Corporate Debt Restructuring

When It Comes to Bad Loans of Banks, Nothing is as It Seems

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One of the issues that I have been regularly writing about is the bad state of banks in India. The tragedy is that their state continues to get worse as time progresses.

As on September 30, 2015, the bad loans of the banking system amounted to 5.1% of the total loans given by banks. The number was at 4.6% as on March 31, 2015. This is a huge jump of 50 basis points in a short period of just six months. One basis point is one hundredth of a percentage.

The trouble is that even the bad loans number of 5.1% of total loans, may not be the right number. This is primarily because over the years the Indian banks, in particular public sector banks, seem to have mastered the art of not recognising a bad loan as a bad loan. They have turned the practice of kicking the can down the road, to an art form.

Banks have used various methods to delay the recognition of bad loans and this has made balance sheets of banks more opaque. As Suresh Ganapathy and Sameer Bhise of Macquarie Research write in a recent research note titled Apocalypse Now: “The biggest problem that we now have with the Indian banking industry is that various regulatory forbearance techniques like restructuring (for under-construction infra and long term projects), 5:25 refinancing, SDR (strategic debt restructuring), NPL sales to ARCs (asset reconstruction companies) etc., are making the balance sheets of banks more opaque.”

Forbearance essentially means “holding back”. In the context of banking it means that the bank gives more time/better terms to the borrower to repay the loan, among other things. This could mean extending the term of the loan, lowering the interest or even postponing the repayment of the principal of the loan for a few years. Such loans are also referred to as restructured loans.

These options were supposed to be used sparingly. Nevertheless, banks in general and public sector banks in particular have massively abused these options over the years, in order to postpone the recognition of bad loans.

The bad loans of public sector banks stand at 6.2% of total loans, as on September 30, 2015. The restructured loans on the other hand stand at 7.9% of total loans. For the system as a whole, the number stands at 6%, which is higher than total bad loans, which stand at 5.1% of total loans.

The trouble is that many of the loans which were restructured in the years gone by have been defaulted on. As mentioned earlier one of the popular methods of restructuring a loan is to give the borrower a moratorium of few years on the repayment of the principal amount of the loan. The idea is that in that period the company will manage to set its business right and be in a position to start repaying the loan.

But that hasn’t happened. The restructured loans have been turning into bad loans. Ganpathy and Bhise of Macquarie Research estimate that the failure rate of restructured loans has jumped from 24% to 41%, over the last two years. “Many of these loans have come out of their principal moratorium and started defaulting,” the analysts point out.

What such a large default rate clearly tells us is that many of these loans should not have been restructured in the first place. As a November 2014 editorial in the Mint newspaper points out: “The decision to restructure a loan was supposed to be a technical one, taking into account the viability of the borrower. But in case of government banks, the decision to restructure has often been influenced by political considerations, and has depended on the clout of the concerned promoters.” The restructured loans now being defaulted on would have been restructured before the Narendra Modi government came to power in May 2014.

The situation is likely to get worse given that around half of the restructured loans were restructured over the last two years. Hence, companies have a moratorium on principal repayments for a period of two years. Once they start coming out of this moratorium, the loan defaults will go up.

Over and above this many companies continue to remain highly leveraged, that is they have significantly more debt on their books in comparison to their equity. In fact, as the Financial Stability Report released by the Reserve Bank of India(RBI) in December 2015 points out: “The proportion of companies among the leveraged companies with debt equity ratio of >=3 (termed as ‘highly leveraged’ companies) increased from 13.6 per cent in September 2014 to 15.3 per cent in September 2015, while the share of debt of these companies in the total debt increased from 22.9 to 24.9 per cent.”

This has happened because banks have lent more money to companies which are already in trouble and not in a position to repay their loans. As Parag Jariwala and Vikesh Mehta of Religaire Institutional Research write in a research note titled SDR: A band-aid for a bullet wound: “Bank funding to stressed corporates has gone up in the last 2-3 years and most of it is towards funding additional working capital requirement, loss funding and interest accruals (not paid). This will translate into large and bulky credit cost for banks if these accounts slip into non-performing assets [bad loans].”

Also, there is the problem of large borrowers. As Jariwala and Mehta point out: “The RBI’s analysis shows that stressed assets [bad loans + restructured assets] as a proportion of total loans to large corporates have gone up from 13.8% in Mar’15 to 15.5% in Sep’15.”

Further, what is worrying is that banks are still to recognise many of these loans as bad loans. As Ganpathy and Bhise point out: “The issue is that some of these large corporate groups have already been downgraded to default by rating agencies. Since banks have a 90-day window to classify as non-performing loans plus have other regulatory forbearance techniques like restructuring (still can be done for underconstruction projects) and 5:25 refinancing, these assets are not being shown as non-performing loans on the books.”

The analysts estimate that large borrowers form around 11-12% of total bank loans and roughly 15% of these loans are likely to turn into bad loans over the years.

Once these factors are taken into account, Ganpathy and Bhise feel that “potentially 16-18% of the loans will attract higher provisions and/or see write-offs over the next 3-4 years.” This means nearly one-sixth of bank loans can still go bad. And that is a huge number.

Hence, when it comes to bank loans, nothing is as it seems.

Stay tuned!

The column originally appeared in the Vivek Kaul Diary on January 21, 2016

In 2016, banks will continue to kick the bad loans can down the road

RBI-Logo_8
In June 2015, the Reserve Bank of India(RBI) came with the strategic debt restructuring(SDR) scheme. This scheme allows the banks to convert a part of the debt owed to them by corporates into equity and is actively being used to kick the bad loans can down the road.

As the RBI notification on the SDR scheme pointed out: “It has been observed that in many cases of restructuring of accounts, borrower companies are not able to come out of stress due to operational/ managerial inefficiencies despite substantial sacrifices made by the lending banks. In such cases, change of ownership will be a preferred option.”

Under the corporate debt restructuring scheme banks restructured loans by lowering the interest rate charged to the borrower or the borrower was given more time to repay the loan i.e. the tenure of the loan was increased, among other things.
But the restructuring did not help with a good portion of the restructured loans between 2011 and 2014, turning into bad loans. Crisil Research puts the number at 40%.

Further, as Parag Jariwala and Vikesh Mehta of Religaire Institutional Research write in a research note titled SDR: A band-aid for a bullet wound: “Indian banks went on a massive restructuring spree over 2012-2013 and 2013-2014. The corporate debt restructuring (CDR) cell received 530 cases till March 2015 from banks looking to restructure debt aggregating to Rs 4 lakh crore without classifying these accounts as NPAs.”

But this did not work. As Jariwala and Mehta point out: “On the whole, the success of CDR packages in rehabilitating stressed assets remains in question – the failure rate for the above restructured cases has increased to ~36% in September 2015 from 24% in September 2013. Out of the 530 cases received, close to 190 cases aggregating to Rs 70,000 crore have exited CDR due to repayment failures.” Most of these failures have been with regard to loans where banks had entered into a moratorium of two years with corporates, for repayment of principal amount of the loan.

One of the reasons for the failure of CDR has been the lack of interest and cooperation from the promoters who had taken on bank loans. Their intention has been to default on the bank loans they have taken on. SDR has been initiated to address this problem.  As Ashish Gupta, Prashant Kumar and Kush Shah of Credit Suisse write in a research note titled Failed CDR now SDR: “SDR allows banks to convert part of their debt to equity to take controlling stake (at least 51%) in the stressed company and thereby, banks can effect change in ownership wherever existing management is not performing. This gives banks significant power while dealing with non-performing or non-cooperating promoters.”

The idea with SDR is to convert the weak bank debt into equity and then sell the equity to a new promoter, and recover the money owed to the banks by the corporate. As the RBI Annual Report for 2014-2015 points out: “RBI and SEBI have together allowed banks to write in clauses that allow banks to convert loans to equity in case the project gets stressed again. Not only will such Strategic Debt Restructuring give creditors some upside, in return for reducing the project’s debt, it can also give them the control needed to redeploy the asset (say with a more effective promoter).”

SDR allows banks to postpone asset classification of a loan for a period of 18 months. This means that if a loan is in the process of turning into a bad loan and the bank has converted that into equity, it does not need to categorise that as a bad loan.

Also, the equity shares post conversion are exempt from following the “mark to market” rule. This means if the share price of the company falls below the price at which the debt was converted into equity, the bank does not need to book the difference as a loss during the 18-month period.

SDR essentially gives a bank (actually to the consortium of banks to whom the money is owed by the corporate, and which is referred to as joint lenders’ forum) a period of 18 months to look for a buyer for the company which they have taken over.

The question is will it allow banks to recover the loans that they have given to corporates and which are now in a risky territory? As the Credit Suisse analysts point out: “There has been a significant pick-up in activities under the SDR route over the past few months, with the banks invoking SDR in case of nine accounts with debt of ~Rs57,000 crore (~1% of system loans,). Majority of these accounts have been restructured earlier and have failed to achieve the targets set during the restructuring. Also, with their restructuring moratoriums now ending many would have been on the verge of turning non-performing assets.”

What does this mean? It means banks have tried rescuing the loans they had given to corporates by restructuring them in the past. And they have failed at it. Now these restructured loans are being put through strategic debt restructuring and being converted into equity. If the option of strategic debt restructuring wasn’t available to banks, they would have had to possibly recognise these loans as bad loans.

The Religaire analysts estimate that banks will “end up refinancing 30-40 ailing accounts under the scheme in the next one year, thus postponing non-performing assets [bad loans] recognition of Rs 1.5 lakh crore.”

The other option before banks is to sell these loans to asset restructuring companies for a loss, and then account for that loss over a period of two years. But given that they have the option of postponing any losses through the SDR route, they are more likely to take that route.

What is also interesting is that banks need to keep the companies in which they have converted their debt into equity through the SDR route, running, until they are able to find buyers for them. This means that the lending to these companies can’t completely stop.

Hence, banks will have to provide working capital finance to these companies as well as  fresh loans, so that these companies can continue to pay interest on their remaining debt.

As the Religaire analysts write: “It is important for lenders to keep companies under SDR running until they find new buyers. Banks are thus likely to continue funding interest costs and working capital during the 18-month SDR window. This includes meeting guarantees invoked by state governments or developers for delayed project completion. We assume that debt levels (including interest) will rise ~20% during this period.”

To conclude, as I keep saying things are not looking good for Indian banks.

The column originally appeared on the Vivek Kaul’s Diary on January 7, 2016

Fasten your seatbelts: Not only United Bank, a major part of banking is in trouble

 indian rupeesVivek Kaul 
In an editorial today (i.e. February 26, 2014), on the troubled United Bank of India, The Financial Express asks “Wasn’t anybody watching?”. “It is amazing that things could have been allowed to come to such a pass without action being taken to stop it,” the pink-paper points out.
In fact, The Financial Express should have been asking this question about the Indian banking sector as a whole, and not just the United Bank in particular. As of September 30, 2013, the stressed asset ratio of the Indian banking system as a whole stood at 10.2% of its total assets.
This is the highest since the financial year 2003-2004 (i.e. the period between April 1, 2003 and March 31, 2004) point out Tushar Poddar and Vishal Vaibhaw of Goldman Sachs in a recent report titled India: No ‘banking’ on growth.
Interestingly, the public sector banks are in a worse situation that their private sector counterparts. As the latest RBI Financial Stability Report points out “Among the bank-groups, the public sector banks continue to have distinctly higher stressed advances at 12.3 per cent of total advances, of which restructured standard advances were around 7.4 per cent.”
The stressed asset ratio is the sum of gross non performing assets plus restructured loans divided by the total assets held by the Indian banking system. What this means in simple English is that for every Rs 100 given by Indian banks as a loan(a loan is an asset for a bank) nearly Rs 10.2 is in shaky territory. The borrower has either stopped to repay this loan or the loan has been restructured, where the borrower has been allowed easier terms to repay the loan (which also entails some loss for the bank) by increasing the tenure of the loan or lowering the interest rate.
The restructuring of a loan happens through the Corporate Debt Restructuring(CDR) cell. The Goldman Sachs analysts point out in their report that 85% of restructured loans were restructured during the last two years (i.e. financial year 2011-2012 and 2012-2013).
What makes the situation even more precarious is the fact that the stressed loans could keep increasing. Goldman Sachs projects that among the banks its research team covers stressed loans could go up by as much as 25% in 2013-2014 (i.e. the period between April 1, 2013 and March 31, 2014). Also, some of the troubled loans have still not been restructured or classified as bad loans by banks. Hence, the situation is worse than what the numbers tell us.
As Akash Prakash of Amansa Capital wrote in a recent column in the Business Standard “Most investors believe that many of the problem assets are yet to be recognised by the system. These banks continue to increase their exposure to the problem areas of power and infrastructure.”
Five sectors, namely, Infrastructure, Iron & Steel, Textiles, Aviation and Mining, have the highest level of stressed advances. “At system level, these five sectors together contribute around 24 percent of total advances of SCBs [scheduled commercial banks], and account for around 51 per cent of their total stressed advances…The share of above mentioned five sectors in the loans portfolio of Public Sector Banks,” the RBI Financial Stability Report points out. Hence, the public sector banks are in greater trouble than their private counterparts.
Of the five sectors the infrastructure sector has contributed around 30% of the total stressed assets even though its share of total loans is only about 15%.
The banks have also not been provisioning enough money against stressed loans. “Moreover, provisions for stressed assets are still low, and the lowest in the region. For public-sector banks under its coverage, our Financials Research team assesses the provision coverage ratio for stressed loans at only 24%,” write Poddar and Vaibhav.
What this means is that the banks are not setting aside enough money to deal with prospect of a greater amount of their stressed loans being defaulted on by borrowers and turning into bad loans. And to that extent, banks have been over-declaring profits. That wouldn’t have been the case if they had not been under-provisioning.
Despite the under-provisioning the capital adequacy ratio of banks has fallen dramatically in the recent past. “The Capital to Risk Weighted Assets Ratio (CRAR) at system level declined to 12.7 per cent as at end September 2013 from 13.8 per cent in as at end March 2013…At bank-group level, PSBs recorded the lowest CRAR at 11.2 per cent,” the RBI Financial Stability Report points out. In fact, since September 30, the capital adequacy ratio of the entire banking system would have fallen even more, given that bad loans have gone up. The capital adequacy ratio of a bank is the total capital of the bank divided by its risk weighted assets.
In the days to come, the banks, particularly public sector banks (given their falling capital adequacy ratio), will have to raise more capital to have a greater buffer against the mounting bad loans. The RBI estimated in late 2012 that banks need to raise around $26-28 billion (or around Rs 1,61,200 crore – Rs 1,73, 600 crore, if one dollar equals Rs 62) by 2018.
This is a huge amount. “The capital raising requirement could increase to US$43bn [Rs 2,66,600 crore] under a stress scenario where gross NPLs[non performing loans] and restructured assets rise to 15% of loans, the previous historical high,” estimates Goldman Sachs.
So where is this money going to come from? For the financial year 2014-2015 (i.e. the period between April 1, 2014 and March 31, 2015). the finance minister P Chidambaram has set aside only Rs 11,200 crore for capital infusion into public sector banks. This is simply not enough.
So should government pump in more money into the banks? It simply doesn’t have the capacity to do so. As Akash Prakash writes “There is no way the government can fund this; there is simply no fiscal capacity. Nor do investors want to stand in front of this freight train, since the capital needs for most banks are greater than their current market capitalisation.”
Let’s take the case of the United Bank of India. The current market capitalisation of the bank is around Rs 1442 crore(assuming a share price of Rs 26). The government has decided to pump in Rs 800 crore into the bank. Given that, the market capitalisation of the bank is around Rs 1442 crore, which private investor would have been ready to pump in Rs 800 crore? Also, when the State Bank of India tried to sell shares worth Rs 9,600 crore to institutional investors recently, it failed to raise the targeted amount and had to be rescued with the Life Insurance Corporation pitching in and picking up its shares.
If the biggest public sector bank in the country, which accounts for nearly 20% of Indian banking, is unable to sell its shares completely, what is the chance for other public sector banks being able to do so?
Given these reasons, Indian banking is in for a tough time ahead. Fasten your seatbelts. 
The article originally appeared on www.FirstBiz.com on February 26, 2014. 
(Vivek Kaul is a writer. He tweets @kaul_vivek) 

Are banks are putting lipstick on a pig to make it look like a princess?

lipstick-pig-illustrationVivek Kaul 
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 The Financial 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.
The article originally appeared on www.firstpost.com on November 22, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)