Joydeep Sen
It would sound simplistic to say that bonds are of two types, secured and unsecured. But that is what we read in our college textbooks. At that time, we were too young to understand the real import of the term ‘secured’ bonds.
We were told that secured means the bonds are secured by charge against assets of the company, which could be land or building or machinery or receivables. We were given to understand by our professors that if a company defaults, the security i.e. the charged assets can be sold off and the money realised.
As we grew up, we realised that is not how it works. If a company defaults, or is not in good shape, the bank would rather not realise the assets but ‘evergreen’ the loan. Even if the lender intends to sell the charged assets, it is not the bank’s discretion but it has to go through the court of law. Once a case goes to the court of law, how much time it takes to settle, years or decades, is anybody’s guess.
The first ray of light came in the form of The Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 (also known as the SARFAESI Act). We were told, by the provisions of the Act, that it allows banks and other financial institutions to auction residential or commercial properties (of the defaulter) to recover loans.
We again realised that that is not how it works. ICICI Bank took possession of one of the properties of Mardia Chemicals in Ahmedabad district. However, even before, the promoters of Mardia had milked off the assets from the property. Post the bank taking possession of the property, Mardia put a counter claim against the bank and filed a case in the Supreme Court challenging the constitutional validity of the Act.
Till the Supreme Court upheld the constitutional validity of the Act, it was not clear how this law can be applied. Even thereafter, there was not much change on the ground. The basic tenet remained that if you are a small borrower and you cannot repay, you are in trouble and if you are a large borrower and you cannot repay, the bank is in trouble.
The first positive change came in the form of Asset Quality Review of banks launched by the RBI, a cleansing up drive, in 2015. Then force was added by the Insolvency and Bankruptcy Code of 2016, which allowed taking away the business from the defaulting promoter. A decisive threshold was crossed.
The February 12, 2018 Circular from the RBI stating all the ‘band aid’ schemes till that date were no longer applicable and defaulters have to be dealt under IBC only, put the final seal on this ‘swatchh Bharat abhiyaan’. Now what is the relevance of all this discussion?
The relevance is, recently, there were issues with a few cash-challenged corporates, in Loan-Against-Securities (LAS) deals, where the promoters did not put up additional collateral shares/pay up cash when the equity shares price crashed and coverage dipped below the stipulated minimum. These deals are also known as ‘promoter funding’ as promoter’s shares are pledged for the deal.
For non-bank institutions who cannot give one-on-one loans to strike such deals, there is a bond issued by a company in the group, typically an obscure company, and the security for the bond is promoter’s shares pledged with the lender. To be noted, in case of default, shares can be sold by the lender, without the intervention of the court of law as in case of ‘secured’ bonds with charge against physical assets.
These LAS deals, post non-top-up, are being given a shady description and there is a perception that bonds secured by equity shares are effectively unsecured. Let’s pause a moment and think, what’s the security in a ‘secured bond’?
The charge against physical assets is typically 1 to 1.25 times of the value of the bond, though it may be a higher coverage. The audit on whether it is being maintained at the stipulated coverage is done once a year and there too I am not sure whether it is monitored religiously.
The point is, the security coverage or lack of it is not as optically visible and we tend to believe it is secured. Basically it is lack of information. In a LAS deal, if the stipulated coverage is 2 times, there is a share price discovery every day and the extent of security coverage can be monitored by the lender every day.
To conclude, it is not so much about the security collateral. It is about whether the borrowing corporate pays the interest on due dates and principal on maturity. That in turn depends on whether the corporate has the money to pay and the intention to pay. Ownership stocks are closer to the heart of the promoter and binds them better than losing some physical assets. When it comes to crunch, IBC is the coup de grace.