Banks are paying the price as India Inc sits on a debt time bomb

When corporates do not have enough money to repay the interest on their 
outstanding debt, banks can’t be in the best of shape.Reuters

by  FP Vivek Kaul Nov 22, 2013

Borrowing money to run or expand a business is standard operating procedure. The only thing is that the money that has been borrowed needs to be repaid. But sometimes the business does not make enough to repay the borrowed money or debt as it is referred to as.

And some other times, the business does not make enough money even to repay the interest on the debt, that it has taken on. Indian businesses are going through that phase right now. A significant number of them are not making enough money to even repay the interest on the debt that they taken on.

In a report dated November 19, 2013, Ashish Gupta, Prashant Kumar and Kush Shah of Credit Suisse make this point. As they write “Of our sample of listed companies(around 3,700 listed companies), the share of loans with corporates having interest coverage (IC1) <1 went up to 34% (versus 31% in 1Q14). Of these, 80% (78% in 1Q) of loans were with companies which had IC<1 for at least four quarters in the past two years and 26% of them have not covered interest in eight consecutive quarters.”

Now what does this mean in simple English? Around 34% of the listed companies that Credit Suisse follows have an interest coverage ratio of less than one. Interest coverage ratio is essentially the earnings before interest and taxes of a company divided by its interest expense. If the interest coverage ratio is less than one what it means is that the company is not making enough money to pay the interest on its outstanding debt.

Hence, more than one third of the listed companies in the Credit Suisse sample are not making enough money to pay the interest on their debt. Of this lot nearly 80% have had an interest coverage ratio of less than one in at least four quarters in the past two years. And 26% have not made enough money to cover their interest for eight consecutive quarters.

The only conclusion that one can draw from this is that India Inc is sitting on a debt time bomb. “Large corporates continue to be under significant stress as out of the top-50 companies by debt with interest coverage<1 in the second quarter, 23 companies haven’t covered interest in seven or more quarters in past two years and 38 companies were loss making at a profit after tax level,” write the analysts.

A lot of this borrowing was carried out during the easy money years of 2003-2008, when banks were falling over one another to lend money. But now the chickens are coming home to roost. When corporates do not have enough money to repay the interest on their outstanding debt, banks can’t be in the best of shape.

The non performing assets of banks have been on their way up. As economist Madan Sabnavis wrote in a recent column in The Financial Express “Ever since the economy started slipping, companies have found it difficult to service their loans leading to NPAs’ volume increasing from 2.4% in FY11 to 3.0% in FY12 and around 3.6% in FY13. In absolute numbers, they stood at around Rs 1.9 lakh crore in March 2013.”

But what is even more worrying is the rate at which the total amount of restructured loans have been growing. Under restructuring, companies are allowed a certain moratorium on repayment of the outstanding debt. The interest rates to be paid on the outstanding debt are eased at the same time.

In a note dated November 7, 2013, Gupta and Kumar of Credit Suisse had pointed out that “ Indian Bank.restructured loans were at Rs3.3 trillion (Rs 3,30,000 crore) of which 55% has come through the corporate debt restructuring route.” The total amount of restructured loans are now at 6% of the total loans that banks have given(around 47% of networth of the banks).

And this continues to grow at a huge speed. In October 2013, the corporate debt restructuring cell received new references of Rs 170 billion (Rs 17,000 crore).

Economist Madan Sabnavis throws some more numbers. “The CDR website shows that the volume of restructured debt has increased continuously, touching Rs 2.72 lakh crore as of September 2013 from Rs 0.9 lakh crore in FY09, and was at Rs 2.29 lakh crore by March 2013. In terms of a ratio as a percentage of total advances, CDR was higher at 4.4%, and even traditionally this ratio has been higher than the declared gross NPA ratio…Adding the NPAs to CDRs, the total would stand at 8% for FY13, which is quite scary,” he wrote in TheFinancial Express.

The reasoning given for corporate debt restructuring is that often a project that the business has borrowed for, does not take off due to external circumstances. This can vary from the environmental clearance not coming in to the land required for the project not being acquired in time.

But with the amount of loans being restructured rising at such a rapid rate leads one to wonder whether the banks genuinely feel that these loans will be repaid or as they just postponing the problem? Take the case of October 2013. New references of Rs 17,000 crore were made to the CDR cell. In comparison for the period of July 1 to September 30, 2013, references to the CDR cell had stood at Rs 24,900 crore.

The Reserve Bank of India(RBI) is clearly worried about this. “You can put lipstick on a pig but it doesn’t become a princess. So dressing up a loan and showing it as restructured and not provisioning for it when it stops paying, is an issue. Anything which postpones a problem than recognising it is to be avoided,” Raghuram Rajan, the RBI governor said a few days back.

But just being worried will not help.

India Inc sitting on debt bomb:

India Inc sitting on debt bomb: 

Why the health of large corporates should worry us all

G Seetharaman ET :25 th Aug 2013

Earlier this week, the director of the Central Bureau of Investigation Ranjit Sinha warned that the agency may begin a probe into the rising volume of loan defaults, and look into the possible culpability of senior officials of mainly public sector banks.

Pointing to the fact that non-performing assets (NPAs) of public sector banks had risen by 95% between 2010 and 2012, he made the additional point that the bulk of NPAs were from the top 30 defaulters for most public sector banks.

Former Reserve Bank of India (RBI) governor C Rangarajan, who was present at the event in Delhi where Sinha made those comments, differed pointing to the fact that NPA levels are also due to the weak state of the economy.

"Every NPA is not due to motivated actions of bank employees," he is reported to have said. Much of the weakness in the economy, and the recent crash in the rupee and stocks, has been blamed on the failure of the current government to carry out structural reforms.

The weak economy is certainly an important part of the large and growing NPA problem. But even the RBI itself doesn't seem to think that's the only story.

In a speech recently on bank lending to the infrastructure sector, which now accounts for 35% of total loans to industry, deputy governor KC Chakrabarty stated: "I reiterate that the reason for NPAs is non-performing administration.

In the case of infrastructure, this could also be on account of non-performance beyond that of the bank management — that of policymakers, bureaucracy etc.

But what is really puzzling is why this affects the public sector banks the most...The answer lies squarely in the poor project appraisal techniques, lack of accountability, post-disbursal supervision, etc.

In our assessment, the project appraisal and the decision making in public sector banks has been more impressionistic rather than being information based.

How else does one defend the eagerness of some banks to fund power distribution companies with negative net worth!"

"The huge leverage of Indian infrastructure companies is a combination of their over-willingness to take on projects and poor lending standards of banks," points out Nick Paulson-Ellis, chief executive of Espirito Santo Securities India.

"Private banks are much more prudent in their lending than state-owned banks," he adds. "Over the past few years, loan growth has been driven by a few levered corporates, initially leveraging up the balance sheet and later rolling over — the balance sheets at some of these corporates are stretched," a report by Morgan Stanley pointed out.

What are the consequences of such high levels of leverage, and what do they imply for the ability of corporate India to not just weather the downturn, but emerge from it leaner and stronger?

Fuelled by Debt

A recent report by Credit Suisse points to the scale of the problem in the context of large corporate houses.

According to the report, 10 corporate groups — the Adanis, Vedanta, GMR, GVK and Jaypee among others — together account for around 13% of all banking system loans. In other words, the Indian banking system — and this is to a considerable extent the problem of public sector banks — is heavily exposed to the fortunes of just these groups. The report, an updated version of a similar one published last year, points to worrying trends.

One, the collective debt levels of these groups have actually risen from last year by 15%. Secondly, their ability to service this debt has deteriorated.

"The largest increases have been at groups such as GVK, Lanco and ADA where the gross debt levels are up 24% year on year. For most of these corporate groups, the debt increase even outpaced capital expenditure. Asset sales — key for deleveraging for most of these — have still not taken-off; only GMR and Videocon have had some success on that front," says the report.

The groups for their part punch holes in the Credit Suisse report. A Reliance ADA Group spokesperson argues that "a figure of gross debt without reference to the break-up and the purpose for which it has been incurred is quite meaningless and altogether misleading."

He adds: "Our levels of debt are more than reasonable and commensurate looking at the scale and magnitude of the projects we are developing, and their assured high-quality revenues... The increase in debt from fiscal years 2012 to 2013 is a natural consequence of debt being drawn down for capex as our various projects have moved towards completion."

 
An Essar spokesperson says: "Each individual asset ties up its own financing as per their capital requirement which comes with varying terms and maturity profile. Therefore consolidation of debt of individual companies to arrive at gross debt and repayment could be misrepresentative."