Brief discussion on restructuring of loans: By CA Mahesh Bansal

A brief discussion on restructuring of loans –

Debt restructuring is a method used by companies with outstanding debt obligations to alter the terms of the debt agreements in order to achieve some advantages. Sometimes, there may arise circumstances when a borrower may not be able to honor its debt obligations towards the lender. Such debt obligations may either be repayment of principal or servicing of interest thereon or any other similar obligation. Then, it may request the lender to relax some of the terms & conditions associated with the loan so that it may take some relief, consolidate its financial position and again be able to meet its future debt obligations in a timely manner. Companies use debt restructuring to avoid default on existing debt.

Now, the question arises is what are the instances when a loan is said to have been restructured. The following are the main instances or examples when you can say confidently that the loan has actually been restructured.

1. Extension of repayment period- Suppose a term loan was originally sanctioned for a total period of 7 years. If, the bank subsequently extends the total period (called ‘tenure’) of the loan to say 8 years on request of the borrower, the loan will be said as ‘restructured’.

2. Extension of moratorium period- generally, the repayment of term loan starts after the gap of a number of months. If I avail a loan for the establishment of a new factory today and it will make me say 8 months to complete the construction, the bank may allow me to start repayment of principal after 12 months from today. During this period of 12 months, I will need to pay only interest accrued on the loan every month. This initial period of 12 months is called ‘moratorium’ and the repayment of the principal amount will commence after the moratorium. If initially the moratorium was stipulated as say 12 months and if the bank extends this moratorium to say 18 months with or without extension of the total period of the loan, the loan will be said as ‘restructured’. The moratorium may need to be extended for many reasons including delay in the establishment of the unit or delay in commencement of commercial production or initial cash inflows being less than originally anticipated.

3. Reschedulement of principal installments- Sometimes it is possible that the total tenure of the loan remains unchanged. The moratorium also remains unchanged but the installments of principal are re-arranged, the loan shall be said as ‘restructured’. This may be required for the reason that the cash inflows in initial years of operations may not be at par with the projections. So, the loan repayment schedule may need to be revised in such a manner that the installments of initial years are changed downwards and the installments of subsequent years are changed upwards.

4. Funding of overdue interest- Sometimes, it may happen that a borrower is not able to service the interest on the loan for any reason for a continuous period of a few months. Also, its financial position is also not favorable and it feels that it may not be able to service the overdue interest in near future in one tranche. So, the bank may create a second term loan out of the overdue interest amount so that the borrower can repay it in a number of installments in the same way as a term loan. In this case also, the original term loan shall be called as ‘restructured’

5. Conversion of a part of loan into equity- Sometimes, the financial position of a borrower may be in such a bad position that it is unable to service even the interest on outstanding loan facility and is unable to recover in near future. So, the lenders may decide to convert a part of loans into equity so that the interest burden on the borrower may be decreased and it can revive as soon as possible. It will also be treated as ‘restructuring’. When the unit recovers again and start making profits, the banks will take share in profits as shareholders.

6. Reduction in rate of interest- Sometimes, it is possible that the borrower is not able to service its debt obligations at the present rate of interest. So, the lenders may decide to decrease the rate of interest to some extent so that the unit can sustain it. This will also be called as ‘restructuring’.

7. Conversion of working capital facility into term loan- Sometimes, the commercial operations of a unit decline to such a level that neither it needs the working capital facility at the existing level nor it is able to service the interest on the entire facility but the working capital facility stands fully utilized due to continuous losses or involvement of funds in obsolete stock or book debts. In such a case, the bank may agree to convert a part of the utilized working capital facility into term loan which needs to be repaid in various installments over a longer period and the remaining working capital facility continues as such.

Anyone or more of the above said instances will make the loan a ‘restructured loan’. Please mind that the above list is not an exhaustive list and there may be a few more instances that may be termed as ‘restructuring’.

Any further query from any of the members on relevant topics is always welcome.

CA Mahesh Bansal
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