FAQs on Resolution of Loan Accounts under COVID-19 stress

– Team Vinod Kothari Consultants P. Ltd. (finserv@vinodkothari.com)

Updated as on October 17, 2020

Background

As a part of measures for combating the effect of COVID-19 on the economy, the Reserve Bank of India (RBI), on August 6, 2020[1], introduced Resolution Framework for COVID-19 Related Stress (‘ResFraCoRS’), a special window for resolution of assets undergoing stress due to COVID-19 disruption[2]. This special window was introduced in addition to the Prudential Framework on Resolution of Stressed Assets issued on June 7, 2019 (FRESA)[3]. We have earlier covered FRESA in a separate write up titled “Prudential Framework for Resolution of Stressed Assets: New Dispensation for dealing with NPAs”[4]

The ResFraCoRS notification (‘Framework’) referred to an expert committee which shall identify suitable parameters, recommend sector-specific parameters, recommend financial and non-financial conditions to be incorporated in the RP, and to vet the RP as discussed above.

Further, the ResFraCoRS notification requires the RP with an amount of Rs. 1500 crores or more to be vetted by the expert committee.

Based on the recommendations of the expert committee submitted to RBI on September 4, 2020[5], the RBI issued a follow-up circular on September 7, 2020[6], which shall be complied, in addition to and as a part of the ResFraCoRS.

We have prepared below, a set of FAQs on ResFraCoRS, based on the aforementioned circulars issued by the RBI.

Furthermore, the RBI released FAQs with respect to the said scheme on October 14, 2020. The below FAQs have been updated after considering the clarifications provided by the RBI in its FAQs.

Timeline of events under ResFraCoRS

Frequently Asked Questions (FAQs) –

General

1.If loan modification/restructuring is a mutual contract between the lender and the borrower, why should I be seeing the regulatory framework?

True, loan modification is a mutual contract between the lender and the borrower. However, the Prudential Guidelines provide that if a facility is restructured, with a view to averting a credit weakness, then the restructured facility is regarded as a non-performing facility. This is a general feature of prudential regulations that assets are to be immediately classified as substandard upon restructuring. Hence, if a restructuring is done without adherence to the regulatory framework, then the facility will be treated as non-performing, immediately upon restructuring,

2. How does the loan modification help the lender, borrower, or both?

Loan modification restructures the servicing requirements of a loan, so that the borrower may meet the obligations. If the terms of the loan remain unconnected to the cashflows of the borrower, the borrower may not be able to perform. A non-performing borrower soon starts attracting penal clauses of the loan facility, thereby pushing the borrower further into the realm of non-performance. Eventually, the problem becomes incapable of resolution and may result in the insolvency or chronic default. A chronic default, while meaning exorbitant cost on the borrower, also causes a clog on the books of the lender, and eventually, results in an inefficient economy.

A good credit system is what can be serviced – there is no point in creating credit that cannot be serviced. Therefore, a loan modification, where required, should be encouraged.

Applicability – lenders and borrowers

3. On what lenders shall the ResFraCoRS be applicable?

ResFraCoRS shall be applicable to all banks, NBFCs, HFCs, AIFIs, etc. who have extended loans to eligible borrowers.

4. Are all NBFCs considered as eligible lenders for the purpose of this Framework?

The FRESA was addressed to only systemically important NBFCs and deposit-taking NBFCs. However, the ResFraCoRS, which is a special window to deal with COVID-related disruptions is applicable to all NBFCs. Unlike FRESA, the ResFraCoRS deals with personal loans also, and NBFCs are a key provider of personal loans.

5. Who shall be the eligible borrowers?

Following shall be the eligibility criteria for the borrowers:

  • The borrower/loan account should not be falling under the list of ineligible loans/exposures provided in the ResFraCoRS notification;
  • In case of resolution of personal loans, the Loan Account should, as on March 1, 2020, be:
    • classified as ‘standard’ in the books of the lender
    • not be in default for more than 30 days with the lender
  • In case of other than personal loans, the loan account should, as on March 1, 2020, be:
    • classified as ‘standard’ in the books of all the lenders
    • not be in default for more than 30 days with any of the lenders
  • The loan accounts should continue to be classified as ‘standard’ in the books of the lender or all the lenders, as the case may be, till the date of invocation of RP.

5A. What kind of personal loans would be covered under the Covid-19 restructuring window? Would it be applicable to car loans/ education loans, etc.?

Under the framework, personal loans refers to loans given to individuals and consist of –

Sr. No. Type of loan covered Definition/ remarks, if any
a. Consumer credit Consumer credit refers to the loans given to individuals, which consists of –

(a)    loans for consumer durables,

(b)   credit card receivables,

(c)    auto loans (other than loans for commercial use),

(d)   personal loans secured by gold, gold jewellery, immovable property, fixed deposits (including FCNR(B)), shares and bonds, etc., (other than for business / commercial purposes),

(e)    personal loans to professionals (excluding loans for business purposes), and

(f)     loans given for other consumptions purposes (e.g., social ceremonies, etc.).

 

However, it excludes

(a)    education loans,

(b)   loans given for creation/ enhancement of immovable assets (e.g., housing, etc.),

(c)    loans given for investment in financial assets (shares, debentures, etc.), and

(d)   consumption loans given to farmers under KCC.

b. Education loan While the above definition of consumer credit excludes education loans, housing loans and loans for purchase of financial assets, these loans are covered within the overall definition of “Personal Loans”
c. Loans given for creation/ enhancement of immovable assets (e.g., housing, etc.)
d. Loans given for investment in financial assets (shares, debentures, etc.)

Thus looking at the above definition of personal loans, car loans, education loans, and several other types of loan exposures would be covered under ResFraCoRS.

5B. From a lender’s perspective, will an entire category of borrowers be eligible to avail the restructuring benefit?

The restructuring option is applicable for personal loans and other eligible exposures, where the borrower account is classified as standard, but not in default for more than 30 days (SMA-0) as on 1st March, 2020. Accordingly, the restructuring benefit would be applicable only to those who are not excluded under the RBI circular- such as MSME borrower with less than Rs.25crore exposure, are classified as SMA-0 as on March 1, 2020 and are having stress on account of Covid19.

In this regard, an entire category of borrower may be said to be facing stress due to the Covid disruption and subject to fulfillment of the eligibility conditions the restructuring benefit may be extended to them.

5C. Will Loans Against Property (LAP) be eligible under this Scheme?

The end use of LAP is usually for personal purposes. In such a case, personal loans secured by immovable property and other than for business /commercial purposes shall be considered as a personal loan.

For an MSME borrower availing LAP for business purpose and having aggregate exposure of more than 25cr, the same shall be covered under the said framework under Part B- other than Personal Loans.

In case the borrower is a non-MSME, such as an individual or an entity, there is no limit on the exposure and accordingly, there can be two situations-
a. the borrower is availing a LAP facility for personal use- this will be eligible under the framework under the head Personal Loan
b. the borrower is availing a LAP facility for business/commercial use- this will be eligible under the framework under Part B- Other than Personal Loans.

5D. Can restructuring under this framework be done for loans granted after March 1, 2020?

The idea behind this framework is to provide benefit to the accounts which are likely to suffer owing to COVID-19 disruption. If a loan was granted after March 1, 2020, the lender must have had established a preliminary view of the impact of disruption and would have taken the same into consideration before deciding the terms of the loan.

Hence, loans given after the beginning of the disruption should not be eligible for restructuring benefit under this framework.

6. Is a “financial service provider” an eligible borrower, to avail the benefit of the restructuring under the Framework?

 The ResFraCoRs specifically exclude exposures to financial service providers. Therefore, financial service providers are not eligible borrowers. The definition of the term “financial service provider” has been drawn from the Insolvency and Bankruptcy Code, 2016. Apparently, NBFCs are covered under the definition of Financial Service Provider.

6A. Is the scheme applicable to MSMEs as well?

The scheme is applicable on MSME borrowers whose aggregate exposure to lending institutions collectively, is Rs. 25 crores or more as on March 1, 2020. The reason for the criteria of Rs. 25 crores or more collective exposure is because there is a separate notification for Micro, Small and Medium Enterprises (MSME) sector – Restructuring of Advances dated August 6, 2020, which is applicable on MSME borrowers having loan limits up to Rs.25 crores.

6B. The criteria for classification of enterprises as MSMEs was revised in July 2020. Should the revised criteria be considered for the purpose of this scheme?

The RBI has in its FAQs clarified that- “For the purpose of eligibility for resolution under the Resolution Framework, the definition of MSME that would be applicable is the one that existed as on March 1, 2020.”

The erstwhile definition of MSMEs prescribed the criteria based on investment limits for manufacturing and service sector entities. There has been a revision in the limits of investment and the addition of turnover limits as an additional requirement. However, for the purpose of determining eligibility under the Scheme, borrowers who were classified as MSME as on March 1, 2020 as per the then existing definition shall be considered.

Pursuant to the notification dated August 21, 2020, registration is a mandatory requirement for MSME borrowers. For this Scheme, since the erstwhile definition is to be considered, which implies that even unregistered MSMEs as on March 1, 2020, shall be eligible.

However, in our view, based on the RBI instructions vide August 21 notification, it is recommended to require all existing MSME borrowers to register on the Udyam portal.

7. Will all exposures be eligible for restructuring under this scheme, say investment exposures in form of Debentures, CP etc.?

Para 3 of the guidelines for the scheme states that the scheme is for all eligible corporate and personal exposures. Hence, the ResFraCoRS may be invoked for the resolution of all exposures to eligible borrowers, including investment exposures.

The same has also been clarified by the RBI in its FAQs.

7A. How will restructuring of debentures, CP etc. be done?

The terms determined at the time of issue of debentures, CP etc. are the final terms. Any change in the same shall be done with the approval of the investors. We have separately dealt with the manner and procedure for restructuring of debentures in our write-up- http://vinodkothari.com/2020/04/covid-19-and-debenture-restructuring/. Similar procedure may be applied to other instruments such as CP as well.

7B. A bank has given a loan to an NBFC, and discovers that due to the prevailing situation, the NBFC will not be able to meet its obligations as they currently exist. Can the bank restructure the facility?

 As stated above, the ResFraCoRS exclude exposures to FSPs. Therefore, the benefits under the said framework shall not be available in case of restructuring of loans extended to such entities.

However, banks can, at their discretion, consider restructuring of loans extended to FSPs, in such case, the general principles relating to restructuring of loans shall apply, including downgrading of account to NPA etc.

8. Under what circumstances or with what underlying motive is the ResFraCoRS applicable?

Any borrower, whose ability to service loan/credit facilities has been disrupted because of the COVID disruption may be covered by the Framework.

In our view, the types of borrowers may be classed into:

  • Those who had credit weakness/deterioration in credit prior to the beginning of the crisis
  • Those who did not demonstrate credit weakness before the COVID disruption (that is, before March 2020) but have had cashflow stress (mild, moderate of severe) during the COVID disruption; once the moratorium period is cover, their business is normal are not having any issues in their ability to service the facility
  • Those who did not demonstrate credit weakness before the COVID disruption (that is, before March 2020) but have had cashflow stress during the COVID disruption, which now seems to having a lasting impact on their servicing ability;
  • Those who did not demonstrate any credit weakness either before, during or after the COVID disruption

In our view, type (a) does not qualify for the present framework, as the intent of the present framework is only to modify those loans that have been disrupted due to the Covid-19 related stress.

Type (b) also does not require any restructuring. During the 6 months of moratorium, a standstill was granted, and that sufficiently helped the borrower. The borrower is back to the same cashflows as before the crisis/

Type (d) borrowers obviously do not require any restructuring.

It is type (c ) where the Framework requires help. That is where the present Framework operates.

To give an example,

  • A personal loan, home loan or car loan was given to a borrower, which was deducted from his monthly salaries. During the month of April to June, the borrower was given a moratorium as his office was shut and the borrower did not get salaries. From the month of July, the office is back in operation and the borrower keeps on getting salaries as before. Obviously there is no need for restructuring in the present case.
  • An infrastructure sector contract had taken a loan for an excavator. The excavator was lying idle during the months of April- June. July -Aug-Sept are typical monsoon months. It is expected that from October, normal construction activity may pick. The borrower’s servicing ability does not require any loan modification.
  • A loan was given for a CRE project. The project was stuck during April to July. While construction has begun in the month of August, however, it is apprehended that the demand for real estate may remain very sluggish at least over the next 12 months. This seems to be an appropriate case for ResFraCoRS.

Further, under the ResFraCoRS, the eligible borrowers may be divided into 3 categories:

  • Category 1- Borrowers of personal loans;
  • Category 2- Other than personal loan borrowers, which have availed loans from a single financial institution only;
  • Category 3- Other than personal loan borrowers, which have availed loans from more than one financial institution;

9. Is it applicable to both term loans as well as working capital facilities?

The eligibility criteria for ResFraCoRS is based on the asset classification of the borrower and not on the type of loan facility. The demarcation of term loans and working capital facility has to be done for the purpose of granting moratorium, however, for considering restructuring under this framework, any exposure to the borrower shall be covered. Hence, irrespective of the loan account being a term loan or working capital facility, in case it fulfills the eligibility criteria and the lenders have established that the stress in the account is due to covid disruption, the loans may be restructured under this framework.

 Formulation of RP

10. The August 6, 2020 as well as the June 7, 2019 circulars refer to a resolution plan – what exactly is a resolution plan?

The objective of a loan modification is not merely to grant concessions – it is to ensure that the terms of the loan are restructured so as to make the loan serviceable, at the same time, without compromising the interests of the lender(s). Hence, the “resolution plan” is the structured approach of the lender in modifying the terms of the loan so as to make the terms mutually agreeable, and mutually beneficial.

Quite often, in cases of large exposures, a resolution plan may involve capitalization of interest, partial conversion of debt into equity, change in terms of security, infusion of capital by the borrower, etc. Therefore, the resolution plan is a comprehensive approach to loan modification.

It is also notable that there are, often, cases of multiple lenders to the same borrower. Therefore, the loan modification is expected to take care of the interests of multiple lenders in a cohesive approach.

11. What are the different options/approaches in the resolution plan?

In case of personal loans covered in Part A, the resolution plans may inter alia include the following:

  • rescheduling of payments;
  • conversion of any interest accrued, or to be accrued, into another credit facility;
  • granting of moratorium, based on an assessment of income streams of the borrower, subject to a maximum of two years.
  • Modifying the overall tenor of the loan.

In case of other exposures covered in Part B, the RP may involve any action / plan / reorganization including, but not limited to:

  • regularisation of the account by payment of all over dues by the borrower entity;
  • sale of the exposures to other entities / investors;
  • sanctioning of additional credit facilities;
  • allowing extension of the residual tenor of the loan;
  • granting moratorium;
  • conversion of debt into instruments such as equity, debentures etc.
  • change in ownership and restructuring, except compromise settlements which shall continue to be governed by the provisions of the Prudential Framework or the relevant instructions, if any, applicable to specific categories of lending institutions.

The resolution plan may also include sanctioning of additional credit facilities to address the financial stress of the borrower on account of Covid19 even if there is no renegotiation of existing debt.

12. What is the meaning of “invocation” of an RP? Who invokes it? Borrower or lender? If there are multiple lenders, can it be invoked by any lender?

In case of personal loans the borrower and lender should agree to proceed with RP. The date on which the borrower and lender agree to proceed with the RP shall be the date of “invocation”.

In case of other exposures, where there is only one lending institution with exposure to the borrower, the decision regarding the request for resolution by the borrower may be taken by the lending institution as per the Board approved policy of the institution and within the contours of this framework.

This is similar to the existing Corporate Debt Restructuring scheme of RBI where the borrower does not have the inherent right to ask the lenders to restructure, however, the borrower may certainly request lenders to consider the same. Further, for this purpose, the date of invocation shall be the date on which both the borrower and lending institution have agreed to proceed with a resolution plan under this framework.

In case of multiple lenders with exposure to the borrower, the resolution process shall be treated as invoked in respect of any borrower if lending institutions –

  • Representing 75% by value of the total outstanding credit facilities (fund based as well non-fund based), and
  • not less than 60% of lending institutions by number agree to invoke the same.

13. The facility is currently not in default. It was within 30 days past due as on 1st March and thereafter, the facility was covered by moratorium. On 1st September, the lender realises that the cashflows of the borrower may be strained. Does the lender have to wait for any default? Can there be restructuring even when there is no default?

In our view, the resolution may be done for an imminent or incipient, or even apprehended default. The whole idea of resolution is to resolve a problem before it becomes unsurmountable. Hence, the fact of any default is not a precondition.

14. Who will frame the repayment plan?

In case of category 1 and 2 borrowers, the lender shall frame the RP. In case of multiple lenders i.e. category 3 borrowers, execution of ICA is a mandatory requirement wherein all the lenders shall agree on a resolution process, based on which a RP shall be formulated. Further, the Expert Committee shall verify the RP implemented in case the aggregate exposure of the lending institutions is Rs. 1500 crore or more.

15. What are the different stages of the loan restructuring process?

  • Realisation that a restructuring is required
  • Invocation of restructuring plan
  • Framing of restructuring plan
  • Signing of an ICA
  • Implementation of the restructuring plan including putting in place an escrow mechanism etc
  • Review period
  • Post-review period

 16. What are the preconditions for invocation of RP?

For categories 1 and 2:

  • The borrower should be eligible; and
  • The borrower and lender should agree to proceed with RP.

For category 3:

  • The borrower should be eligible;
  • Lending institutions representing at least 75 % by value of the total outstanding credit facilities (fund based as well non-fund based) agree to invoke the RP; and
  • At least 60 % of lending institutions by number agree to invoke the RP.

 17. In case of borrowers with business loans, is there any classification/ categorisation of borrowers based on the size of the exposure?

Under the Framework, it may be useful to classify borrowers into the following sizes:

  • Aggregate exposure of Rs 100 crores or more – Independent credit evaluation (ICE) by any one credit rating agency (CRA) authorized by the RBI under FRESA to be carried out.
  • Aggregate exposure of Rs 1500 crores or more- the RP shall be subject to vetting by the expert committee.

17A. In case of accounts for which ICE is conducted, is there a prescribed rating that an account must achieve in order to be restuctured?

The RBI released its FAQs regarding restructuring on October 14, 2020. The FAQs state that – “Only such resolution plans which receive a credit opinion of RP4 or better for the residual debt from a CRAs shall be considered for implementation under the Resolution Framework. In case credit opinion is obtained from more than one CRA, all such credit opinions must be RP4 or better.”

17B. What does the RP4 rating indicate?

RP is a rating indicator used by rating agencies for ICE of residual debts of borrowers. RP4 rating indicates that the debt facility/instrument has a moderate degree of safety regarding timely servicing of financial obligations and carries moderate credit risk.

18. One of the measures is providing a moratorium on loan repayment. Will this moratorium be a part of the existing moratorium facility provided to borrowers?

The ResFraCoRS notification provides that in cases where moratorium is granted to eligible borrowers, such moratorium shall be subject to a ceiling of 2 years. It is to be noted that the resolution under this framework is independent of any moratorium or other relief provided to the borrowers under other frameworks introduced by the RBI.

Hence, the above mentioned period of 2 years shall be in addition to the earlier moratorium granted to the borrowers. The earlier moratorium is not to be included in this period of 2 years.

This has been further clarified by para 28 of the ResFraCoRS notification, which states that the moratorium shall come into force immediately upon implementation of the resolution plan.

19. Can the debt be converted into equity instruments?

Conversion of debt into equity may be done provided the amortisation schedule and the coupon carried by such debt securities must be similar to the terms of the debt held on the books of the lending institutions, post implementation of the resolution plan.

Further, equity instruments are to be valued at market value, if quoted, or else, should be valued at the lowest value arrived using the book value or discounted cashflow valuation methodologies. Equity instruments, where classified as NPA shall be valued at market value, if quoted, or else, shall be collectively valued at Re.1. [Refer para 19 (c) and (d) of Annex to the Prudential Framework dated 7th June, 2019].

20. Can the debt be converted into NCDs/ preference shares or any other instrument?

Yes, the special window makes it clear that conversion of debt into NCDs or preference shares or any other instrument may be done. The debentures/ bonds would be valued on the YTM basis as per para 3.7.1 of the Master Circular – Prudential Norms for Classification, Valuation and Operation of Investment Portfolio by Banks[7] dated July 1, 2015 (as amended from time to time) or would be valued as per other relevant instructions as applicable to specific categories of lending institutions.

In case of conversion of any portion of the debt into any other security, the same shall collectively be valued at Re.1.

ICA and Escrow Arrangement

21. Is signing of Inter-Creditor Agreement (ICA) mandatory?

The notification clarifies that signing of ICA is a mandatory requirement for all lending institutions in all cases involving multiple lending institutions, where the resolution process is invoked.

22. Is there any time limit for signing the ICA?

The ICA should be signed within 30 days of invocation of RP.

 23. What will happen if ICA is not signed within the time limit?

In case the ICA is not signed within the prescribed time limit, the invocation of RP shall lapse. Further, additional provision of 20% will have to be maintained in respect of the carrying debt of the borrower in question, i.e. total outstanding of the borrower to all its lenders.

24. How should escrow accounts be maintained in case of ICA?

Escrow accounts shall be required only in case of category 3 borrowers. Para 10 of the follow-up circular states that the escrow account shall be maintained after implementation of RP on borrower-account level, i.e. the legal entities to which the lending institutions.

25. What are the limitations of the restructuring under the ResFraCoRS Framework?

The main limitation of the restructuring under ResFraCoRS is the tenor restrictiction of 2 years, in case of granting of moratorium under resolution plans. Further, the ratios prescribed under the financial parameters by the expert committee are required to be met by 2022 and on an ongoing basis thereafter. It must be noted that the expert committee suggested that the  TOL/Adjusted TNW and Debt/ EBIDTA ratios should be met by FY 2023. Further, some of the conditions (discussed later) of the Prudential Framework of June, 2019 are also additionally applicable in case of ResFraCoRS.

Relevance of the 7th June 2019 – Prudential Framework for Resolution of Stressed assets

26. Is the COVID-related framework a special case within the 7th June 2019 Directions, or is it an independent restructuring proposition?

The ResFraCoRS is a special window under the 7th June, 2019 – Prudential Framework for Resolution of Stressed Assets issued by RBI. Accordingly, the requirements specified in the Prudential Framework of June, 2019 would also apply in case of ResFraCoRS.

It is further clarified that accounts which do not fulfill the required eligibility conditions to be considered for resolution under the ResFraCoRS may continue to be considered for resolution under the Prudential Framework of June, 2019, or the relevant instructions as applicable to specific category of lending institutions where the Prudential Framework is not applicable.

27. What are the major provisions of the June, 2019 Directions which are applicable to the Covid-related restructuring as well?

The ResFraCoRS specifically mentions that without prejudice to the specific conditions applicable to this facility, all the norms applicable to implementation of a resolution plan, including the mandatory requirement of Inter Creditor Agreements (ICA) and specific implementation conditions, as laid out in the Prudential Framework shall be applicable to all lending institutions for any resolution plan implemented under this facility. Terms used in this document, to the extent not defined in the ResFraCoRS, shall have the same meaning assigned to them in the Prudential Framework.

Accordingly, the following major provisions of the Prudential Framework of June, 2019 would apply to the ResFraCoRS as well –

 

Para No. Particulars Requirement
9 Policy for resolution of stressed assets Lenders must put in place a Board approved policy for resolution of stressed assets.

 

This is apart from the policies mentioned in the COVID-related framework and these may be combined into a single policy as well.

10 Inter Creditor Agreement (ICA) The ICA shall provide that any decision agreed by lenders representing 75% by value of total outstanding credit facilities (fund based as well non-fund based) and 60% of lenders by number shall be binding upon all the lenders.

 

Additionally, the ICA may, inter alia, provide for rights and duties of majority lenders, duties and protection of rights of dissenting lenders, treatment of lenders with priority in cash flows/differential security interest, etc. In particular, the RPs shall provide for payment not less than the liquidation value due to the dissenting lenders.

Further, para 13 of the Prudential Framework dealing with inclusions in the RP are also applicable to ResFraCoRS with some modifications/ exceptions stated in para 27 of ResFraCoRS. Furthermore, it seems that para 16 of the Prudential Framework would also apply in case of ResFraCoRS (para 16 deals with deemed implementation in case of RP involving lenders exiting the exposure by assigning the exposures to third party or a RP involving recovery action).

28. The Prudential Framework mentions other requirements such as “Review Period” and “Prudential Norms”. Would these apply in case of ResFraCoRS?

Para 6 of ResFraCoRS states that all norms applicable to “implementation of a RP” under the Prudential Framework of June, 2019 would apply to ResFraCoRS. Accordingly, prudential norms would not be applicable in case of ResFraCoRS as this is already specifically taken care of in ResFraCoRS itself.

Furthermore, other requirements such as review of the borrowers account within 30 days of default would not apply as the ResFraCoRS already prescribed specific eligibility norms in its framework.

Financial Parameters

29. What financial parameters are to be considered while formulating the RP?

The notification has defined a set of 5 key ratios that must be mandatorily considered while finalising the resolution plan in respect of eligible borrowers. While the mandatory ratios must be followed, lenders have the liberty to consider other financial parameters as well, while finalizing the resolution assumptions in respect of eligible borrowers.

The Key ratios and definitions along with additional remarks on the same are presented below –

 

Sr. No. Key Ratio Definition
1 Total Outside Liabilities / Adjusted Tangible Net Worth (TOL/ATNW)

 

(Ceiling)

Addition of long-term debt, short term debt, current liabilities and provisions along with deferred tax liability divided by tangible net worth net of the investments and loans in the group and outside entities.
Remarks – In respect of those sectors where the sector-specific thresholds have not been specified, lending institutions shall make their own internal assessments regarding TOL/ATNW.

 

Compliance to TOL/ATNW agreed as per the resolution plan is expected to be ensured by the lending institutions at the time of implementation itself.

 

Nevertheless, in all cases, this ratio shall have to be maintained as per the resolution plan by March 31, 2022 and on an ongoing basis thereafter.

 

Wherever the resolution plan envisages equity infusion, the same may be suitably phased-in over this period.

 

Another concern in this regard is that the definition of Adjusted Tangible Net Worth provides for deduction of investments and loans in the group and outside entities. Considering a large proportion of the eligible borrowers for this framework will be infrastructure companies, this could be a major problem. Most of the entities engaged in the infrastructure space operate through SPVs, instead of working directly. Therefore, the majority of their assets are deployed in the equity of the SPVs. If the above definition of ATNW is to be followed, these entities will become ineligible for the purpose of this framework.

2 Total Debt / EBITDA

 

(Ceiling)

Addition of short term and long-term debt divided by addition of profit before tax, interest and finance charges along with depreciation and amortisation.
Remarks –

In respect of those sectors where the sector-specific thresholds have not been specified, lending institutions shall make their own internal assessments regarding Total Debt/ EBITDA.

This shall have to be maintained as per the resolution plan by March 31, 2022 and on an ongoing basis thereafter.

3 Current Ratio

 

(Floor)

Current assets divided by current liabilities
Remarks –

Current ratio in all cases shall be 1.0 and above.

This shall have to be maintained as per the resolution plan by March 31, 2022 and on an ongoing basis thereafter.

4 Debt Service Coverage Ratio (DSCR)

 

(Floor)

For the relevant year addition of net cash accruals along with interest and finance charges divided by addition of current portion of long term debt with interest and finance charges.
Remarks –

This shall have to be maintained as per the resolution plan by March 31, 2022 and on an ongoing basis thereafter.

5 Average Debt Service Coverage Ratio (ADSCR)

 

(Floor)

Over the period of the loan addition of net cash accruals along with interest and finance charges divided by addition of current portion of long term debt with interest and finance charges.
Remarks –

ADSCR shall in all cases be 1.2 and above.

This shall have to be maintained as per the resolution plan by March 31, 2022 and on an ongoing basis thereafter.

30. Are the financial parameters required to be considered in all the cases?

The financial parameters shall be considered in case of RP formulated for borrowers eligible under part B of  ResFraCoRS.  Part B of the ResFraCoRS deals with borrowers falling in categories 2 and 3.

31. What are prescribed thresholds to be maintained in respect to the ratios?

The expert committee has prescribed thresholds specific to the nature of the various industries. The annexure to the follow-up circular contains the ceilings/floors prescribed with respect to 26 sectors/industries.

32. What should be done in case there are no sector-specific parameters prescribed with respect to a certain industry?

While the follow-up circular prescribes ratio limits for a wide variety of industries, certain borrowers may not fall in any of those sectors. Further, in the annexure, certain ratios for some sectors have not been prescribed. For such kinds of borrowers, the lenders shall determine the limits considering the financial situation of the borrower, viability of borrower’s business, and the stress on the borrower. However, the current ratio and DSCR in all cases shall be 1.0 and above, and ADSCR shall be 1.2 and above.

33. The sectors specified in the framework do not include financial services, does this mean financial services entities (such as NBFCs, HFCs, who have availed loans from other NBFCs/banks) are not eligible for restructuring under this framework?

The sector specific ratios are provided as general parameters to be considered while formulating RP. This in no way indicates that the borrowers belonging to such sectors shall not be eligible for restructuring.

In case of borrowers falling in the sectors for which the ratios are not specified, the lender shall decide its own limits based on the assessment of the borrower.

However, please refer to our response on eligibility of loans to FSPs under this framework.

34. Who shall meet the ratios?

The borrower is required to meet the ratios at entity-level and the lenders are required to ensure that the same is being met as per the timelines.

For the real estate sector, the expert committee recommended that the ratios with respect to particular projects be met since the loans are usually granted for a project. However, the RBI, in the follow-up circular has not laid any such provision.

35. At what point of time shall these ratios be considered?

The above mentioned key ratios shall have to be maintained by the borrower as per the resolution plan by March 31, 2022 and on an ongoing basis thereafter.

Additionally, TOL/ATNW shall be required to be maintained by the borrower at the time of implementation of the RP itself, as per the resolution plan by March 31, 2022 and on an ongoing basis thereafter.

36. As discussed above, TOL/ATNW shall be maintained at the time of implementation. What should be done in case the ratio is not met?

In case the TOL/ATNW ratio is not met at the time of implementation, the same may require equity infusion by the promoters or conversion of outstanding debt to equity to meet the criteria.

 37. Several instruments are treated as debt due to Ind-AS, would these instruments be considered to be included in the definition of TOL/ATNW?

The definition of TOL/ATNW provided under the notification dated 07th September, 2020 seems to be hinting towards what is legally considered to be a debt. Thus, for the purposes of TOL/ATNW, instruments considered as a debt as per Ind-AS would not come under this definition.

For instance, redeemable preference shares are considered as a debt as per Ind-AS 32. However, for the purpose of TOL/ATNW, redeemable preference shares would not be considered.

38. What parameters shall be considered other than the ratios prescribed by the follow-up circular?

Lenders shall, in addition to the above mentioned ratios, consider pre-Covid-19 operating and financial performance of the borrower and impact of Covid-19 on its operating and financial performance at the time of finalising the resolution plan. Further, they shall also assess the expected cashflows in subsequent years, to ensure that the ratios will be complied with on an ongoing basis.

39. Should these ratios be met by the borrower at the time before covid?

The ResFraCoRS is for the borrowers whose business is otherwise viable but has been affected due to covid disruption. Hence, financial institutions considering to restructure loan accounts under ResFraCoRS, shall evaluate the financial condition of borrower pre and post covid.

These ratios provide a quantifiable basis for evaluating the financial condition of the borrower. Going by the intent, the borrower should positively meet the ratios before crisis and thereafter reach the ratios in the prescribed time.

40. What if ratios are not met in the pre-covid period?

In case the ratios are not met pre covid, it is an indication that financial strength of the borrower was not very stable even before the crisis. Hence, it is not because of the crisis that the borrower is unable to pay. Considering this, the account of the borrower should not be restructured under ResFraCoRS.

It is noteworthy that the ratios are not the sole indicators of financial strength of a borrower. Several other parameters as suitable to the nature of the borrower should also be considered.

 41. What if out of 5, only 3 ratios are met in the pre-covid period?

In case the borrower meets some of the ratios and not all, the lenders shall assess other parameters as well to evaluate financial condition of the borrower and decide whether restructuring shall be done for such borrower account.

42. In case there is only a single lender to a borrower, what ratios or parameters shall be met by such borrower?

Para 5 of the follow-up circular clearly states that the above mentioned ratios shall be met even in case a borrower has availed loan from only one lending institution. These kinds of borrowers shall fall under category 2 discussed above. Even though certain provisions of the ResFraCoRS may not be applicable on this category, maintenance of ratios shall certainly be applicable.

43. What happens if the borrower fails to meet the ratios at any time after implementation of RP?

If the borrower is unable to meet the prescribed ratios it shall be construed as a default on its part to comply with the terms of the RP. This would result in downgrade of asset classification of the borrower to NPA, with all lending institutions, including those who did not sign the ICA, from the date of implementation of the RP or the date from which the borrower had been classified as NPA before implementation of the plan, whichever is earlier.

Provisioning requirements

44. Para 39 of the Framework states that a provision of 10% shall be applicable on accounts which have been restructured in terms of the Framework. How is the restructuring, under this Framework, then different from any other restructuring?

In case of any other restructuring, the classification of the asset gets downgraded to NPA status. The provision requirement on NPAs may be 10%, but that 10% is for a sub-standard asset.

In case of restructuring under the Framework, if the restructuring is done, the asset retains its standard status and the 10% provision shall be a ‘provision specific to the asset’ created considering the risk involved in the asset after restructuring.

It is also notable that there was no requirement of the 10% provision under the June 2019 Directions. There were disincentives against not implementing the resolution plan within the timelines in para 17 of the Directions.

44A. What will be the treatment of additional provisions in the books of NBFCs which are IndAS compliant?

NBFCs that are required to comply with IndAS shall continue to be guided by the guidelines duly approved by their Boards and as per ICAI advisories for recognition of significant increase in credit risk and computation of Expected Credit Losses.

The additional provisioning requirement discussed above shall be treated as the prudential floor for the purpose ECL computation.

45. Will there be a case for reversal of the provision as referred to above?

Yes, half of the provisions may be reversed if the borrower repays 20% of the residual debt outstanding to the lender or lenders as the case maybe, provided the asset has not slipped into NPA post implementation of the RP.

Further, the remaining half may also be reversed when additional 10% of the carrying debt is repaid. However, it shall be ensured that such reversal does not result in reduction of provisions below the provisioning requirements as per IRAC provisions.

Credit information reporting

46. Does the fact of restructuring under the Framework have to be reported to CRILC or anywhere else?

 As per the ResFraCoRS, for the purpose of credit reporting, the accounts shall be treated as restructured if the resolution plan involves renegotiations that would be classified as restructuring under the FRESA. The credit history of the borrowers shall consequently be governed by the respective policies of the credit information companies as applicable to accounts that are restructured.

Other Considerations

47. As per ResFraCoRS, a policy is required to be adopted for resolution of assets under the said framework. Will the follow-up circular require amendment to the policy adopted by a company in this regard?

In our view, considering that the key ratios are mandatory, a suitable modification to the policy would be required to be made.

 48. The follow-up circular talks about gradation of borrowers. On what basis shall the gradation be done?

The follow-up circular states that lenders may carry out a gradation of the borrowers. This gradation shall be done based on the impact of the pandemic on a specific sector or the borrower. As per the recommendation of the expert committee, borrowers may be graded into mild, moderate and severe impact borrowers.

While considering the gradation of the borrowers, the amount and risk involved, extent of legal/regulatory compliances involved in the resolution process etc. should also be factored in.

 49. What is the purpose of such gradation?

Gradation of borrowers based on the severity of impact, extent of compliances and the amount and risks involved, enables the lenders to distinguish the accounts that require more attention. Based on the gradation, lenders may decide upon internal procedures such as delegation, time involvement etc, for various categories of accounts.

 

[1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11941&Mode=0#FT2

[2] Our write-up on the Framework may be referred here- http://vinodkothari.com/2020/08/resolution-framework-for-covid-19-related-stress-resfracors/

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

[4] http://vinodkothari.com/2019/06/fresa/

[5] https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=1157

[6] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11961&Mode=0

[7] https://www.rbi.org.in/Scripts/BS_ViewMasCirculardetails.aspx?id=9904#371

Additional relief from COVID-19 disruptions

Based on the recommendations of the Monetary Policy Committee

-Financial Services Division (finserv@vinodkothari.com)

Extension of the restructuring norms for MSME debt

The RBI via a notification on 1st January 2019[1] had allowed NBFCs and banks to restructure their advances to MSMEs, classified as ‘standard’, without any asset classification downgrade and the same was extended further on 11th February 2020.[2]

Through the notification dated August 6, 2020[3], the RBI has again extended the timeline for restructuring till March 31, 2021.

Further, the notification dated August 6, 2020 provides that the accounts which may have slipped into NPA category between March 2, 2020 and date of implementation i.e. from August 6, 2020 to March 31, 2021, may be upgraded as ‘standard asset’, as on the date of implementation of the restructuring plan.

For accounts restructured under these guidelines, the lenders are required to maintain an additional provision of 5% over and above the provision already held by them with respect to standard assets. Though, the extension notification does not specifically provide such provisioning requirements for NBFCs, however, reading in consonance with the January 2019 notification, it can be said that the requirement is for both banks and NBFCs.

The extension of relaxation would chiefly benefit the MSME borrowers who are having sound businesses as well as repayment capabilities however, are unable to meet their obligations post 1st March 2020, due to widespread disruption caused by the pandemic. The move would ensure that MSMEs that are having a viable business standing are not hit by negative classification just because of short term volatilities.

Advances against Gold Ornaments and Jewellery

The existing RBI guidelines[4] require that for the loan granted by banks against the security of gold jewelry i.e. gold loans a Loan-to-Value (LTV) Ratio of maximum upto 75% has to be maintained. Through notification dated August 6, 2020[5], LTV requirement has been relaxed temporarily. Accordingly, banks may now lend up to 90% of the amount of gold jewellery pledged until March 31, 2021.

Banks may, while sanctioning new loans, grant relatively more amount of loan. Further, using the advantage of extended LTV, banks may also consider providing top-up loans to the existing borrowers, on existing security of gold jewellery.

After March 31, 2021, the LTV requirement shall be restored back to 75%. While the notification mentions that fresh loans granted after such date shall have an LTV of 75%, it is silent about the treatment of existing loans. Clarification in this regard is expected from the RBI.

In the absence of any clarification, the loans given before March 31, 2021 shall also be bound by the LTV of 75% after such date. Accordingly, the banks should either structure the loan in such a manner that the LTV comes down to 75% after receiving repayments up to March 31, 2021 or the banks may have to call back a certain portion of loan so as to meet the LTV requirement after such date.

It may also be noted that despite the high amount of market penetration of NBFCs in gold loan sector[6], no such relaxation has been provided to NBFCs.

Priority Sector Lending by Banks

The RBI has revised the existing guidelines on priority sector lending (PSL) by banks[7]. While the detailed PSL guidelines are yet to be released, following are a few major changes that will be introduced:

  • Start-ups would be a new sector to come under the ambit of priority sectors
  • The limits for renewable energy, including solar power and compressed bio-gas plants, small and marginal farmers and weaker sections are proposed to be increased.
  • An incentive-based system shall be introduced, which shall address the regional disparities in the flow of priority sector credit. Under this system, higher weight will be assigned for incremental priority sector credit in the identified districts where credit flow is comparatively lower and vice versa.

 

[1] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11445&Mode=0

[2] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11808&Mode=0

[3] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11942&Mode=0

[4] https://www.rbi.org.in/Scripts/BS_CircularIndexDisplay.aspx?Id=9124 and https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=8701&Mode=0

[5] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11944&Mode=0

[6] https://assets.kpmg/content/dam/kpmg/in/pdf/2020/01/return-of-gold-financiers-in-organised-lending-market.pdf

[7] https://m.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=10497

Resolution Framework for Covid-19-related stress

Other related write-ups:

 

 

Recent Trends in Crypto-Industry: India & Abroad

-Megha Mittal

(mittal@vinodkothari.com)

“Opportunity amidst tragedy” would likely be the most suitable phrase to summarise the journey of cryptos during the Global Pandemic- with disruption taking a toll on people and economies, and physical proximities massively restrictred, cryptos have outshone traditional assets, by virtue of its inherent features- easy liquidity, access and digitalisation.

Further, as countries around the globe attempt to stimulate their economies by opening floodgates of liquid funds, the ‘digital natives’ have and are expected to increasingly venture into adventure-some investments- think, cryptos. And while such adventurous investing may be short-lived, the results may infact have a long-lasting impact- it is this expected impact that has sets the ‘bull’ stage for cryptos in times to come.

In this brief note, we cover the recent highlights and developments in the crypto-industry, also discussing developments in the relatively new concepts of stablecoins, crypto-lending.

Read more

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. The scheme was further amended on 4th August 2020 for widening the scope of the said scheme

Under this Scheme the GoI, through a trust, will guarantee loans provided by banks and Financial Institutions (FIs) to Individuals 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 operating guidelines 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 and individual businessman. 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.

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

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

  1.  All Scheduled Commercial Banks. Other banks such as RRBs, co-operative banks etc. shall not be eligible lenders.
  2.  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.

  1. 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

  1. 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.

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

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

  1. 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.
  1. 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%].

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

The Eligible Borrowers shall be entities/individuals 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 /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 50 crores.
  • Turnover for FY 2019-20: The turnover of the Eligible Borrower, for financial year 2019-20, should be upto Rs 250 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/Individuals 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.
  1. 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.

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

Hence, there was 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.

To ensure clarity, the revised operational guidelines include business loans taken by individuals for their own businesses in the ambit of scheme, Further, individual would be required to fulfil eligibility criteria for the borrower.

  1. 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.

  1. 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.

  1. 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 250 crores.

 

Signed ………….            Date:…………………

  1. 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.

  1. 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.

  1. 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.

  1. A LAP loan was granted to a business entity/Individual.  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.

  1. 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 C and C is an Eligible Borrower.
  1. 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.

  1. 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.

  1. Whether the threshold limit of outstanding credit of Rs. 50 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. 50 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 50 crores or not, the willing MLI may seek information about other loans obtained by the borrower.

  1. For the threshold limit of outstanding credit of Rs. 50 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.
  1. 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
  1. 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. 50 Crore or less as on 29th Feb 2020;

(ii) turnover for 2019-20 was upto Rs. 250 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.

  1. 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.

  1. 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.

  1. 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

  1. 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
  1. 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.

  1. 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.

  1. 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.

  1. 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.

  1. 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.

  1. 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.

  1. 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.

  1. 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.

  1. 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.

  1. 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.

  1. 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.

  1. 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 the lender whose share of ECLGS loan is proposed to be extended by a specific lender. Further, it would be necessary for the specific lender to agree to provide ECLGS facility on behalf of such of the lenders.

Lender-Borrower documentation

  1. 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.

  1. 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

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

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

  1. 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.

  1. 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.

  1. 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.

  1. 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.

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

The RBI issued a notification on June 22, 2020 stating that since the facilities provided under the Scheme are backed by guarantee from GoI, the same shall be assigned 0% risk weight, in the books of MLIs.

Guarantor and the guarantee

  1. 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’).

  1. 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.

  1. 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.

  1. To what extent will the guarantee be extended?

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

  1. 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.

  1. 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.

  1. 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.

  1. 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

  1. 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. Further,  even if the original facility has gone off the balance sheet, the additional funding being given by the originator-servicer will be on-the-balance sheet.

Any interpretation of the guarantee scheme has to serve the purpose for which the scheme was envisaged – which is, clearly, to provide additional liquidity to borrowers affected by the disruption. There can be no suggestion that borrowers whose loans have been securitised will not need additional liquidity. Hence, the Scheme intends to wrap all additional lendings done by the lender, within the limits of 20%.

  1. 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.

  1. 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.

 

[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)

Updated as on August 18, 2020

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.

2A.  Will bonds or CPs issued in secondary market be eligible for purchase under the Scheme?
The Scheme specifically mentions that the bonds/CPs issued by financial companies shall be eligible assets to be purchased under the Scheme. The term ‘issue’ clearly indicates that the bonds/CPs shall be purchased from the primary market only.

  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.

57A. Will investment grade debt paper of NBFCs/HFCs/MFIs be determined without adjustments for the COVID scenario considering the grading may have been downgraded?
As per the Scheme, the rating of debt paper as on date of transaction would apply. In this regard, a circular issued by SEBI on March 30, 2020 maybe considered, which directs rating agencies to not consider delay in repayments owing to the lockdown as ‘default’. Thus, the rating issued by the credit rating agencies would already adjust the delays owing to COVID disruptions.

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.

Amendments to the Scheme

With an intent to extend the benefits of the scheme during the current crisis, a notification dated August 17, 2020 was released by the MoF making certain amendments to the scheme. Through the amendment, the tenure of the scheme has been extended by 3 months. Hence, PSBs can purchase the pools till 19th November, 2020. The crystallisation for the purpose of determining the guarantee shall be done on 19th November, 2020.

Further, investments in bonds/CPs of rating AA and AA- have been allowed upto 50% of the total portfolio of bonds/CPs purchased by the PSB under the scheme. The limit earlier was 25%. This increase would allow more bonds/CPs to come under the scheme and would enable the NBFCs/HFCs/MFIs with investment grade ratings but not very high ratings to procure funding to an extended limit.

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:

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