020, whether the said account would continue to age in terms of days past due (DPD) as being in default even during the period of moratorium. Our view was strongly that a moratorium on current payment obligation, while at the same time expecting the borrower to continue to service past obligations, was completely illogical. Such a view also came from a judicial proceeding in the case of Anant Raj Limited Vs. Yes Bank Limited dated April 6, 2020[5]

However, the RBI seems to have had a view, stated in a mail addressed to the IBA,  that the moratorium did not affect past obligations of the customer. Hence, if the account was in default as on 1st March, the DPD will continue to increase if the payments are not cleared during the moratorium period.

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