Framework for risk assessment of loan facilities collateralised by equity shares ICICI Bank UK has been taking exposures

which are collateralized by a certain amount of value of equity shares of a company primarily listed on Indian stock exchanges. Some of the key risks that we run in such transactions are as follows: Value of the collateral is a perceived value and could be independent of the business and financial performance of the company. Value of shares could change due to events not related specifically to the company or the industry like a negative view on the economy, testing of a nuclear device by a country, negative sentiment on the stock market, change in government, etc. over which are outside the control of the company management Our ability to sell the shares when the cover drops below the stipulated cover in a timely fashion. Amongst other parameters, this is a function of the attractiveness of the industry, the extent of shareholding, the liquidity of the scrip, etc some of which could change over time. Also, we have yet to build a track record in selling a significant shareholding of a company. No recourse to any other security. No clear source of cash flows to take out the loan.

Given the risks associated with such loan facilities, we propose to limit the exposure of such and other facilities linked to the capital markets to 100% of the Banks LECB. To introduce objectivity and consistency to the risk assessment framework for such deals, we recommend the following key mandatory conditions : the company whose equity shares are being taken as collateral should be rated at least A+ (CRISIL/ICRA/Internal rating). Covenants like a maximum Debt/ EBIDTA of 3 times or a minimum rating of A+ (by CRISIL/ ICRA, if rated externally) to be maintained over the life of the facility to be stipulated. Tenor of lending to be restricted to three years only An overall cap of USD 30.0 mn for facilities backed by a specific share as collateral. An exception can be taken only in the case of highly rated, liquid shares. Extent of cover (value of scrip/ loan) will be a minimum of two. The shares should be free of any lock in. Price of scrip will be based on the lower of the last one years average price or current price. The trailing P/E multiple as compared to the industry multiple would also need to be examined and if significantly higher, would need to be adjusted for in the price of the share. The promoter should have a minimum unencumbered shareholding in the company of an amount equivalent to 4 times the facility (including the amount required to maintain the aforesaid minimum cover of 2). Of this, a minimum amount of shares equivalent to 0.5 times the facility, would be in demat form and placed with the security trustee for the transaction for top up purposes. The shareholder would provide a non-disposal undertaking on the remainder shares viz. a minimum of 1.5 times of the facility amount.

The percentage of shareholding equivalent to the amount of facility should be a maximum of 5%. If higher, the shareholding percentage should be large enough to cause distress to the promoter if sold. Time for liquidation of collateral equal to the amount of facility based on the average daily volumes traded on the NSE for the past 12 months and assuming that the Bank can sell an amount of shares per day equivalent to such daily volume on a continuous basis till the required amount of stock is liquidated should be a maximum of 10 days. It is to be noted that practically the time to sell such stock would be much higher. Floating stock of the company should be a minimum of 20%. Loans against unlisted shares will not be done Scrip to be in the A/ B1 Group of the BSE

From a structuring perspective, the key mandatory conditions are : The number of days required to top up the cover, in case the cover falls below the stipulated minimum, has to be a maximum of 4 days. A debt service reserve account equivalent to 6 months interest on the facility to be maintained with the Bank. A 50% drop in price is treated as an event of default. The security cover based on last 2 years average price should be at least equal to 1. Share price monitoring has to be done on a daily basis External security trustee has to be appointed Other issues, inter alia, that would also be considered would be : a) Ability to gain or create pain in the case of default (criticality of the shareholding to the promoter) : This is the amount of pain value that we can create for the promoter or the amount of gain that could accrue to a competitor were the shares sold to it b) clarity of the source of take out of the loan c) promoter comfort/ reputation d) Market volatility of the scrip (the stock beta/ correlation with BSE Sensex for the scrip to be used as a surrogate) e) legal issues viz. whether we have a pledge or a NDU with safety net f) restrictions on shares with respect to FII/ FDI investment limits g) attractiveness of the industry sector h) Market volatility of the scrip (the stock beta/ correlation with BSE Sensex for the scrip to be used as a surrogate) Attempt should also be made to introduce private equity like additional covenants where possible (for e.g. if the promoter has significant shareholding in the company which we have shares of) to create enough nuisance value for the promoter. We shall attempt to set up indicative benchmarks with increase in our experience in such lending as an aid to the business groups for risk assessment of such facilities.