Offlate I have been listening many “Debt Recast” by banks to some of the institutions like Kingfisher, may be Suzlon. Could you please post a detailed article on this debt recast ? Will this affect banks ?
Debt Recast means that your lenders alter the terms of your loan easing your interest and / or principal burden, and this is usually done when a company is facing adverse circumstances. Lenders believe that easing the loan conditions will help the company get back on its feet and will be beneficial for them in the long run.
If you look at how the Kingfisher Airlines story has evolved in the past few years, Kingfisher lenders had recast their debt once in November 2010 and the details from that debt recast are good examples of what easing interest or principal burden means.
Here are the five main points from that debt recast:
(1) Conversion of debt of upto Rs. 1355 crores from lenders into share capital.
(2) Conversion of debt of upto Rs. 648 crores from promoters into share capital.
(3) Reschedulement of repayment of the balance debt to lenders over 9 years with a moratorium of 2 years.
(4) Reduction in interest rates.
(5) Sanction of additional fund and non-fund based facilities by the lenders.
The first of these points is fairly easy to understand which means that the lenders converted their debt into shares and this resulted in forgoing their guaranteed interest payments and instead their loans are now converted into shares which don’t have a guaranteed payout and are more volatile in nature. Kingfisher Airlines benefited because they are relieved of interest payment on this part of the debt and this eases their cash outflow.
The second point is interesting because it doesn’t directly affect the lenders, but the lenders negotiate with promoters of the airlines and say that since we are forgoing our loans, you should match that too. In this case, the debt from the owners was converted into shares and they gave up their right to regular interest payment as well.
The third point means that the debt is spread out over a longer repayment period and moratorium means that there will be a delay in payment of the debt.
Reduction in interest rates doesn’t need any further explanation.
The last point of sanctioning additional funds means that the lenders have agreed to give them more money with the hope that it will help them recover some of their old dues. They may have done this because the company needed to pay salaries or oil bills and had immediate need for cash.
So, to summarize, debt recasts are done when a company is struggling and its lenders believe that they are better off putting some money in the company, easing their loan burdens and getting it back healthy again instead of trying to recover their assets when the company goes bankrupt. This does affect banks negatively except if in the long run the company turns around and the lender’s shares are worth more than
As you can probably see, this is a bad situation for both the lenders and the promoters. Both have to forgo their interest payments, and even the principal on their debt will have to be written down.
So to answer Karthik’s original question – yes, this does affect banks and usually adversely (unless they get great terms which is unlikely) and I’d imagine that no bank ever wants to get into a situation where they want to do a debt recast. However, in the long run this can turn out to be a good thing if the company turns around and the shares are worth a lot more than the debt.
The primary reason to do a debt recast is because the banks and lenders believe that easing up the loan terms will benefit the company and it will be able to get back on its feet and this will result in more money for the banks than a bankruptcy situation.
It seems that 2 years ago, banks believed that Kingfisher Airlines still had a chance, and did a debt recast, but that thinking has changed now, and it looks like they don’t believe the airline will survive at all.
There have been news reports that banks have an exposure of Rs. 7,000 crores on Kingfisher Airlines and the collateral barely covers this loan, and that shows you why banks did a recast two years ago.
They knew that in case of a bankruptcy, they can only get what the collateral was worth and it’s clear now that the collateral wasn’t enough to cover much of the loan. It was better at the time to pump in some more cash, ease terms and hope that things turn around. The past two years have shown that the situation hasn’t improved, and it looks like now the banks feel that it’s better to write off these loans instead of pumping in more funds and throwing good money after bad.
To summarize, banks do a debt recast when they think that the company still has a chance at survival and can be more profitable to the banks if it survives even though that means some losses in the short run. This does affect banks negatively and I imagine neither a bank nor a company ever wishes to be in this situation.