It has been more than a month since the announcement of the lock-down in India by the Central Government, and longer in many other parts of the world. While economists and analysts across the globe are trying to evaluate the impact of the COVID-19 pandemic and devise relief measures, a quick reading of the monetary policy released by the Reserve Bank of India (RBI) on 7 April 2020 suggests that the true economic impact of the pandemic on growth, liquidity and inflation would depend upon the speed with which the outbreak is contained and economic activity across the globe returns to normalcy. Any kind of forecasts are subject to massive revisions depending on the aforementioned factors.
RBI’s Relief Measures
Meanwhile the RBI displaying conventional prudence and responsibility has taken a series of relief measures to ensure that the impact on the private credit sector in India is mitigated. Some of the key measures adopted by the RBI are:
RBI’s key focus has been on transmission of credit into the economy. In keeping up with its commitment, the three important measures adopted by the RBI that may benefit non-banking financial companies (NBFCs) are:
· Introduction of long-term repo operation (LTRO) facility infusing ₹ 1,50,000 crores worth of liquidity into the economy through banks by launching the Targeted Long-Term Repo Operation (TLTRO) (1.0) and (2.0) facilities. Given that the primary beneficiaries of TLTRO 1.0 turned out to be public sector entities and large corporates, the RBI also launched TLTRO 2.0 for a further amount of ₹ 50,000 crores to cater to the non-banking finance and micro finance sector.
· Reduction in repo and reverse repo rates, freeing up of regulatory capital for borrowings from the RBI by allowing (a) dipping up to 3 per cent into the statutory liquidity ratio, and (b) reduction in cash reserve ratio by 100 basis points.
· Increase in the investment limit for foreign portfolio investors (FPIs) in corporate bonds to 15% of outstanding stock for the financial year 2020-21 with the revised limits for April-September, 2020- at ₹ 4,29,244 crores and for October-March 2021 at ₹ 5,41,488 crores.
Shock Absorption Measures
The shock absorption measures have mainly revolved around restructuring and provisioning related reliefs. A quick snapshot is provided below:
· Flexibility to eligible borrowers, and lending institutions, including NBFCs, on granting a moratorium of 3 months on payment of all instalments of term loans falling due between 1 March 2020 and 31 May 2020 without the lenders having to restructure such accounts or downgrade the asset classification pursuant to the COVID-19 – Regulatory Package issued by the RBI on 27 March 2020. However, for such accounts in default during the moratorium the lending institutions will be required to make general provisioning of not less than 10% of the total outstanding of such accounts, to be phased over two quarters as under: (i) quarter ended March 31, 2020 – not less than 5%; and (ii) quarter ending June 30, 2020 – not less than 5 % to be adjusted against the actual provisioning requirements for slippages from the accounts reckoned for such provisions. The residual provisions at the end of the financial year can be written back or adjusted against the provisions required for all other accounts.
· Deferment of the recovery of interest applied for all lending institutions including NBFCs, in respect of working capital facilities sanctioned in the form of cash credit / overdraft, during the period from 1 March 2020 to 31 May 2020.
· Allowing lending institutions including NBFCs to reduce the applicable margins or reassess the working capital cycle of borrowers.
· Exemption from reporting of defaults to credit bureaus during this moratorium period.
· Extension of the date of commencement of commercial operation (DCCO) for commercial real estate (CRE) projects along with consequential shift in repayment schedule for equal or shorter duration (including the start date and end date of revised repayment schedule) to not be treated as restructuring provided that (i) the revised DCCO falls within the period of one year from the original DCCO stipulated at the time of financial closure for CRE projects; and (ii) all other terms and conditions of the loan remain unchanged.
Insolvency Related Reliefs
The other important area has been on the insolvency front. The RBI and the Insolvency and Bankruptcy Board of India have been quick in reacting with corresponding relief measures. A few important announcements are following:
· Exclusion of the lockdown period from calculation of any timelines for insolvency resolution process and liquidation proceedings pursuant to Section 40C of the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) (Third Amendment) Regulations, 2020 and Section 47A of the Insolvency and Bankruptcy Board of India (Liquidation Process) (Second Amendment) Regulations, 2020.
· For systemically important NBFCs (SI NBFCs) and deposit taking NBFCs (DT NBFCs), Exclusion of moratorium period from March 1, 2020 to May 31, 2020 from “review period” for accounts under “review” as on 1 March 2020 from the calculation of the 30-day timeline for the Review Period under the Prudential Framework for Resolution of Stressed Assets issued by the RBI on 7 June 2019 (Stressed Assets Framework).
· Grant of additional 90 days for implementation of resolution plan under the Stressed Assets Framework. Additional provisioning requirements to be triggered after the expiry of 90 days.
· Increase in the threshold for initiation of corporate insolvency resolution process (CIRP) under the Insolvency and Bankruptcy Code 2016 from Rupees One lakhs to Rupees One crore to prevent triggering of insolvency proceedings against Micro, Small & Medium Enterprises.
Please see our Firm’s detailed ergo in this regard on https://www.khaitanco.com/covid-19.
Lastly, since the lockdown, the courts in India have been sympathetic towards borrowers. For instance, in the case of Rural Fairprice Wholesale Limited v IDBI Trusteeship Services Limited, while not going into the details of recognising pandemic as a force majeure event or reasons for frustration of contract, the Bombay High Court on 3 April 2020 granted temporary relief to the borrower from invocation of pledge. In Anant Raj v Yes Bank Limited, the Delhi High Court on 6 April 2020 granted temporary relief to the borrower from being classified as a non-performing asset in view of the RBI COVID Relief Package issued on 27 March 2020 even for defaulting accounts prior to the period of moratorium. Though this position is now settled with clarifications from the RBI under Prudential Norms on Income Recognition, Asset Classification and Provisioning Pertaining to Advances - Projects under Implementation issued by the RBI on 17 April 2020. Further in the case of M/s Halliburton Offshore Services Inc v Vedanta Limited & Anr. the Delhi High Court on 20 April 2020 recognising the pandemic and the consequential lock down as force majeure event granted an interim injunction on invocation of bank guarantees by Vedanta Limited on account of delay in completion of works.
Key Takeaways for NBFCs
The liquidity and prudential measures taken by the RBI and corresponding reliefs on the insolvency side are likely to absorb some of the shock waves. However, heart of the crisis for NBFCs lies in the breakdown of the demand and supply chain, over and above the existing liquidity crunch that was faced by NBFCs even prior to the pandemic.
Until normalcy in economic activity returns, it is difficult to hazard a guess on the exact degree of harm caused to the financial system and the reconstruction efforts that will have to be adopted. However, the continuing regulatory measures do call for some detailing and analysis. Accordingly, we have curated a few thoughts for NBFCs to navigate through these tough times:
(i) Engaging with existing borrowers
For NBFCs, the primary concern would be to pass on the benefit of the relief granted by the RBI, to their borrowers. Whether a 3 months principal and interest moratorium is indeed a relief for NBFCs, while the general 10% provisioning requirements continue to apply and with no visibility on timing for reconstruction efforts to start, remains a big question. We acknowledge that these measures are interim and may be modified or extended depending on the course of the pandemic. However, for it to be truly beneficial and avoiding further regulatory risks, NBFCs should consider the following:
(a) formulate class specific policy on engaging with borrowers and renegotiation of terms of their facility to avoid claims of differential or fraudulent treatment. For instance, the impact of the pandemic on CRE projects would be significantly higher in relative terms than industries engaged in essential services. Similarly, retail NBFCs financing travel and lifestyle expenses are going to be more affected than NBFCs financing education and healthcare needs. For NBFCs, this analysis will be more crucial since the moratorium on term loans is likely to increase the mismatch between their assets and liabilities.
(b) the 3 months moratorium under the COVID-19 relief package is an option for the borrower and not a mandatory action, hence explain the pros and cons of choosing to avail this relief while interest continues to accrue. This will also ensure that NBFCs are complying with the fair practices code and corporate governance related norms.
(c) convey the concerns of borrowers, onward to their higher management, and to the regulators (as an information building exercise and realistic indicators of economic needs of each sectors).
(d) ensure transparency, legal back up and clear understanding of the implications before effecting any policy change or change in terms of the loan.
(e) extend the repayment terms for CRE projects funded by NBFCs.
(f) the present situation may also lead to non-payment defaults. In most cases the facility documents provide for corresponding reliefs in form of liquidated damages, ability to call an event of default or even seek mandatory prepayment. In this case, the borrowers are most likely to seek waivers for existing and anticipated defaults. NBFCs may consider granting such waivers on a case to case basis unless regulations mandate it.
(ii) Engaging with the RBI
The reliefs are welcome interim measures. However, it would be important that NBFCs engage with the RBI and other regulators on a continuing basis to voice their concerns and provide necessary information.
For instance, the extension of time period for deployment of funds of TLTRO 1.0 and TLTRO 2.0, appears to be a timely outcome of the banks informing the RBI of the constraints in deployment of these funds due to demand shortage or inadequate time available for effective underwriting. Information will be the key to shock absorption and NBFCs, like banks, can play an important role in this.
This channel can also be utilised for effective discourse on differential treatment provided to a few financial products by not extending the relief package to them and some of the ambiguity in the relief measures.
For instance, the COVID-19 Relief package excludes from its purview, financing facilities like cashflow discounting, factoring etc and debt securities like non-convertible debentures, with no real intelligible difference in treatment given to this section. Similarly, the leeway provided to CRE projects in form of extension of DCCO and corresponding repayment schedule without having to restructure the account is not available for residential real estate projects. Besides, the general provisioning requirement of 10% for accounts under default during the moratorium, also seems to be causing great hardship for NBFCs. Initially some of the banks had also denied the benefit of the moratorium to NBFCs as borrowers. However, in a recent development a few banks have agreed to extend the benefit of moratorium to NBFCs on a case to case basis. This appears to be a direct outcome of the discussions held with the RBI earlier this week.
(iii) Accessing Liquidity
The RBI has opened multiple channels of liquidity for NBFCs. On one side there is an increase in the limits for investment by FPIs in corporate bonds, on the other side banks are being mandated to utilise at-least 50% of TLTRO 2.0 for funding NBFCs and micro finance institutions. Surely some of existing concerns on non-performing assets (NPAs), poor underwriting, and confidence of investors in this sector over-loom which also reflected in poor response to tranche 1 of TLTRO 2.0, however the increased access to liquidity could be a good starting point to reclaim its position in the leverage space. Concerns on insolvency, portfolio management may be managed with innovative bankruptcy remote structures like covered debt, securitisation, effective supervision and better underwriting.
(iv) Negotiating the terms of facilities
Going forward, risk allocation by NBFCs in their pricing, tenure, cancellation, and disbursements will be key factor. As borrowers, NBFCs will have to be prudent in negotiating clauses on cancellation of the facility, interest resets, structuring drawdowns, and repayment schedules. Provisions relating to regulatory changes and increased pricing for source of funding causing an undue hardship for NBFCs, should necessarily result in prepayment and other exit stipulations. . For instance, the recently released FAQs by RBI on TLTRO facility clarified that if a bank fails to deploy funds within the specified time frame, the interest rate on un-deployed funds will increase to prevailing policy repo rate plus 200 bps for the number of days such funds remain un-deployed. This incremental interest will have to be paid along with regular interest at the time of maturity. Where NBFCs are borrowing from banks, it should be ensured that risk of increased cost due to delayed deployment of TLTRO funds is not passed on to the NBFC or at-least adequately negotiated.
There should be increased focus on the provisions relating to force majeure events finding a place in the facility agreement.
As lenders, NBFC should ensure pass through of regulatory costs or increased cost due to regulatory intervention are included in interest reset related provisions in their lending documents. The repayment schedules should be formulated with due regard to the effect of the pandemic for next couple of years on revenue and cashflows of the borrower.
(v) Rethinking insolvency and security enforcement
It will be important for NBFCs to be alive to regulatory moratorium / suspension of recovery rights and general determination made by the courts in enforcement proceedings. As discussed earlier, moratorium effectively ensures that no insolvency proceedings can be started against borrowers for defaults occurring between 1 March – 31 May 2020 (if the loans are otherwise standard). For SI NBFCs and DT NBFCs, the review period and timelines for implementation of resolution plans have also been extended. This will provide NBFCs with some time to ponder over their resolution strategy. Courts are inclined to adopt a sympathetic approach to any pandemic related disputes in favour of the performer of the contract to the extent such performance is affected by the pandemic. Therefore, engaging in bilateral negotiations and adopting cautious measures towards borrowers may be more prudent than raising disputes in these circumstances.
(vi) Realignment of potential growth areas
The trends in lending immediately prior to the pandemic were indicating growth of retail lending segments. NBFCs were betting on the increase in earning capacity and overall lifestyle of individual borrowers. The COVID-19 slowdown and the impending recession on global scale would lead to decrease in demand and incidents of defaults by originally risk-free borrowers. Even when the recession starts to fade, NBFCs will not resume full-fledged lending but will stick to rather stringent lending policies. These NBFCs will experience a widescale decrease in new loans and repayment of existing loans and increase in defaults which will majorly impact liquidity for the bigger players but solvency for many others. Therefore, growth strategy, innovative risk free / bankruptcy remote structures and identification of potential sectors will be a key to NBFC growth.
The Way Forward
In these times, there are no straights answers. The analysis above at best offers a few tips on navigating through these turbulent times and see it as an opportunity to revive an otherwise troubled space. The idea would be to continue the discourse and find viable solutions.
- Manisha Shroff (Partner), Smita Jha (Principal Associate), Shrooti Shukla (Associate) and Sonakshi Faujdar (Associate)
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