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SECTION B - AVAILABILITY AND FORMS OF FINANCING FOR ENTERPRISES B1. Business financing arrangements generally. (a) Is it more usual for the financing needs of these types of corporates to be satisfied out of capital (equity) raisings; retained earnings; or external borrowings? A combination of all three methods may be used for the purposes of raising capital. However, it is more usual for corporates to resort to external borrowing for their financing needs. However, the State Bank of Pakistan Prudential Regulations for Commercial Banks and the State Bank of Pakistan Prudential Regulations for Non Banking Financial Institutions ("NBFIs") place a limit on the extent of lending by banks and require so that a certain debt-equity ratio be maintained at a prescribed level (presently 60:40) in the case of long term debts. Consequently, external borrowing has to be balanced to that extent. In addition, usually current assets and over-heads are financed by short term borrowings. (b) What are the main sources for borrowing for these types of corporates? Commercial Banks are the main source for borrowing corporates. In addition, NBFIs certain Development Finance Institutions ("DFIs"), Investment Banks, Leasing Companies, Modarabas (closed-end mutual funds) also provide finances. Foreign Lending Agencies such as the World Bank, IFC, ADB, CDC etc. play a significant role. As indicated above, borrowings may also be in the form of lease financing from leasing companies with buy back arrangements. A number of leasing companies are operating in Pakistan but most of them are not doing well because of the high cost of funds such companies have to borrow for their operations. (c) Is there significant competition among lenders and significant choice of sources for borrowing available to these type of corporates? There is significant competition as there are a large number of
commercial banks interested in offering financing especially for
what are considered to be blue chip companies. Depending on the
repayment period, Commercial Banks, NBFIs and DFIs are open to long
term lending and therefore corporates have a sufficient choice of
lenders. Most lenders (including foreign banks operating in the
country) are keen to meet the short term financial needs of corporates.
(d) What is the present average rate of interest payable in respect of unsecured and secured debt? Under the State Bank of Pakistan Prudential Regulations for Commercial Banks and NBFI's, unsecured debt is not allowed (except to a nominal limit of Rs.100,000 in the case of Commercial Banks lending to a person including a company). The interest rate for secured debt depends on the credit rating of the borrower but the average rate varies between 16 to 22%, with leasing companies charging upto 25%. At present, there is excess liquidity available in the financial sector. Therefore, competitive interest rates may be available to blue chip borrowers. (e) Is finance generally available for long, medium and short term borrowings? Yes. However, finance for long and medium term borrowings is usually available only from the public sector banks, NBFIs, DFIs and Foreign Lending Agencies. Private Commercial Banks however, prefer short term lending. The State Bank of Pakistan (the central bank of the country) also requires commercial banks to lend in large part on short term basis. B2. Central or other similar bank control or influence. (a) What part does the central bank of this country play in the regulation of the banking and finance sector? Would it intervene or seek to influence the outcome or course of events if, for example a large corporate with debt exposure to a number of banks was in financial difficulty? The State Bank of Pakistan plays a substantial regulatory role in the banking, and finance sector and in implementing the country's monetary policy through the State Bank of Pakistan Act, 1957, the Foreign Exchange Regulation Act, 1947 and the circulars of the State Bank. Although, there are recent precedents of the State Bank intervening in case of insolvent and financially troubled financial institutions in order to safeguard the overall financial sector in Pakistan. The State Bank, however, is not known to have played the role of directly bailing out a borrower in financial difficulty. (b) Is there any tradition in this country for a 'main' or 'house' or 'lead' bank to become involved as a chief negotiator or leader in the case of the financial difficulty or insolvency of a large corporate borrower with debt exposure to a number of banks? In the case of syndicate borrowing, the lead bank would theoretically assume the role of chief negotiator or leader in negotiating a restructuring with the corporate borrower; however, this is not always the case and the general experience is that each time the lead bank has assumed this role, it has failed and every bank has gone its own way. [These issue are further raised later in this working guide, so a general answer will suffice here] B3. Assessment of borrowing risk and monitoring of financial position (a) Is assessment or analysis of lending risk widely practised in this country? Yes. All banks and financial institutions, as a rule do assess and analyse lending risk to any particular customer or to a class of borrowers. For this purpose, the Banking Companies Ordinance, 1962 of Pakistan authorises banks to exchange, on confidential basis, information about their clients. (b) If so, does the average lending bank make adequate assessment of risk analysis when contemplating lending to a corporate borrower? As mentioned, all banks are expected to, and in almost all cases, do try to make adequate assessment or risk analysis when contemplating lending to a corporate borrower and foreign banks and private sector banks do, on balance, make adequate risk assessment. However, historically as the bad debt portfolio of public sector banks and DFIs has shown, the assessment by these institutions is not adequate or the decision to lend based on such assessment is not correct. (c) Would it be usual or common for a lending bank to regularly monitor the financial performance of a corporate borrower? Yes. Most sophisticated foreign and local bank do regularly monitor the performance of their customers in the light of the underlying financing/security documents. However, we must admit that monitoring by some of the larger banks in the public sector and by some new banks in the private sector may not be adequate or may not be translated into tangible steps. (d) Would it be usual or common for a lending bank to be regularly supplied with copies of the financial statements of a corporate borrower? The requirement for regular provision of financial statements or information is a standard provision in almost all long term agreements for financing. The Banks and NBFIs are required to obtain such statements owing to the reporting requirement to the State Bank under the State Bank's Prudential Regulations for Commercial Banks and NBFI's. B4. Foreign bank lending. (a) Is there a significant source of foreign lending in this country? Foreign lending (lending by banks from outside Pakistan), is a significant source of funding for industrial projects (especially for large industrial projects) requiring currency imports of plant and machinery. Trade related finances by foreign banks, especially for import of petroleum products, is also common. Foreign controlled companies also borrow from foreign banks against State Bank of Pakistan repatriation guarantees for meeting working capital requirements. In addition, foreign lending to the public sector by Foreign Lending Agencies has been a significant source of funding. (b) If so, is it usual for this funding to be provided by the foreign banks alone or in combination with funding from local or domestic banks? Both alone (very rarely) and in combination with local or domestic banks. However, this really depends upon the size of the project and arrangement to be placed for financing. In big projects, where "Financial Close" is a condition precedent, in that considerable finances by foreign and local banks must be committed and a combination of finances by foreign and local banks is put in place. As indicated above, funding by foreign banks alone is very rare, for the reason that foreign banks provide foreign currency requirements of a project as against which, local banks provide local currency requirements. (c) Are you able to detect whether there are significant differences in approach and funding terms when a foreign bank is involved in the lending (as compared with a purely local or domestic funding)? There is a significant difference when a foreign bank is involved both as to approach and as to funding terms. (d) If so, what are the main differences? Foreign banks lending is, as above mentioned, in foreign currency. Therefore, elaborate foreign currency loan and security agreements developed by international law firms are used. As against this, the local financing documents are simpler and shorter. Secondly, there is much greater due diligence and evaluation of business prospects for the reason that funds are provided based upon a project's success and cash flow so as to get an assurance about repayment. To some extent, this criteria is also used by local banks, but greater reliance is placed on security as a matter of policy as well as under the State Bank's directives. B5. Exclusive lending. (a) Is 'related' or 'exclusive' lending (i.e. where a corporate borrower and a bank have an established commercial relationship such that only that lender is looked to as the source of borrowing by the corporate borrower) common in this country? This is rare for large corporates, but not unknown for small and medium sized corporates. A very large part of funding is provided by the five large commercial banks, Habib Bank, National Bank of Pakistan, United Bank, Muslim Commercial Bank and Allied Bank. The first three are in the public sector and the other two are in the private sector (although previously these were also in the public sector and have been privatised). These banks are large enough to have deposits from all over the country and, therefore, in a position to lend. These banks like to have a one to one relationship with their customers. Therefore, as mentioned above, for small and medium sized projects, a dedicated relationship exists as general rule. (b) If so, what effect does this have if the corporate borrower is in financial difficulty or is insolvent? All the risk is placed on one institution or few institutions. If the financial difficulty is of a temporary nature, or is possible to be rectified, the sole lender or lenders do try to help with a view to protecting their investment. However, in the case of insolvency or where a project closes down, the lender has to take a beating and make provision for the loss in its balance sheet. B6. Syndicated lending. (a) Is 'syndicated' lending (i.e. where a group of banks or financial institutions join together to provide funding for a corporate borrower) common in this country? Yes, but usually only for top rated and/or large companies. (b) If so: (i) does a lead bank perform the role of 'agent' on behalf of all
the lenders; and/or Our answer is in the affirmative, the agent
may be one of the lenders or an arranger or a specific bank (not
being one of the lenders) appointed to act as agent. B7. Subordinated debt (a) Is the concept known as 'debt subordination' (i.e. a contractual arrangement between lenders in which there are 'layers' of 'senior' and 'junior' debt and which has the effect of postponing repayment of the 'junior' debt until payment has been made of the 'senior' debt) recognised and practised in this country? Yes. This concept is recognised and practiced in Pakistan. However, in most cases, the loans provided by the directors and sponsors of a Company are made subordinate to the loans provided by banks and other financial institutions. In very few exceptional cases, some times loans provided by any bank or banks may be subordinated to the laons provided by other banks. (b) If so, is debt subordination recognised and/or enforced under the insolvency regime of this country? There is some doubt about the priority and subordinated rights in the case of unsecured facilities/debts. However, in case of secured facilities/debts, the rule of priority of charges will apply. As a general rule, the subordinate debts will not be secured pari passu with or in priority to senior debts. Therefore, where the security in enforced, the senior debts will be paid in priority to the subordinate debts. Section 121 of the Companies Ordinance deals with the registration of mortgages and charges. Once a mortgage or charge is registered, any person acquiring such property or any part thereof, or any share or interest therein is deemed to have notice of the mortgage or charge from the date of registration. Such registered charges and mortgages are enforceable against a liquidator in insolvency proceedings where a company is being wound up (see detailed discussion later in this Report). Thus, in every such case, the charge security of the senior debt will have priority to the charge securing subordinate debt (subject to the terms and conditions of the security documents) B8. Banks and equity/debt. (a) Is it permissible for banks to own equity in a corporate borrower? There is no bar on holding of equity by banks. However, under the Banking Companies Ordinance 1962, no banking company is to hold shares in any company whether as a pledgee, mortgagee or absolute owner, of an amount exceeding 30% of the paid up share capital of the company or 30% of its own paid up share capital and reserves, whichever is less. In certain exceptional specified cases, a bank may hold 100% shares by establishing subsidiary companies, such as companies established for undertaking and executing trusts for undertaking of the administration of estates as executors, trustees or other wise, and for certain other allied purposes. (b) If so, is it permissible for a bank to convert debt to equity? Yes. However, this will be subject to contract between the bank
and the borrower. Secondly, banks cannot automatically convert,
but will request the borrower to issue shares in lieu of the loan
amount. In fact, the proposal will come from the borrower company
in case of its imminent insolvency. In certain cases, banks acquire
a right to convert a part of its loan into equity, especially where
the borrower company is a listed company. In such cases, the bank
exercises its rights of conversion where the price of the shares
of the borrower on the stock exchange substantially exceeds the
conversion price agreed between the bank and the borrower. (c) Are there instances where this has in fact occurred, particularly in the context of either: (i) in the context of an 'informal work out' as a result of the
insolvency or approaching insolvency of a corporate borrower; or
(ii) in the context of a formal insolvency administration of a
corporate borrower? (d) In such a case, is it usual for the bank to be then represented on the management or board of the corporate borrower? If the bank acquires 14.29% shares of a borrower, the bank will have a right to get elected a nominee on the Board of Directors of the borrower company (which is a public company). Election of Directors are held under the cumulative system of voting. At an election of Directors, each member has such number of votes as is the product of the number of shares held by him and the number of Directors to be elected. A member may cast all his votes in favour of one candidate or distribute the same amongst any candidates. A public company must have at least seven Directors. If any person holds 14.29% shares of a public company, such person, including a bank, will be able to get at least one Director elected on the basis of his shareholding under the above described cumulative system of voting. In addition, it should be noted that the Companies Ordinance authorises companies to appoint on their Boards any persons nominated by their creditors. Therefore, by agreement between any bank and a borrower company, a bank may have nominee Directors on the board of the borrower. [This aspect is raised later in this working guide, so only general answers are required here] B9. Debt Trading (a) Is there a market for 'debt trading' (i.e. where a bank might sell or trade the debt owed to it by a corporate borrower) in this country? A potential market may exist, but it is very difficult to trade debts because of stamp-duty charged on the documents involved in transferring debts. This duty varies from province to province. The rate of stamp-duty in the Province of Sindh could be as high as 7% of the amount of debt to be sold/transferred. Because of this reason, a market has not developed. (b) If so, is debt trading common in this country, particularly where the corporate borrower is insolvent or near insolvent? For the reason set out above, debt trading is not common in Pakistan. [This issue is raised later in this working guide, so a general answer will suffice here] B10. Guarantees to support lending. (a) Is the concept of a third party 'guarantee' (as distinct from a security over property) to support corporate borrowing known and practised in this country? Yes. This concept is known and, where possible, practiced in Pakistan. (b) Is there a law which regulates the power to take or give a guarantee? Pakistan Contract Act, 1872. (c) Is it common or usual for corporate borrowing to be supported by guarantee/s? It is not common. Corporate borrowing is generally secured by a charge over the assets of a borrower. However, as additional security, banks do sometimes require the directors/owners to provide their personal guarantees. The State Bank regulations also require that personal guarantees of directors should be obtained, as additional security, in case of private companies and partnerships. (d) If so, are these guarantees usually taken from owners/directors of the corporate borrower; from other corporates associated with the corporate borrower (e.g. subsidiaries or holding company); or from unrelated third parties? Our answer at (c) above has coverd this question as well. When required, personal guarantees are obtained from directors/owners. In the case of subsidiaries, guarantees may be obtained from the holding companies. (e) Is there a law which regulates the enforcement of guarantees? The enforcement of guarantees is regulated by the Contract Act, 1872 and by a special law enacted for facilitating recoveries by banks, i.e., the Banking Companies (Recovery of Loans, Advances, Credits and Finances) Act, 1997. (f) Is it easy or difficult in practice to enforce guarantee obligations? Where a guarantee is given by a bank, it is usually easy to enforce the guarantee. A bank will strictly adhere to the terms of the guarantee and only in the case of a derogation thereof or in exceptional circumstances, will a bank refuse to honour its guarantee obligations. Where however, a guarantee is given by the owners/directors of a corporate borrower itself, enforcement of a guarantee is usually more difficult to enforce unless backed by readily realisable security. (g) Is it usual to require that a guarantor should give security over the property of the guarantor as an additional comfort to the lender? Depends on the circumstances of each case. Where a borrower is not in a position to offer tangible security, such as a charge over any property, the lending bank may require the guarantor to create a charge in favour of the bank over his property as security for his guarantee obligations. (h) Does the insolvency of a corporate borrower have any effect on the enforcement of a guarantee? This will depend upon the wording of the guarantee. If the guarantee specifically states that it will remain in full force despite the winding-up or insolvency or any other disability of the corporate borrower and that the guarantor will be considered as primary obligor as well, then, in such case, there should be no difficulty in enforcing a guarantee. In the absence of such words in a gurantee, it may become difficult to enforce a guarantee. Under the Contract Act of Pakistan, the obligation of a surety (i.e. the guarantor) is co-extensive with that of the principal debtor (unless it is otherwise provided in the guarantee contract). Thus, where a corporate borrower is under liquidation and the amount received by or payable to any creditor by the liquidator of the corporate borrower is not sufficient to fully pay-off the amount due to such creditor by the corporate borrower, the creditor should be able to invoke and enforce any guarantee furnished to it as security for the obligations of the corporate borrower if the guarantee specifically states that the obligations of the surety under the guarantee will not be affected by the insolvency or winding up of the corporate borrower. |
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