Fintelligence 06 (dated 30 October 2014). Contact us at [email protected] st In the previous newsletter dated 01 Oct. 2014, we presented the monthly regulatory update covering RBI, SEBI and other relevant legislations pertinent to HFCs. In this letter we look at alternative capital raising options for NBFCs and HFCs. While only equity is considered as core capital, RBI has allowed NBFCs to raise supplementary capital through instruments which carry “equity-like” features such as subordination in terms of payment of coupon and redemption of principal, mandatory lock-in and non-availability of security. These are designed to ensure such capital instruments have the capability to absorb loss in case of stress and provide protection to senior debt holders. Supplementary capital: All financial institutions, including NBFCs and HFCs are required to maintain a minimum capital adequacy ratio of 15% or 12%, as the case may be. In addition to core capital, which comprises of equity and accumulated reserves, institutions are also allowed to raise supplementary capital to the extent permitted by RBI / NHB. Supplementary capital also provides protection to senior debt holders, but to a lower extent compared to core capital. Considering that equity is quite rare and the most expensive form of capital, supplementary capital allows the entity to increase its financial leverage while meeting minimum capital adequacy norms. Supplementary capital instrumental have characteristics of both debt and equity instruments. These instruments are subordinated to senior debt holders for repayment of interest and principal. As these instruments carry higher credit risk compared to senior investors, investors typically expect higher returns on these instruments. According to prudential norms, instruments must satisfy the following norms to be considered as supplementary capital: Fully paid up "Instruments" only Discounting in the years leading to maturity Unsecured Supplementary Capital Subordination to senior creditors No Put Option No restrictive clauses Fintelligence 06 (dated 30 October 2014). Contact us at [email protected] Types of Supplementary Capital: NBFCs and HFCs are allowed to raise supplementary capital via the instruments mentioned below. The classification of these instruments under Tier I / Tier II capital depends on the level of protection that each instrument offers to senior lenders. Instrument Available to Classification Compulsorily Convertible Preference Shares (CCPS) Perpetual Debt (PD) NBFC & HFC Tier I without limit NBFC Hybrid Tier II Bonds (Hybrid) Redeemable Preference Shares (RPS) Subordinated Debt (Sub Debt) HFC NBFC & HFC NBFC & HFC Tier I upto 15% of total Tier I capital; balance can be classified as Tier II without limit Tier II Tier II without limit Tier II upto 50% of Tier I Key features of various forms of supplementary capital: The regulators have defined the various key features of the different forms of supplementary capital instruments that are available to NBFCs & HFCs. These are tabulated below: Seniority: Feature Seniority CCPS RPS RBI Norms applicable to NBFCs PD Sub Debt Senior only to Equity Senior to Tier I capital CCPS RPS RBI Norms applicable to NBFCs PD Sub Debt Tier I Tier II Tier I / Tier II Tier II Tier II Tier II 100% 100% Upto 15% of Tier I; balance in Tier II 100% subject to progressiv e Discount in last 5 Years 100% subject to progressive Discount in last 5 Years 100% subject to progressive Discount in last 5 Years Not mandatory if on private placement basis and not listed Not mandatory if on private placement basis and not listed Not mandatory if on private placement basis and not listed Minimum "adequate safety" rating i.e., 'A' category or above Minimum "adequate safety" rating i.e., 'A' category or above Senior only to Equity and CCPS Senior most capital instrument NHB norms applicable to HFCs Hybrid Sub Debt Senior to Equity, PD, RPS, PD; Junior to Lower Tier II Bonds Senior most capital instrument Eligibility: Feature Classificatio n Amount eligible for Inclusion Security Rating Unsecured Not Required NHB norms applicable to HFCs Hybrid Sub Debt Fintelligence 06 (dated 30 October 2014). Contact us at [email protected] Issue Size: Feature CCPS RPS Minimum issue size (per investor) NA NA Rs. 25 lakhs (multiples of Rs. 5 lakhs thereafter) if private placement No Limit No Limit No Limit No Limit 100% of T-I along with other T-II No limit; Classified as Tier I upto 15% of Tier I; balance as Tier II Feature CCPS RPS Redeemable Min Maturity (years) No Perpetual Yes NA Max Maturity (years) Put Option Call Option Perpetual Not specified NA NA RBI / NHB Approval for Redemption NA No Yes; After 10 Years with prior RBI Approval Required CCPS RPS Maximum issue size Maximum issue size RBI Norms applicable to NBFCs PD Sub Debt NHB norms applicable to HFCs Hybrid Sub Debt Rs. 25 lakhs (multiples of Rs. 5 lakhs thereafter) if private placement No Limit Rs. 25 lakhs (multiples of Rs. 5 lakhs thereafter) if private placement Rs. 25 lakhs (multiples of Rs. 5 lakhs thereafter) if private placement No Limit No Limit 50% of Tier I 100% of T-I along with other T-II 50% of Tier I Redeemablility: RBI Norms applicable to NBFCs PD Sub Debt No Perpetual; call option allowed after 10 years Perpetual No Yes; Min 10 Years; Prior RBI Approval Required NHB norms applicable to HFCs Hybrid Sub Debt Yes 5* Yes 15 Yes 5* Not specified No Yes; Min 5 Years; Prior RBI Approval Required Not specified Not specified No Yes; After 10 Years with prior NHB Approval Required No Yes; Min 5 Years; Prior NHB Approval Required Returns: Feature RBI Norms applicable to NBFCs PD Sub Debt Return Type Rate of Interest / Dividend Dividend No Restriction Dividend No Restriction Interest No Restriction; maybe fixed or floating Step-Up Option NA No Yes. Can be exercised only Interest No Restriction; maybe fixed or floating No NHB norms applicable to HFCs Hybrid Sub Debt Interest No Restriction; maybe fixed or floating Interest No Restriction; maybe fixed or floating Yes. Can be exercised No Fintelligence 06 (dated 30 October 2014). Contact us at [email protected] Feature CCPS RPS RBI Norms applicable to NBFCs PD Sub Debt once during the whole life of the instrument after the lapse of 10 yrs; not more than 100 bps NHB norms applicable to HFCs Hybrid Sub Debt only once during the whole life of the instrument after the lapse of 10 yrs; not more than 100 bps Taxation: Feature - For issuer - For Investor CCPS Dividend is not tax deductible; Dividend Distribution tax to be paid by issuer Dividend is Tax free RPS Dividend is not tax deductible; Dividend Distribution tax to be paid by issuer Dividend is Tax free RBI Norms applicable to NBFCs PD Sub Debt NHB norms applicable to HFCs Hybrid Sub Debt Interest tax deductible Interest tax deductible Interest tax deductible Interest tax deductible Interest taxable Interest taxable Interest taxable Interest taxable Payout / Redemption: Feature Interest / Dividend CCPS Only in case of profits and after interest / dividend paid against other capital instruments RPS Restricted if Loss / CRAR below minimum RBI Norms applicable to NBFCs PD Sub Debt Restricted if Loss / CRAR below minimum NHB norms applicable to HFCs Hybrid Sub Debt Restricted Restricted if Restricted if if Loss / Loss / CRAR Loss / CRAR CRAR below below below minimum; minimum; minimum; may be paid may be paid may be with prior with prior paid with approval approval prior from NHB from NHB approval from RBI Principal NA NA; Call option NA; Call option NA; Call NA; Call NA; Call cannot be cannot be option option option exercised if exercised if cannot be cannot be cannot be CRAR is / will CRAR is / will exercised if exercised if exercised if be below be below CRAR is / CRAR is / CRAR is / regulatory regulatory will be will be below will be below minimum minimum below regulatory regulatory regulatory minimum minimum minimum * The minimum maturity for subordinated debt instruments is not prescribed by RBI / NHB. However, unsecured subordinated instruments with an initial tenure of less than five years would be considered as public deposits Fintelligence 06 (dated 30 October 2014). Contact us at [email protected] The Regulations specifically mention that subordinated / hybrid / perpetual debt can be raised only in the form of “instruments”. As such, loans may not be eligible for classification as Tier I or Tier II capital even if all other conditions as satisfied. Capital instruments can be issued only in Indian Rupees. HFCs may issue hybrid capital in foreign currency with prior approval from NHB / RBI. In case of Subordinated debt and Hybrid Upper Tier II capital, the amount qualifying for Tier II capital is subject to discounting in the last 5 years to maturity as given below: Remaining maturity of the instruments (i) up to one year (ii) More than one year but upto two years (iii) More than two years but upto three years (iv) More than three years but upto four years (v) More than four years but upto five years Rate of discount (%) 100 80 60 40 20 Capital instruments are exempt from reserve requirements Only QIPs or other investors who have given positive consent for subscribing to subordinated debt 1 instruments can invest in such instruments . Supplementary capital instruments enable finance companies to increase their financial leverage while still complying with capital adequacy norms. At the minimum prescribed level of capitalisation (15% and 12%, 2 respectively, for NBFCs and HFCs), the leverage is limited to 5.7x for NBFCs and 7.3x for HFCs in case the capital adequacy requirement is met wholly out of equity. However, except in case of NBFC-MFIs, Tier I capital requirement is not prescribed by the Regulators. Instead, the regulations place a cap on Tier II capital at 100% of Tier I and perpetual debt at 15% of total Tier I. Assuming and NBFC / HFC takes full advantage of supplementary capital limits, the financial leverage can theoretically be as high as 15x. We hope you found the update useful. We welcome your feedback to us at [email protected] and would be glad to revert in case you need any further details. 1 2 SEBI (DIP) Guidelines, 2000 Assuming 100% Risk Weight for underlying portfolio.
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