06th July 2022 (Version 3)

The increasing level of stressed assets in the balance sheets of Indian banks/financial institutions have been an area of concern for the bankers and regulator. The introduction of radical measures such as IBC (Insolvency & Bankruptcy Code) is expected to gradually result in an improvement in the credit culture and act as a deterrent to willful defaulters. While the intent of the regulation is to nudge the banks towards weeding out structurally unviable cases, it do allow flexibility to the banks to resolve such potentially viable cases in certain cases through resolution plans, wherever lenders expect that the revised debt servicing requirements (as per resolution plan) can be aligned to cash flows generated from the underlying assets.

Based on RBI’s " Prudential Framework for Resolution of Stressed Assets” dated June 7, 2019, Acuité has developed a framework for RP ratings [also known as Independent Credit Evaluation (ICE)] to ensure a credible and consistent approach towards such cases. The RP rating methodology is based on an assessment of the following factors:  

The Resolution plan typically entails splitting overall exposure as on a cutoff date into its sustainable and unsustainable components, and subsequently extending the maturity of the debt to align it with the operational cash flows. It is pertinent to note that Acuité will be rating only the Sustainable Portion of the exposure. The RP rating will not be applicable to the Unsustainable portion of the exposure. However, the commitments under all categories of debt (sustainable as well as unsustainable) will be reckoned while arriving at the debt service coverage indicators. Generally, the repayment of the unsustainable portion of debt (which could be in the debt instruments with equity like characteristics) is typically after the payment of sustainable debt. However, in certain cases, the payment of the unsustainable debt could also commence during the initial period of repayment. In such a case, the assumption is that the sustainable debt will have precedence over the unsustainable debt 

ASSESSMENT OF REASONS FOR WEAKENING OF THE CREDIT PROFILE 

In this case, Acuité shall primarily rely on the TEV report, Resolution Plan, and other related data furnished by the company in this regard along with discussions with management and bankers. Acuité may also call other documents such as Annual Report, Latest stock audit report, Forensic Audit Report, Monthly Operational data, to arrive at the final decision. 

The brief parameters to be looked at are as follows: 

1. Industry Risk over the period of the resolution plan. The assessment of Industry Risk is more to understand the extent of cyclicality, the competitive landscape, regulatory environment, risks emanating from emergence of new technologies, threats from overseas suppliers, and user sector performance among others during the period of the resolution plan. . The cyclicality of the industry particularly becomes extremely relevant, since the operating cash flows of the units in a cyclical sector may vary significantly depending on whether the unit is operating at a trough or peak of the cycle. 
2. Market Position – Current market position in terms of type of clientele, extent of pricing power, diversity in markets, among others. The market position assessment entails a study of the clientele profile, terms of payment, extent of pricing flexibility, extent of market coverage, threats from substitutes, among others. 
3. Operational Efficiency: Operational efficiency benefits from factors such as integrated nature of operations, proximity to raw material supply, strategic location, tie-ups, access to proprietary technology. 
4. FINANCIALS: Since most of the resolution plans pertain to stressed assets, the conventional measures of credit assessment will not be suitable for RP ratings. The key issue to be examined in such cases is of adequacy of cash flows to service the debt commitments. Hence, in RP resolution plans, the focus is on cash flows rather than profitability/gearing etc. The cash flow focus helps in understanding the cash flow buffers available keeping in mind the debt servicing commitments. Since the resolution, plans are long tenure plans (in some cases beyond 20 years) and the cash flow visibility beyond the initial 3-5 years is difficult. Acuité believes that the likelihood of the variance from base estimates significantly increases with very long tenor plans (> 7 years); hence, sensitivity analysis becomes an essential part of such plans. Other factors such as the presence of DSRA (Debt Service Reserve Account) help in mitigating the impact of temporary inadequacy in cash flows. Hence, these factors also have a bearing on the overall assessment.
5. Resource raising capacity of Promoter: The Promoter’s ability to infuse additional funds (beyond the initial upfront contribution as required under restructuring guidelines) is assessed under this parameter. The promoter’s ability to raise funds through disposal of non-core assets and personal assets becomes relevant. The key factor is the importance attached by the promoter to the distressed entity and the promoter’s willingness to support the resolution plan. 
6. Management continuity and Professionalism: Since the continuity of management is critical for the smooth revival of a company, the management succession is assessed. The nature of the ownership is also assessed. In certain cases, the lenders may decide to induct new promoters or a new investor may come in with a majority stake. In such cases, the competence and background of the new investors assumes relevance.