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Graphic: Paras Jain/Mint
Graphic: Paras Jain/Mint

About one-third of incremental industry loans in past 5 years unsustainable under S4A

An analysis of incremental corporate debt of 445 listed firms with median Interest Coverage Ratio less than 1 for five years show 1 in every 3 rupees is stressed

Mumbai: About one out of every three rupees lent to industry over the past five years would have been classified as unsustainable under the central bank’s sustainable structuring of stressed assets, or S4A norms, according to a Mint analysis.

Under S4A, banks are allowed to split a stressed firm’s debt into the two parts—sustainable and unsustainable. Sustainable debt (which has to be at least 50% of total funded exposure) is defined as that portion of debt that can be serviced by the company’s immediate cash flows. In other words, if a company had only this portion of debt, its interest coverage ratio (ICR) would be one, or its earnings from core operations would equal interest payments. Anything above this level of debt is unsustainable.

For firms, whose median ICR is less than one in the five fiscal years to 2015-16, the increase in debt has been Rs2.85 trillion—that is 37% of the Rs7.65-trillion rise in bank credit to industry. Note that all these firms had an ICR below one in fiscal 2016 too.

To be sure, it doesn’t mean that banks have been responsible for the total increase in debt of these financially weak firms since debt profiles of companies include corporate bonds, commercial papers, external commercial borrowings and other instruments.

Still, it does indicate that they are partly responsible for letting companies accumulate debt despite insufficient cash flows. For the top eight stressed accounts in the banking system, which are either under S4A or other bad loan resolution schemes, total debt doubled over five years even as ICRs crashed.

A large part of the debt given out to weaker companies, experts point out, were purely working capital loans that were used by such companies to often pay interest on their old debt. The net result, though, was that the overall debt of these companies kept rising, leading to unsustainable debt increases.

The Indian banking system was sitting on bad loan pile of .3 trillion at the end of June. Including restructured loans, this was as high as 9.2 trillion, Reuters reported Monday after filing a Right to Information query.

According to Abhishek Bhattacharya, director, financial institutions at India Ratings & Research Ltd, even before the stress began to show on bank books, the recipe for disaster was in the making. As banks were lenders of last resort during the times of global economic turmoil, infrastructure firms often agreed to accept funding where unrealistic financial goals were a norm.

“The projections were too optimistic, and bankers often forgot basics like checking if the equity being brought in by the promoters was their own or borrowed from somewhere else," he said.

Once the project delays started and the breaching of the loan covenants began, bank guarantees started getting revoked adding to the total debt.

“After this, the strategy was to keep things rolling till a turnaround happened and the companies were making enough money to repay their lenders," Bhattacharya added.

Bankers, however, say that evergreening is an unfair accusation.

“Giving out the working capital loans is not a crime, neither is repaying previous loans. The money did not leave the system in any case. Sometimes, lenders have to take tough calls like this to ensure that an asset does not go to waste," said the former deputy managing director of a large state-owned bank, speaking on condition of anonymity. This banker was closely involved with the resolving a number of stressed asset cases.

“If we stop supporting big projects, or demand repayments right away, we will be choking the economy," said the senior official of another large public sector bank, seeking anonymity as he is not allowed to be quoted in the press.

In a report released in August 2015, India Ratings had predicted that even in the best case scenario, stressed companies would not be able to service about 25% of their debt, leading to at least Rs1 trillion worth haircut for the lenders.

Dinkar V., partner (restructuring) at consulting firm EY, believes that these issues have grown to a full-blown crisis due to a short term view on stress adopted by the stakeholders. Corporate stress needs a quick and decisive revival strategy rather than an indefinite deferral of the problem, he said.

“If a comprehensive turnaround plan was identified and implemented in a timely manner, the magnitude of the problem could have been mitigated. While there has been limited will from the lenders to engender such a strategy, their ability has been hampered by a judicial framework which did not entirely support them,"said Dinkar.

With the introduction of the Insolvency & Bankruptcy Code, which is expected to be functional in early 2017, lenders should have more teeth while dealing with the stressed firms, leading to timely revival of these businesses.

Note: The headline of this story has been corrected.

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