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Commentary

SEBI Relaxes Norms for Debt to Equity

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SEBI will now allow banks to convert debt to equity with regulatory easing. In its latest board meeting, it has allowed financial institutions to be free of some of the disclosure and acquisition norms (ICDR and SAST) if they convert debt to equity of “listed borrower companies in distress” .

This is broadly supposed to help banks. In two ways:

  • They can take over the management of the company (convert debt to majority shareholding) and then sell the company over to other people
  • Such conversion may not have the same norms as any other such equity acquisition – such as requirement of an open offer or such.

It’s not very clear what the fine-print is like. But here’s a primer:

What Does Debt To Equity Mean?

Let’s say Bhushan Steel owes State Bank of India Rs. 5,000 cr.

Let’s say Bhushan Steel is “distressed”, under whatever definition of the word is eventually acceptable.

SBI can say, listen, forget the debt, why don’t you just issue me shares worth Rs. 5,000 cr.

Currently Bhushan Steel’s market capitalization is just Rs. 1700 cr. at the price of Rs. 75 per share. That is, about 22.65 cr. shares are outstanding, of which:

  • 14.26 cr. shares are held by the promoters (63%)
  • 8.39 cr. share are by the public (37%)

Now SBI can say listen, issue me shares, at Rs. 50 each (because you are “distressed”, so a lower price than market) to cover my loan of Rs. 5000 cr.

That would mean 100 cr. shares more would have to be issued.

That means the new shareholding will become:

  • SBI: 100 cr. shares (81%)
  • Promoters: the same 14.26 cr. shares (12%)
  • Public: 8.39 cr. shares (7%)

SBI now, practically OWNS Bhushan steel.

As you can see, Bhushan steel shares then are owned by SBI. Obviously for a company like this, the share price will drop post such a move (which is why financiers want to be able to give a lower price)

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Current Norms Needed to be Relaxed

SEBI’s current norms create hassles in such situations. Effectively such a transaction is a change of management, and the takeover rules will require SBI to make an open offer to everyone else at the same price.

Secondly under the rules, the price cannot be lower than the last six month average price (or the last 15 day average price).

Thirdly, SBI owns 81% which is way greater than the 75% max shareholding of promoters allowed by SEBI.

Lastly, such a transaction would need the approval of smaller shareholders as it amounts to change of promoters.

These norms will have to be relaxed, because banks don’t want to have to make open offers, and do need the ability to convert at a lower price.

Impact: Will Be For Ultra-Distress Sales Only

Do you really think SBI will convert shares of Bhushan Steel and then become the promoter of the company? Not a chance.

At best, it will convert shares and immediately sell it to someone else. Note that such a sale will then be to a non-bank (obviously, since banks can’t run steel plants or such businesses). Therefore, that sale will not have such a relaxation of no-open-offer etc. Obviously, to effect a quick transfer, the buyer will also want to avoid things like filing open offers etc. which is not being given.

Will small shareholders suffer? Let’s first see. If they shares have ANY value whatsoever, the promoters would have had to pledge them to the banks. The banks can easily sell those shares in the market too, or acquire them at market prices and write off some of the debt. In practical cases, the banks would already have done this.

The only time when a bank will avoid selling shares is if the stock has fallen so much that there is just no point selling the shares to change any metric. Case in point: Bhushan Steel, the real company. Even if the banks sold all the promoter shares in the market at Rs. 75, they will recover just Rs. 1100 cr. or such. The company owes banks over 36,000 cr. rupees, into which the 1,100 cr. worth of equity doesn’t even make a dent.

So at this point, if the bank were to convert debt to equity, the minority shareholder is more or less hosed anyway, even before the conversion. Not forcing the banks to offer other shareholders an exit through an open offer will not hurt them much more.

Banks don’t even sell shares that are pledged to them, even as the share price falls. There’s no rule preventing them from doing that. It’s unlikely they will use the debt to equity conversion route unless the stock is in the doldrums. And therein lies the googly.

Price Cannot Be Less Than Face Value

Banks cannot convert at a price less than the face value of a share. In case of a deeply distressed asset, the price would already have fallen to below face value, in most circumstances. (Btw, Bhushan Steel is not even an NPA, and isn’t “distressed” yet. If it were, its share price would be much lower)

So the restriction of the conversion price being higher than face value will curtail a banker’s ability to convert.

So: No Positive For Banks

This news is not hugely positive for banks. We don’t know the specifics (SEBI’s press release is devoid of any useful details) so we’ll reserve final judgement. At best it will facilitate a distress sale and a very low price, and banks will have to write off a good part of their investment (since a buyer will definitely not pay what is owed to the banks, he’ll demand a lower price). The only good thing: banks can close off the loan and look forward, and take the loss. Closure is good.

What banks really need to do is aggressively take action (on collateral) before the loan turns so bad it needs to convert to equity. This kind of pro-active behaviour has been missing in our fat, lazy banking system, other than in trying to sell insurance to old women, a skill they possess in abundance. This aggression, if applied to recovering NPAs, will be far more useful than requiring SEBI to relax norms so that they achieve closure on already dead investments.

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  • umar says:

    it is nice of you to assume that the pledged assets are actually worth the loan amount.
    Recovery [aggressive or otherwise] is valid only if the asset’s real value is much more than the debt. We will find out how much of their loan portfolio is really worth the assets it is based on.
    i would say, if they can recover about 15% of their entire oustanding loan portfolio, i would be very very surprised.

  • kumar says:

    what could go wrong? i mean to ask that question seriously.
    banks are already doing a bang-up job with their core business [deposits, loans etc], and this new line [taking control in companies and running them if needed] is just another area of their expertise.
    i commend the government and its arms for coming up with such creative solutions to the biggest problems of our time.