Corporates Will Continue to Default on Bank Loans

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We have extensively written about how corporate loan defaults have screwed up the state of banks in general in India, with public sector banks in particular.

This can be made out from the fact that the aggregate domestic corporate lending non-performing assets (or bad loans) of scheduled commercial banks, as of December 31, 2017, stood at Rs 6,63,877 crore. Bad loans are loans on which repayment has not been made for 90 days or more.

The total domestic bad loans of scheduled commercial banks on December 31, 2017, stood at Rs 8,31,141 crore. This means that the corporate bad loans account for 80% of the overall bad loans of banks.

Having said that, it doesn’t make much sense to paint all the corporates with the same brush. Borrowing is an essential part of corporate growth and that cannot suddenly go out of the equation.

Care Ratings has carried out a very interesting study on corporate borrowing and how the different kinds of borrowers (as per the total amount of borrowing) are placed in their ability to repay bank loans, at this point of time.

Care Ratings took a sample of 2,314 companies, which excludes banks and other finance companies. The total borrowing of these companies stands at Rs 20.02 lakh crore as of March 31, 2017.

The interest coverage ratio of these companies stood at 3.92. Interest coverage ratio is basically obtained by dividing operating profit of a company (or companies) by interest payments that need to be made on outstanding loans, during a particular period. This ratio fell to an almost similar 3.9 for the period April to December 2017.

This tells us that on the whole, the corporates are making enough money to keep servicing the interest that is due on their debt. But averages as usual hide the real story, which starts to change, as soon as we start to dig a little more.

Let’s look at this in detail one by one:

  1. For the period April to December 2017, 578 companies in the sample with an outstanding debt of Rs 4.78 lakh crore, which amounted to 24% of the total debt, had an interest coverage ratio (ICR) of less than 1. This basically means that companies which have taken on one fourth of the corporate debt (as per the sample used) are not earning enough money to keep servicing the interest payments on their debt.

    When the interest coverage ratio is less than one, the operating profit made by the company is less than the interest payment that is due. In such a situation, neither the company, nor the bank is left with many options. If the company’s situation does not improve, it is more than likely to default on the bank loan.

    How has the situation changed when we compare the financial year 2016-2017 with the period April to December 2017? In 2016-2017, 524 companies with total debt amounting to Rs 5.42 lakh crore, had an interest coverage ratio of less than 1.

    What this means is that in April to December 2017, more companies ended up with an interest coverage ratio of less than one. Nevertheless, a smaller amount of money was at stake.

  2. Let’s take a look at Table 1:

    Table 1: Distribution of companies and ICR according to debt sizeTable 1 makes for a very interesting reading. Let’s start with the large companies with a debt of Rs 5,000 crore or more. There are 68 such companies. Their interest coverage ratio has come down from 3.22 to 3.08. But this fall is not huge.

    Further, there are 23 companies with a total debt of Rs 2.82 lakh crore, with an interest coverage ratio of less than one. This basically means that large companies form a bulk of the debt of Rs 4.78 lakh crore of companies, with an interest coverage ratio of less than one.

    This basically means that the banks haven’t seen the last of corporate defaults and more defaults will happen in the time to come.

  3. The companies with a debt of Rs 2,500-5,000 crore are in the worst possible space. The interest coverage has fallen from 2.26 for 2016-2017 and to 1.73 during the period April to December 2017, respectively. Clearly the positon of these companies on their ability to keep paying interest on their debt has come down.

    There are 56 companies in this bracket. Of these 22 companies have an interest coverage ratio of less than one. These companies have a total debt of around Rs 75,000 crore. These companies (along with large companies with an interest coverage ratio of less than one) primarily operate in the steel, engineering and textiles sector. Take a look at Table 2.

    Table 2:

  4. Interestingly, companies with lower levels of debt seem to be better placed on the interest coverage ratio front.
  5. The study further shows that the companies with higher levels of outstanding debt have seen sharper declines in their interest coverage ratio during April to December 2017, in comparison to 2016-2017. As Madan Sabnavis and Rucha Ranadive, the authors of this report put it: “A combination of declining interest coverage ratio and interest coverage ratio less than 1 is a good signal to identify debt service failure.”

To conclude, what these data points tell us for sure is that the banks haven’t seen the last of corporate defaults. There is more to come.

This column originally appeared on Equitymaster on April 17, 2018.