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Guarantees, LoCs to group companies will now have taut strings


Indian corporates will have to think twice before tossing ‘guarantees’ and ‘letters of comfort’ to help group companies raise money, notch up credit ratings, and bargain a lower interest rate on the back of such support from parents.

The rules of the game on ‘corporate guarantees‘ will change with the Reserve Bank of India (RBI) insisting on a water-tight, time-bound mechanism for the issuance of guarantees and their invocation by lending banks.

About a week ago, in a “guidance note” to credit rating agencies, the banking regulator has said that banks have to formally agree to a time frame within which they would invoke a guarantee following a loan default while the corporate guarantor has to commit to a deadline to pay up once the invocation by lenders takes place, a senior industry person told ET.

Rating agencies have been advised by the regulator to perform legal due diligence and ensure that the right structures and agreements are in place so that lenders, as well as borrowers, stick to a formally agreed timeline on invocation and loan repayment.

A corporate guarantee is a promise by the parent to assume the debt obligation of a group company if the latter fails to repay or service a loan.

“Banks rarely pull the trigger soon after a default. They try to negotiate and assess the situation. They may also delay the guarantee invocation to preserve business relationships with the group whose other group companies may be giving good business to the bank. Also, it could be an old client. Besides, recovering a loan through a guarantee invocation can be timing consuming,” said a senior banker.

If a borrower refuses to repay post guarantee invocation, banks have to move the court or initiate proceedings at a Debts Recovery Tribunal.

“But a timeline spelt out in a guarantee document would certainly put extra pressure on a company to behave as it knows the bank is bound to act. I feel putting an end to open-ended corporate guarantees is a step in the right direction,” said another person. “Traditionally, banks never set a timeframe when a guarantee would be invoked. We have to figure out how this would work,” he said.

Almost 90% of the 50,000 debt ratings in the country are on bank loans. Banks prefer rating on loans as risk weightage on such assets comes down, letting lenders preserve some capital.

The rating on a loan which has a corporate guarantee carries the tag ‘CE’ (or, ‘credit enhancement’.) This improves the rating on the loan by at least one notch than it would have fetched without parent support. The RBI note relates to such loans.

RBI also said that an arm of a foreign company in India cannot be given ‘CE’ rating unless the overseas parent has a rating from one of the top three rating agencies in the world.

However, for non-loan debts, like non-convertible debentures or NCDs – a preferred borrowing route for several corporates – ‘CE’ on a rating does not reflect explicit support from the parent. Instead, it simply indicates that some extra cushion, like cash collateral, is set aside by the borrower to give a degree of comfort to financial creditors subscribing to the NCDs.

In the case of securities which are ‘guaranteed’, rating agencies use the nomenclature ‘SO’ (or, structured obligation). But agencies add ‘SO’ to only ratings of securitised papers, like pass-through certificates, which though similar to bonds are riskier instruments and whose servicing of interest and principal repayment depends on the cash flow generated by an underlying pool of loans. Thus, what ‘SO’ is to a securitised paper, ‘CE’ is to a bank loan.

“The guarantee structure for NCDs was streamlined by Sebi. Now RBI is doing it for bank loans which form the bulk of the ratings,” said a source in the loan market.

Guarantees cannot be invoked once lenders initiate action under the Insolvency and Bankruptcy Code against a corporate borrower and their petition is accepted by the National Company Law Tribunal – a quasi-judicial authority set up to deal with corporate disputes. There is a standstill on payouts to creditors by the company concerned once IBC proceedings begin.



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