Tag: debt resolution

Why FD investors get the short end of the stick under waterfall mechanism

Personal Finance

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Shivram, an FD investor in Dewan Housing Finance Limited (DHFL) talks to his chartered accountant cousin Janaki to understand the waterfall mechanism.

Shivram: Sorry to bore you with this when you’ve come for a fun visit Janu. I had DHFL fixed deposits when it went bust in 2019. I was happy to read somewhere that the Piramal group is going to take it over under IBC. I saw a resolution plan where FD holders will get back their money. But now I see the whole thing is going to drag on more, because creditors aren’t happy.

Janaki: Many of my clients hold not just FDs but also secured NCDs in DHFL.

Shivram: See, what irritates me is that these big lenders like banks and insurance companies are blocking FD holders from getting more money. They just voted out a proposal to give FD holders an additional ₹966 crore, over the ₹1241 crore proposed in the original plan. That would have meant my getting back over 40 per cent of the money, instead of 23 per cent. I’m already taking a 60 per cent ‘haircut’. Why can’t small investors get entire money back? Only big guys can afford costly haircuts!

Janaki: I see that you aren’t aware of the waterfall mechanism. When a company goes broke and has less assets than liabilities, this mechanism decides which lenders get priority over others.

Shivram: The only waterfall I know is in Kutralam! So Janu, tell me, why is this waterfall giving me a haircut?

Janaki: Haha, you see, haircuts and waterfalls come into play in the DHFL case because the Piramal group which is acquiring it is willing to pay only ₹37,250 crore for it. But DHFL has outstanding dues totalling to over ₹90,000 crore. So, lenders have to take haircuts.

Shivram: But how do they decide that pensioners like me take an 80 per cent haircut?

Janaki: That’s what the waterfall mechanism does. Imagine a mini-waterfall, not Kutralam, where the water pours down from a height and there are buckets placed below it at different levels. Water flows into the second bucket only when the first one overflows. The third bucket gets filled after the second. If there isn’t enough, the bottom buckets get only a trickle. Similarly, waterfall mechanism in debt resolution decides which creditors of a company are the top buckets when there isn’t enough money.

Shivram: Why does this waterfall mean FD holders get only 23 per cent of their money?

Janaki: Because FDs in a company/NBFC are unsecured borrowings. The IBC’s waterfall mechanism gives clear priority. With any money that comes in, the resolution costs are met first and any accumulated dues to workmen are paid off. Secured creditors get top priority. Salary dues to employees come after them and unsecured financial creditors like depositors only after that.

Shivram: You’re telling me people who invested in DHFL NCDs will not take haircuts?

Janaki: They too will but probably less than FD holders.

Shivram: So is nobody going to take a bigger haircut than me?

Janaki: Equity investors are, Shiv. They come last in the waterfall mechanism.

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Reliance Home Finance debt resolution: Voting likely to be completed by June 15

Banking & Finance

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The debt resolution of Reliance Home Finance is understood to be in the final stages, with voting on the bids likely to be completed over the next few days.

“The voting for the debt resolution of Reliance Home Finance started on May 31 and is likely to be completed by June 15. The winning bidder will be selected from among the four final and binding bids received by the lenders,” said a person familiar with the development.

The four final bidders include ARES SSG along with Assets Care and Reconstruction Enterprise, Authum Infrastructure and Investment, Avenue Capital along with ARCIL and Capri Global Capital.

In its fourth-quarter results announced last month, it had said the debt resolution process is in the final stages. It had reported a net loss of ₹444.62 crore in the fourth quarter ended March 31 as against a net loss of ₹238.37 crore in the same quarter of the previous fiscal year.

Reliance Home Finance is a subsidiary of Anil Ambani controlled Reliance Capital. Its ₹11,200 crore debt resolution is expected to help Reliance Capital.

Bank of Baroda is the lead banker under the Inter Creditor Agreement to resolve debt-ridden Reliance Home Finance. The lenders had in August last year proceeded with the resolution plan and had sought bids for the two companies.

Its total financial indebtedness stands at ₹13,312.96 crore, according to a recent regulatory filing. The total amount of outstanding borrowings from banks and financial institutions amounts to ₹4,435.08 crore.

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Bad bank should have been set up 3-4 years back, not now: Kotak Securities report

Banking & Finance

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Establishing a bad bank today would aggregate but not serve the purpose that has been observed in other markets, Kotak Securities Ltd (KSL) said in a report.

Bad bank is perhaps well served in the initial leg of the loan recognition cycle, it added.

“While we are unaware of its probability and design, creation of a bad bank would have been most fruitful three-four years back (perhaps just after the Asset Quality Review) or earlier when the stress was just building up and banks were looking to delay recognition for various reasons.

“Today, the banking system is relatively more solid with slippages declining in the corporate segment for the past two years and high NPL (non-performing loan) coverage ratios, which enable faster resolution,” said KSL analysts M B Mahesh, Nischint Chawathe, Abhijeet Sakhare, Ashlesh Sonje and Dipanjan Ghosh.

Also read: Kotak Securities launches start-up investment and engagement programme

Based on insights gained from two key reports of BIS and IMF, the report observed that a successful bad bank needs a critical mass (healthy buy-in from lenders) of impaired assets, robust legal framework for debt resolution, along with strong commitment to reforms.

The analysts observed that segregation of impaired assets without sufficient recapitalisation has insignificant impact on future loan growth and NPL creation. A bad bank is expensive to establish, needs a well-defined mandate, and clear exit strategy.

Further, timing of formation and pricing of assets are crucial as the objective is to release stress from lenders early in the cycle so that they can refocus efforts in creating credit. Finally, there are instances of bad banks not achieving their desired objective, the analysts said.

After nearly a decade of elevated slippages, FY2019-20 saw a much lower slippage trend with evidence of it moving closer to normalisation before the impact caused by Covid-19, the report said.

The analysts said they are yet to assess the impact of Covid-19 but in their view the corporate portfolio appears to be holding quite well.

Also read: Rate of decline in fresh lending and deposit rates slows down: Report

Public sector undertaking (PSU) banks PSU, in particular, have gone through this with fresh equity (about ₹3.5-lakh crore over FY2016-21 by the government/Life Insurance Corporation of India) in the past three years and provision coverage ratio (PCR) improving to about 70 per cent from about 40 per cent in the past three-four years.

“A high coverage ratio ensures that faster consensus building is also no longer an issue. We have seen the introduction of IBC as well as consolidation in public banks. We had limited systemic risk from a liability perspective,” the analysts said.

The report observed that one of the key objectives of segregating impaired loans is to restore faith in bank balance sheets and help unlock funding market access. However, PSU banks control a large part of the banking system with a high contribution to NPLs.

“Managerial incentives across organisations are probably still fully not aligned to maximising value through early recognition of bad loans,” the analysts opined.

Also read: Kotak Securities launches platform for buying US equities

Further, given the high contribution of retail deposits, funding stability of these banks is uncorrelated with their financial performance for an extensive period of time.

The analysts said lack of credit growth, especially in the corporate segment, is often attributed to PSU banks’ risk aversion (low capital/high NPLs in the past).

“However, we do argue that corporate deleveraging has been quite slow and credit demand, especially by the better-rated and large wholesale borrowers, has been slower,” they added.

The behaviour of PSU banks has been different with respect to retail and micro, small and medium enterprise (MSME) lending, as these banks have been helping credit growth, especially in recent years and much higher than trend levels post the Covid-19 outbreak.

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