Banks seeing spurt in NPAs due to lower debt servicing ability of firms3 min read . Updated: 31 May 2016, 12:11 PM IST
The proportion of companies who aren't able to pay back loans to banks is increasing
Mumbai: The headline may seem a bit like stating the obvious, but ponder this: in a sample of around 1300 manufacturing companies, those in a poor position to pay back their debt accounted for only 40% of the total borrowings of all 1300 companies in 2010; by 2016, that proportion had increased to 51%.
In a press conference announcing State Bank of India’s March quarter earnings, the lender’s chairperson Arundhati Bhattacharya said a good part of its loans turning bad “are working accounts which are stressed because they aren’t generating enough cash."
For SBI, the gross non-performing assets ratio of loans to large companies jumped to 6.27% at the end of March, about 4 percentage points up since the previous quarter. This ratio was just 0.54% a year ago. Similarly, loans to so-called mid-corporate borrowers are also turning sour with a gross bad loans ratio of 17.12% at the end of March, up 2.8 percentage points since the previous quarter.
One yardstick to look at the debt servicing ability of firms is the interest coverage ratio. This looks at the ratio of operating profits (less depreciation) as a proportion of interest. A ratio less than 1 means that a firm is not earning enough to pay its interest costs.
As the economy slowed down and lending rates remained high in the years after the 2008 crisis, the interest coverage ratio of firms plummeted. Fresh data compiled after the March quarter earnings show that things haven’t improved all that much.
To be sure, at the headline level the numbers do show some improvement. The median interest coverage ratio of 1282 listed manufacturing companies – for whom numbers are available for the past 24 quarters – has risen to 2.97 for the three months ended March. There are a couple of reasons why this has happened.
One, operating profits have increased substantially in the March quarter as margins expanded and firms benefited from the slowdown in commodity prices.
Two, many firms have also sold off assets in an effort to reduce debt. That, plus lower interest rates saw finance costs also come down in some cases.
But the headline number is just the average interest cover ratio of firms irrespective of the size of their debt. Chart 2 shows the distribution of interest cover ratio of firms along with the size of their debt.
For fiscal year 2016, firms with 51% of sample debt still had an interest coverage ratio of less than 2, considered a benchmark for debt at risk. In comparison, firms with 40% of sample debt had a low interest coverage ratio in 2010. The data here refers to a sample of 765 firms which had debt of ₹ 12.8 trillion in fiscal 2016 and ₹ 5.3 trillion in financial year 2010.
A second trend which the headline number hides is that certain industries such as power, metals and construction industries are worse placed in terms of debt servicing ability.
These are the industries which have borne the brunt of the commodity price meltdown and seen demand also plunge. They also account for a good portion of bank credit to the corporate sector and responsible for the rise in NPAs in the last two quarters.
The fact that these firms are not yet earning enough can be seen from the so-called “watch lists" of assets released by banks – accounts which they expect to slip into bad loans this year. To take just one example, power, iron & steel, engineering and construction account for half of SBI’s watch list of ₹ 31,000 crore.
While March quarter operating earnings do show a pick-up, nothing is certain about whether this is a one-off or it is sustainable. A lot depends upon how sharply the economy recovers.