IBC resolutions and haircuts

 What should be the yardstick to evaluate haircuts in IBC 

Recovery versus Total Admitted claims - a fallacy: Recently, one of the largest bank employees' union in India, came out with a list of business firms, said to have been acquired by a business conglomerate through resolutions/liquidation effected under IBC (Insolvency and Bankruptcy Code), with a statement that the business group is the beneficiary at the cost of the banks concerned (average haircut 74%). While the fight against huge haircuts in the banking books (in the resolution process under IBC) by the bank employees' union is understandable, I did not subscribe to the view that was being impressed upon (in their circular) that the process was done in order to help one particular beneficiary. Right from the beginning, the resolutions  done through IBC witnessed haircuts ranging from 40 to 80% and the said list, at best, is only  an affirmation to the general trend since the beginning of the implementation of the code in 2016. The stand of the employees' union portraying a negative picture on the recovery appear to have compelled creation of another theory by some ex-bankers, who say that in calculating recovery percentage, the total income earned from the stressed assets in question, including the period in which it was standard (from the date of extending the loan), shall be part of the numerator. In my view, both the negativity being presented and the defence mechanism employed against such a stand are unacceptable, as both try to evaluate the IBC process by comparing the recovery percentage with the total financial claims admitted alone.

The aim of IBC was to ensure timely resolution of insolvency proceedings to allow continuity in business and maximise distressed business value for creditors through new acquirers. The moot point to be considered is whether the financial creditors were able to recover more than what would have been recovered in the ordinary liquidation process, after getting the case admitted in NCLT under IBC. Had the list brought out by the  employees' union covered the percentage of recovery in relation to (i) the fair value of secured assets and (ii) its forced sale value also, one would have understood of abnormal gain, if any, made by the acquirer.

Let me explain:

Total Claims versus Security Value:

The total claims admitted in the stressed assets include

(i) Principal Outstanding 

(ii) interest accrued not recovered prior to the accounts getting classified as NPA and interest accrued since then till the date of admission of the claims 

(iii) unsecured portion of working capital converted as term loan, interest not recovered converted as a funded term loan, shortfall in the value of security - carved out from the loan outstanding, as a new term loan

(ii) and (iii) reduces the percentage of security available to cover the total outstanding considerably. 

In respect of security value, one witness intangibles like goodwill, receivables (which includes interest portion) as against assets financed, future cash flows with firm agreements in place were added to the secured portion/value of security. All these factors diminishes substantially or become zero, when the business is stressed. 

While the above aspects covered under total claims and arriving at security value explain the expertise employed by the banking professionals to save a stressed account from becoming a NPA, the innovative factors employed, while financing/restructuring the assets, increases the gap between the value of security and the total outstanding considerably.  

Whatever said and done, the above aspects will continue to remain in the lending methods that will be adopted by the bankers in the future also.

How to evaluate success of recovery under IBC:  In the above background, I am of the firm opinion that the recovery percentage after initiating insolvency proceedings under IBC should be evaluated against all the following:

a. Total admitted claims of financial creditors

b. Total amount outstanding as on date of classifying the account as NPA (principal)

c. Fair value of assets, if liquidation process is not initiated

d. Fair value of assets, in case of forced sale

e. Contracted cashflows for the next 5/7 years, if  a resolution plan is in place

Evaluation of the success of bankers: The performance of bankers in recovery should be evaluated by comparing the recovery to (i) total admitted claims and (ii) principal outstanding as they bring out the timely/delayed action in going to IBC for a resolution or otherwise and also the bankers' lending expertise in successful creation of more tangible/realisable assets out of the loans sanctioned. In my opinion, a banker is successful if the recovery covers at least 60% of the admitted claims and at least 75% of the principal outstanding. 

Evaluation of the success of IBC/Committee of Creditors/resolution plan: This should be attempted by comparing the recovery percentage under resolution to the fair value of assets in the normal course and against forced sale(liquidation value). To be termed as a successful resolution plan value, the following criteria are to be satisfied. 

Recovery

• should always be higher than the fair value of assets in the normal sale scenario and 
• at least 25 to 50% more than the liquidation value

The above evaluation also helps one to understand the erosion in value of realisable security due to inordinate delays after a stressed asset is brought under IBC.

To sum up

i. Availability of adequate realisable securities and assured cash inflows in the medium term in future enhances the recovery percentage vis-a-vis total outstanding and 

ii. Faster decisions to implement viable resolution plans by resolution professionals will ensure recovery being much in excess of liquidation value in a distress sale.

Comments are welcome.

Regards.

V.Viswanathan

CGM Retd. e-SBT

10th November 2024.