About the column: In our column “Bull’s Eye“, we take up articles from business dailies like Economic times and Business Standard, and explain them. In each article, we cover an economic/financial concept and a market occurring that the article is focused around; and explain it in the context of that news update.To read more from the column, click here.
By Naman Sanghvi & Sangeet Agarwal:
Actual Article (Original):
Troubled real estate firm Lavasa’s efforts to escape the stigma of bad debt suffered a jolt with the Reserve Bank of India rejecting a request to confer infrastructure status on its loans. The rejection means that the firm cannot enter the special cell set up by banks to help ease the debt burden of troubled companies with high-cost borrowings.
It must take the difficult road of negotiating individually with the banks and its debt will not have any chance of becoming a standard asset. The 850-crore loans on Lavasa’s books are now treated as bad loans by most banks.
Lavasa sought infrastructure status from RBI some months ago on the grounds that it would help the company join the corporate debt restructuring cell set up by banks. The CDR cell helps companies restructure debt, ensuring that their loans stay as a standard asset on banks’ books. Lavasa’s loans would have been converted into a standard asset in the CDR if the RBI had agreed to the move.
“Lavasa Corporation is always in dialogue with all its stakeholders, including bankers and lending institutions,” a Lavasa spokesperson said.
Commercial Real Estate Loans
Allegations which are devoid of any substance and made with a deliberate intention to derail the smooth progress of the project did have an impact on the finances of the company. We are confident of resolving these issues with our bankers and lenders.
It is business as usual at Lavasa as we have sold close to 100% of our properties at Lavasa in phase I and bookings are on in full swing for phase II, which has opened recently. Lavasa is committed to deliver and be the role model in meeting the gigantic urbanisation challenge that India faces,” the Lavasa spokesperson added. Loans granted to Lavasa are classified as commercial real estate loans and CDR norms do not permit their restructuring.
The company must now individually negotiate with banks for restructuring its loans, a difficult but not impossible task, and agree to the various conditions stipulated by them. Banks, which were hoping to avoid making provisions for Lavasa’s debt, will now have to do so.
“This would mean every bank would have their own set of demands to be fulfilled for the restructuring,” said a partner with a consultancy firm. “Since this loan continues to be treated as a real estate loan, it would be a part of the sensitive-sector exposure of banks, and banks would have to set aside higher capital by way of provisions for any contingency,” he added.
HCC’s ambitious hill city project, Lavasa, ran into trouble after the ministry of environment and forests stalled construction at the site for violation of environmental laws. After a long battle between the company and the environment ministry, the latter gave a conditional clearance to the $31-billion project in late 2011.
In January, rating agency CARE downgraded Lavasa to default grade after it delayed payment to banks. HCC, the parent firm, claimed losses of Rs 2 crore a day when work was halted. A silver lining for Lavasa is the approval given by banks for funding the hill city’s second phase. Despite the troubles in the first phase, banks have decided to give Rs 600 crore to help it complete the second phase.
Explanation:
The road to the completion of Lavasa (project) has been bumpy over the past years. Be it accusation by Indian Environment and Forest Ministry of causing environmental damage to the picturesque landscape of Lavasa hills or CARE downgrading its rating from in January 2012; the project has garnered a lot of negative news.
Lavasa, idealized with the aim of bringing the concept of new urbanism/real urban life experience to Indians, recently suffered a major shake as their request to grant infrastructure status on its 850 crore loan was rejected by RBI on July 2011. Lavasa’s high cost borrowings from various banks are now considered as bad debt thus restricting the company to enter Corporate Debt restructuring cell to ease debt burden.
Flow of explanation:
- What is bad debt? – What are its implications?
- What are infrastructure bonds?
- How would ‘infrastructure status’ have helped?
- What are standard performing assets?
- What is Corporate Debt Restructuring?, and what is its relevance in the current context
What is bad debt?
A bad debt is referred to any debt that has been borrowed which in the ‘perception’ of banks and investors is seen as ‘risky’. There might be a possibility of a default on this debt, i.e. – the borrower might not be able to meet its payment obligations. For a company its image in the market is greatly determined by the ‘banks perception of its ability to pay its debt’- now Lavasa was pursuing a way by which they could prevent the perception of the banks of its loans as bad ones, i.e. – through a request for its loans to be considered as ‘an infrastructure status’ loan; and the RBI rejected this proposal.
Infrastructure bonds and how the infrastructure status would have saved Lavasa’s debt from being considered as bad loan:
An infrastructure bond is a bond specifically sold to investors for the purpose of raising money to fund infrastructure projects, i.e., roads, dams, etc. Infrastructure bonds offer tax benefits to investors and are an attractive option. With the protection from government and assistance from infrastructure finance companies the bonds are floated to retail investors/common man which helps firms generate desired cash for successful completion of the infrastructure project.
Seeking Infrastructure bond status on its loan would have made it easier for Lavasa to raise money from retail investors and also they would have commanded a higher value making it more attractive for investors. Bonds can now be issued at a discounted interest i.e., interest that Lavasa would have to pay to is debtors will be lower for the same amount of money. An infrastructure bond status would have given Lavasa more options to raise money, eased its cash flows, made it more valuable and attractive and allowed it to better negotiate a restructuring deal.
Standard Assets and Corporate Debt Restructuring:
Assets which are perceived to be risk free (normal) are referred to as Standard assets. These assets are considered to be performing assets as they on a regular basis generate income. As long as Lavasa’s debt would be perceived as a standard asset no alarm bells will ring in the market as they would be expected to generate stable projectable cash flows. Now to still maintain the status of a standard asset Lavasa would have to ease the expenses being incurred which could be to some extent be achieved through restructuring this debt and re-negotiating interest terms. Restructuring a Debt involves cutting a new deal with Lenders at ‘lower interest rates, ‘longer repayment periods’ or a combination of both and more factors. This option gives companies more cushion and space to repay obligations, thus improving its financials. While longer repayment periods would increase the interest that the borrower might have to pay, Banks take a call on if by increasing the repayment period, a project would have more room/ opportunity to generate revenues and meet its expectations.
For example – if a debt has been restructured at a longer payment period, then more time is given to the debtor to pay back the outstanding amount, thus improving revenues and a company’s financials
Getting this infrastructure status would have allowed Lavasa to enter the CDR cells of banks giving more muscle to Lavasa to negotiate a ‘restructuring’ deal. It is a lot like a VIP pass giving you special privileges over the rest of the masses
‘To give some perspective about this, one could look at the ‘government bail-outs’. Many banks simply cannot fail and go under as they would bring the market down with them leading to a chaotic environment. Instead of letting them become non-performing, governments here have no choice and but to infuse more capital and make a deal which keeps these banks afloat and gives them another chance to right their wrong decisions.
Infrastructure status would have given more muscle to Lavasa for its negotiations; and without this status Lavasa will not have an upper hand when it sits with the banks for a restructuring deal. In fact being now a ‘real estate commercial loan’ banks will be all the more wary, cautious and conservative while dealing.