The Reserve Bank of India’s (RBI) latest financial stability report (FSR) offers a glimmer of hope that corporate balance sheets are starting to heal. There is certainly no sign of a miraculous comeback yet, but the recovery process may have started. Vital signs of this recovery, however, just like in the case of the economy, are still shaky.
One of the findings of the FSR, released this week, was that the subset of companies that fall into the “leveraged" category has declined in the past six months. These are companies that either have a negative net worth or have debt that is more than two times their equity base. RBI’s analysis of the balance sheets of about 2,600 listed non-government, non-financial (NGNF) companies showed that the percentage of companies which are “leveraged" fell to 14% as of March 2016, compared to a peak of 19.4% in September. To stretch the medical analogy, these were the firms that were under observation in the intensive care unit (ICU) and some of them have now been moved out.
Then there were those that had landed themselves in emergency care because their debt levels were more than three times their equity base. The percentage of firms that fell into this category of “highly leveraged" companies has also fallen to 12.9% as of March 2016, compared to the peak of 15.3% in September.
The second important takeaway from the report is that the proportion of debt that is held by firms that are either leveraged or highly leveraged has come down. Debt held by leveraged companies has fallen from 30.5% of the total debt in September 2015 to 20.6% in March 2016. Debt held by highly leveraged companies has fallen to 19% of the total debt compared to 24.9% in September. This means that a lesser amount of bank loans and other forms of debt is now held by companies with precarious financials, and that is good news.
What both these indicators show is that companies are slowly starting to bring their debt levels to more manageable levels. The corporate sector stability indicators show “that the overall risks to the corporate sector, which increased after the global financial crisis during 2007-08, have shown some moderation in 2015-16," said the RBI in its report.
As the data shows, much of the repair work has happened in the past six months alone. This is the period over which banks were forced to classify stressed assets as bad loans. In the attempt to limit the hit to their own balance sheets, banks have pushed companies to sell assets. This is a key reason why corporate credit quality may have seen some improvement.
According to a 13 May report by Kotak Institutional Equities, in the first five months of 2016, nearly 41,000 crore in asset sales were closed or have been announced. This was a large chunk of the 1-trillion in asset sales by stressed companies since 2013, according to the data compiled by the Kotak team.
But asset sales can only go so far in helping improve the quality of corporate credit. It will help most in cases where companies or groups had expanded into a number of non-core business verticals, which they can shed. A broader improvement in corporate credit quality will only follow an improvement in corporate earnings that will help strengthen the ability of companies to service their loans and cut back on their short-term debt needs. The RBI acknowledged that a full recovery is some time away and said that “risks due to lower demand and liquidity pressure remain."
A separate set of data in the RBI’s report also showed that there isn’t much improvement to speak of at an aggregate level. This data point shows that the interest coverage ratio for the sample of non-government, non-financial firms declined marginally in the second half of fiscal 2016. The solvency ratio, defined as sum of profit after tax (PAT) and depreciation to total borrowings, also deteriorated.
Indicators published by credit rating agencies also suggest that while corporate credit quality concerns may have peaked, any improvement in these indicators remains patchy.
A monthly debt quality index published by CARE Ratings shows that the slight improvement in the index levels earlier this year has failed to sustain. “The index witnessed marginal recovery in the month of January 2016 and February 2016 and declined by 0.88 points in March 2016. The month of May also witnessed a downward movement with the index declining to 90.69 from 91.05 in April 2016," said a 9 June report by CARE.
The implications of this are clear: a slow recovery in corporate balance sheets will continue to keep private investments in check. It will mean that banks, despite a rigorous clean-up of their balance sheets in fiscal 2016, will need to stay on guard for further slippages.
Ira Dugal is deputy managing editor, Mint.