NPA Classification: OTS Versus Restructuring for a Textile Borrower
Sunrise Textiles has a term loan outstanding of ₹40 crore with a bank. Interest of ₹1.20 crore and principal instalment of ₹2 crore were due on 31 March; neither was paid. The account was standard on 31 March. On 30 June, the bank’s review shows the account is overdue for 91 days. Security is hypothecation of plant with a realisable value of ₹24 crore and a personal guarantee. The borrower proposes a one-time settlement (OTS) of ₹18 crore, payable 25% upfront and the balance over 12 months. Alternatively, it can restructure the loan by converting ₹6 crore of overdue interest into a funded interest term loan and extending repayment by three years. The branch expects normal operations if a 12-month moratorium is granted. The bank’s policy requires a fresh valuation and a credit rating downgrade review.
1. Classify the account as on 30 June and compute the provisioning requirement, stating your assumptions. What is the effect of the overdue interest?
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The account is an NPA because interest and principal have been overdue for more than 90 days. As on 30 June it has been NPA for up to 12 months, so it is substandard.
For provisioning, take the outstanding including overdue interest unless the interest is already embedded in the ₹40 crore: ₹40.00 crore + ₹1.20 crore = ₹41.20 crore. A secured substandard account attracts 15% provision: 41.20 × 15% = ₹6.18 crore.
If the bank treats only the realisable security of ₹24 crore as secured and the balance as effectively unsecured, the provision will be higher because the unsecured substandard portion attracts a higher rate. The branch must document this split rather than assume full security cover.
The overdue interest should not be capitalised merely to avoid classification. Converting it into a funded interest term loan is a restructuring event; it increases the outstanding on which provision is computed and does not by itself cure the NPA.
2. Compare the OTS and the restructuring proposal. Which should the bank accept, and on what conditions?
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The OTS recovers ₹18 crore, or 18 / 41.20 = 43.7% of outstanding, with ₹4.50 crore upfront. It gives certainty and avoids a long workout, but it crystallises a large haircut and may invite moral hazard if the promoter has capacity to pay more.
The restructuring preserves a larger nominal claim, but it is weaker on judgement: a 12-month moratorium and conversion of overdue interest into a funded interest term loan can amount to evergreening if cash flows are not independently verified. The account remains substandard, provisioning continues, and upgrade should not be automatic.
Recommendation: do not accept either proposal as presented. Obtain a fresh independent valuation and a revised TEV study. Ask for a higher upfront OTS contribution, say 40%, with personal guarantee enforcement and a defined payment security. If restructuring is preferred, require fresh promoter equity, escrow of receivables, a DSRA, milestone covenants, a cap on related-party payments, and a clear upgrade condition after at least 12 months of satisfactory servicing. Choose the option with the higher risk-adjusted recovery, not the higher nominal outstanding.