Banking Article, Banking Finance 2022, Banking Finance September, 2022

Subordinated Debt for Stressed MSMEs

Business Enterprises are navigating through a broad range of interrelated issues that span from keeping their employees and customer safe, shoring-up cash and liquidity, reorienting operations in view of the prolonged lockdown across economy.

To tide over this situation Reserve Bank of India, Government and other regulatory bodies among others have announced various dedicated schemes, regulatory packages & relief measures for business units affected by COVID-19 pandemic.

“Distressed Asset Fund – Subordinated Debt for Stressed MSMEs” is one such scheme to extend support to the promoter(s) of the operational MSMEs which are stressed, viz SMA-2 and NPA accounts as on 30.04.2020 and eligible for restructuring as per RBI guidelines on the books of the Bank.  For availing the sub-debt, the unit must be in running condition and operational.

MSME units such as Individuals / Proprietorship, LLP, Partnership, Private Limited Company or registered company are eligible to be covered under the scheme.

As a special dispensation, Reserve Bank of India has permitted to reckon the funds infused by the Promoters in their MSME units through loans availed under this scheme as equity/ quasi equity from the promoters for debt-equity computation.

“Distressed Assets Fund” of Rs. 4000 crore has been created by Government of India for providing guarantee coverage to the loans given / credit extended to the promoters of the eligible MSME units under the scheme.

Financial assistance has to be provided under the scheme by way of sub-debt facility extended by the lending institution to the Promoters of the MSME units upto 15% of promoter’s stake or Rs. 75 lakh whichever is lower. Only one personal loan account shall be opened in the name of promoters, subject to maximum quantum of finance of Rs. 75.00 Lakh for MSME beneficiary unit.

This personal loan shall not exceed the original debt of the beneficiary. Further, the Equity shall be calculated on the basis of the last available audited balance sheet of a Financial Year. There is moratorium period of 7 years on payment of principal whereas maximum repayment period will be 10 years.

 

About Subordinate Debt:

Subordinated debt refers to the debt owed to an unsecured creditor. It is an unsecured loan or security that ranks below other loans or securities with regards to claims on assets or earnings of the issuer.

In the event of the bankruptcy or liquidation of the debtor, the court will prioritize the outstanding loans which the liquidated assets shall repay. Therefore, subordinated debt can only be paid if any assets left after the claims of secured creditors have been met. Hence, these types of debt with lesser priority make the grade as subordinated debt. In financial parlance, subordinated debt is also known as subordinated loan, subordinated bond, subordinated debenture or junior debt.

The main reason a company going for subordinated debt is that it allows the company a way to raise additional capital after all lines of credit and other resources have been exhausted. Further, issuance of subordinate debts like subordinated loan, subordinated bond, and subordinated debenture has advantage over acquiring money through issuance of equity shares as subordinate debt does not dilute the stake of promoter’s shareholding. In addition, it is a more tax-effective instrument, as interest paid is tax-deductible whereas dividends paid do not get such tax benefit. However, in view of bigger risk associated with subordinated debt, it is important for lenders of subordinate debt to consider a loan applicant’s solvency as well as other loan obligations in order to evaluate the risk should the entity be forced to liquidate.

Should a company go bankrupt, for example, creditors with subordinated debt would not get paid until after other senior debt holders are paid in full. This is indeed the primary difference between subordinated debt and senior debt. Because senior debt has the priority of repayment, it carries lower risk and therefore has lower interest rates.

On the other hand, subordinated debts have a higher risk and therefore come with higher interest rates and consequently a higher expected rate of return for the creditor or lender.

 

Features of scheme “Subordinated Debt for Stressed MSMEs”

Eligible Borrowers

For availing the sub-debt, the unit must be in running condition and operational.  MSMEs should have the potential of becoming commercially viable as per the assessment of the lending institutions. Fraud/ Willful defaulter accounts will not be considered under the proposed scheme.  Personal loan will be provided to the promoters of the MSME units. The MSME itself may be Proprietorship, Partnership, Private Limited Company or registered company etc. (in case of partnership, private limited company etc, only one personal loan account shall be opened in the name of promoters, subject to maximum quantum of finance of Rs. 75.00 Lakh for MSME beneficiary unit).

“Eligible borrower” means the promoters of MSME units which are stressed, viz. SMA-2, and NPA accounts as on 30.04.2020 and    The Scheme is applicable for those MSMEs whose accounts have been standard as on 31.03.2018 and have been in regular operations, either as standard accounts, or as NPA accounts during financial year 2018-19 and financial year 2019-20. However, fraud accounts and willful defaulters will not be considered under the proposed scheme. In cases where recovery proceedings are underway and banks assess that with the facilities provided under the scheme the account would be viable, the banks shall withdraw the recovery proceedings before going ahead with restructuring etc.

Quantum of Finance

Personal loan will be provided to the promoters of the MSME unit.  Under the Sub-debt scheme, finance shall be extended to support the promoter (s) of the distressed MSME units through a debt facility of up to 15% of the promoter contribution (equity plus debt) or Rs 75 lakh whichever is lower.

This personal loan shall not exceed the original debt of the beneficiary.

Due Diligence Proper due diligence should be carried out to assess the viability, need and requirement of sub-debt facility in respect of restructuring of stressed MSME units.
Repayment The sub-debt facility shall have a maximum tenor of 10 years from the guarantee availment date or September 30, 2021 whichever is earlier. The maximum tenor for repayment will be 10 years. There will be a moratorium of 7 years (maximum) on the payment of principal. Till the 7th year, only interest will be paid. While the interest on the sub-debt under the scheme would be required to be serviced regularly (monthly), the principal (along with interest) shall be repaid within a maximum of 3 years, after completion of moratorium, in 36 Equated Monthly Installments (EMIs). Pre-payment of loan is permitted at no additional charge /penalty to the borrower.
Security The sub-debt facility so sanctioned by Bank will rank/have 2nd charge of the existing assets financed under existing facilities for the entire tenor of the sub-debt facility.
Guarantee

Guarantee: Extension of existing security / Personal/ Corporate guarantee of promoters/ concern/ group concerns/ guarantors, as applicable.

Process flow for Loan Disbursement:

  1. Personal loan to be provided to the promoters of the MSME units. The MSME itself may be Proprietorship, Partnership, Private Limited Company or registered company etc.
  2. The loan amount (including margin) shall be disbursed to savings/ current account and subsequently it should be ensured that the loan amount along with margin is brought in the parent MSME unit. A CA certificate for having infused the sub debt/ loan amount as promoter’s contribution in the form of equity (including Quasi Equity into MSME unit has to be obtained and held on record.
  • An undertaking from borrower to be obtained confirming that the loan so availed under this scheme will be infused as equity in the MSME unit. The same will also be incorporated in terms and conditions communicated to borrower.

For this purpose, guarantee is being provided under the Scheme “Credit Guarantee Scheme for Subordinate Debt (CGSSD)”.  It is operationalized through a special window created for this purpose under Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE).

 

The features of the guarantee scheme are as under:

Parameters Description
Eligibility

MSME units such as Individuals / Proprietorship, LLP, Partnership, Private Limited Company or registered company.

Guarantee coverage 90% guarantee coverage would come from scheme / Trust and remaining 10% from the concerned promoter(s).

Any guarantee approved under this scheme shall be over and above the existing loan / guarantee sanctioned by the trust (over and above the eligible limit of Rs.200 lakh under CGTMSE).

Loan Amount eligible under the Guarantee Coverage The guarantee coverage is to be provided to the eligible MSME borrower for the credit facilities extended under this scheme “Subordinated Debt for Stressed MSMEs”. Under this arrangement, promoter(s) of the MSME unit will be given credit equal to 15 % of his/her stake (equity plus debt) or Rs 75 lakh whichever is lower.

In case a borrower has existing limits with more than one lender, the CGSSD can be availed by the borrower through one lender only.

Post-restructuring, NPA classification of these accounts shall be as per the extant IRAC norms.

Guarantee Fee 1.50% per annum on the guaranteed amount on outstanding basis. The Guarantee fee shall be borne by the borrower (s). The guarantee service fee once paid to the Trust is non-refundable. Guarantee service fee shall not be refunded, except under certain circumstances like Excess remittance or, Remittance made more than once against the same portfolio.
Guarantee Cover CGTMSE Guarantee cover for loans under the scheme should be obtained. 90% guarantee coverage would come from scheme/ Trust and remaining 10% from concerned promoter(s) on the credit extended by Bank under the scheme. The guarantee cover would be uncapped, unconditional and irrevocable credit guarantee.
Invocation of guarantee :

 

·         Inform about NPA classification within 90days

·         Branch/RO to Mark NPA in CGTMSE online portal within next (subsequent) quarter from the time it becomes NPA in the online portal.

·         The Trust shall pay 75 per cent of the guaranteed amount on preferring of eligible claim by the Bank, within 30 days, subject to the claim being otherwise found in order and complete in all respects.

·         The balance 25 per cent of the guaranteed amount will be paid on conclusion of recovery proceedings or till the decree gets time barred whichever is earlier.

·         Appropriation of amount realized by the Bank in respect of credit facility after the guarantee has been invoked.

·         Post invocation of the guarantee claim, if any recoveries are made, Bank shall first adjust such recoveries towards the legal costs incurred by them for recovery of the amount and their outstanding amount.

·         Any amount recovered beyond that then shall be provided to trust up to the extent of amount of claim settled by the trust.

DURATION

The Scheme is applicable to all credit facilities sanctioned under CGSSD for a maximum period of 10 years from the guarantee availment date or September 30, 2021 whichever is earlier, or till an amount of Rs. 20,000 crore of guarantee amount is approved.

 

   Some of the important precautionary measures in “Subordinate debt for Stressed MSMEs”:

  • To evaluate credit applications by using prudent banking judgement for selecting commercially viable proposals and conduct the account(s) of the borrowers with normal banking prudence.
  • To closely monitor the borrower account and put in all required efforts to ensure that the account is serviced regularly.
  • To conduct periodical inspection of securities (prime and collateral) for ensuring that the securities are in good and enforceable condition in line with the terms of sanction.
  • To ensure that the credit facility sanctioned under the scheme is not to be wholly or partly utilized for adjustment of any previously outstanding debts, over dues to the Bank including those deemed debts bad or doubtful of recovery.
  • To ensure that the guarantee claim in respect of the credit facility and borrower is lodged with the Trust in the form and in the manner and within such time as may be specified by the Trust in this behalf and that there shall not be any delay on its part to notify the default in the borrowers account which shall result in the Trust facing higher guarantee claims.
  • In the event of default, Bank shall exercise its rights, if any, to take over the assets of the borrower and the amount realized, if any, from the sale of such assets would be first used to settle senior debt. Any subsequent amount left post settlement of senior debt would be appropriated between trust and Bank in the ratio of extent of guarantee coverage.
  • To exercise all the necessary precautions and maintain its recourse to the borrower for entire amount of credit facility owed by Bank and initiate such necessary actions for recovery of the outstanding amount, including such action as may be advised by the Trust.
  • To recover the entire outstanding amount of the credit from the borrower, the guarantee claim should not take away the responsibility of recovering the loan dues.
  • To exercise the same diligence in recovering the dues and safeguarding the interest of the Trust, in all the ways open to it as it might have exercised in the normal course if no guarantee had been furnished by the Trust. Bank shall, in particular, refrain from any act of omission or commission, either before or subsequent to invocation of guarantee, which may adversely affect the interest of the Trustee Company as the guarantor. In particular, the Bank should intimate the Trust while entering into any compromise or arrangement, which may have effect of discharge or waiver of personal guarantee(s) or security.
  • To ensure either through a stipulation in an agreement/ undertaking with the borrower or otherwise, that it shall not create any charge on the security held in the account covered by the guarantee for the benefit of any account not covered by the guarantee, with itself or in favour of any other creditor(s) without intimating the Trust. Further the Branch shall secure for the Trust or its appointed agency, through a stipulation in an agreement / undertaking with the borrower or otherwise, the right to list the defaulted borrowers’ names and particulars on the Website of the Trustee company.
  • To hold on record all such statements, documents, receipts, certificates and other writings with regard to regular operations in the account/ functioning of the unit, it’s viability, financials etc. Inspection may be carried out either through the officers of the Trust or of SIDBI (in case of Institutions other than SIDBI) or any other person appointed by the Trust for the purpose of verification of guarantee coverage/ claim coverage etc. The indicative list may include Power bills, Tax paid receipts, GST Returns, latest available audited financials, IT returns, pre / post sales, inflow of stock & book debts, bills /vouchers etc.

Conclusion: Earlier, due to absence of any guidelines for financial support to NPA or, stressed viable units, Bankers were unable to take any decision. Sub-ordinate debt for stressed MSMEs is opening a gateway for viable stressed or, NPA accounts. In several instances, it has been found that support of small fund may help the company in its revival process.  This scheme is going to play a very important role in revival of sick MSME units either in NPA or, stressed condition if persistence of viability is diligently established.

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