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Photo: Hemant Mishra/Mint
Photo: Hemant Mishra/Mint

Falling promoter equity may throw a spanner in loan recast of companies

  • Fitch Ratings says where banks have to take both the capital and credit risk, they will not be as motivated to lend compared to guaranteed loans where both risks are transferred to the guarantor
  • Analysts believe that the ability of the Indian financial system has been curtailed

MUMBAI : Inability of promoters to bring in fresh equity could significantly hamper loan restructuring of companies across the board hit by sharp fall in revenues due to extended lockdowns. While the government and RBI have announced several key measures to aid liquidity flow into stressed companies, bankers who spoke to Mint on condition of anonymity, maintained that the increasingly lopsided debt-equity ratio of many companies could become a major impediment for any potential loan recast, without which the survival of many businesses will be in question. Promoters in many Indian corporations have in the past have heavily banked on lenders including banks and credit funds to raise equity to infuse in the business. However, lenders say that in the current economic environment promoter funding is likely to become scarce than before.

“What the government has done in terms of the small business loans will revive credit flow to that sector. However, credit to other sectors will take more time to pickup as banks will not be able to lend more without additional securities," said the first banker quoted above.

He added that several of these loans are already stressed and even if we were to restructure these loans, it would need promoters to bring in some amount of equity. “I might have to eventually restructure the loan but have to take a call on promoter equity at a later stage," he said, adding that banks may seek additional promoter guarantees.

The government recently announced that it will guarantee 3 trillion of loans to small businesses facing severe stress during the prolonged lockdown beginning 25 March. While the economy is gradually reopening, these businesses are yet to find their feet. Risk-averse lenders seem quote upbeat about these loans for which there are no fresh collaterals required.

According to Saswata Guha, director of financial institutions at Fitch Ratings in India, these are extraordinary times and several companies are in the thick of this ongoing distress.

“If you look at the financial position of banks, there is very limited incentive for them to actually extend loans to structurally weak entities where a promoter may not be willing to bring in fresh equity, and where banks bear both credit and capital risk. Banks can still choose to give fresh loans even to such companies in the hope of the situation improving but the flipside is that it increases both future balance sheet risks and loss potential," said Guha.

Guha added that where banks have to take both the capital and credit risk, they will not be as motivated to lend compared to guaranteed loans where both risks are transferred to the guarantor.

Meanwhile, the absence of any budgeted capital in FY21 will limit banks’ ability to aggressively lend.

The second banker quoted above said that RBI has already allowed relaxations in working capital margins and these can be reinstated to their original levels by March 2021.

“Although there is limited demand for term loans at the moment, there could be a surge after the lockdown in the next many months. However, banks have to be make some adjustments to their lending structures and be more accommodative if promoters are unable to bring in their contribution," said the second banker quoted above, adding that Indian banks were in stress even in the September quarter of FY20 and the covid-19 pandemic has just made it worse in terms of asset quality.

Analysts believe that the ability of the Indian financial system has been curtailed. A report by Credit Suisse on Wednesday said it estimates that 70% of the financial system's lending capacity is now constrained. Public sector banks (ex-State Bank of India) are 25% of system credit and are still to emerge from bad loan issues, and now in the midst of mergers.

That apart, non-banking financial companies (NBFCs) with 22% of the aggregate credit have been pulling back on growth since the Infrastructure Leasing & Financial Services (IL&FS) crisis in September 2018. “We have seen small private banks seeing deposit outflows and rising liquidity constraints also pull back on growth. Further, external commercial borrowings and bond markets are shut, particularly for borrowers with falling ratings," the Credit Suisse report said.

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