Rs 4 Lakh Crore In Debt Faces Elevated Risk Of Write-Off: India Ratings
85 of the top 500 borrowers face the maximum risk of a write-up.
Nearly Rs 4 lakh crore in debt held by 85 of the most vulnerable corporates could be at an elevated risk of being written-off due to their inability to service their debt, said India Ratings in a report released on Tuesday.
These are companies that have a structural mismatch in cash flows and a high proportion of non-productive assets, said India Ratings.
Economic recovery will marginally benefit these entities. Structural mismatch in cash flow and relatively high proportion of non-productive assets will need to be addressed to restore debt sustainability. Banks may find it difficult to fit such corporates in the Scheme for Sustainable Structuring of Stressed Assets (S4A).India Ratings Report
The rating agency analysed 500 top corporate borrowers and categorised 240 corporates, which have debt of Rs 12.4 lakh crore, as vulnerable.
The analysis comes against the backdrop of slow resolution of bad loans. While a push from the RBI led banks to reclassify stressed loans appropriately and pushed up gross NPAs across the banking sector, the resolution of these assets remains uncertain. Banks were hoping for concessions in schemes like the S4A but the RBI has maintained that atleast 50 percent of a company’s debt should be sustainable for an account to qualify for restructuring. Sustainable debt is defined as debt that can be serviced with existing cash flows. This condition will limit the use of the S4A scheme and may force banks to eventually write-off a larger proportion of stressed debt.
Build-Up Of Non-Productive Assets
According to India Ratings Rs 7.4 lakh crore in debt is held by corporates which saw an incremental build-up of non-productive assets during the fiscal 2011 to fiscal 2016 period. It added that these companies could face a cash flow recovery risk.
The ratings agency said that these companies are unlikely to generate return on capital employed (RoCE) which is higher than their weighted average cost of capital, despite an economic recovery.
When we analysed these companies, we found that the cash flows are much lower than what they were three or four years ago. At the same time, the economy is not picking up just yet and we are definitely going to see a demand impact (from demonetisation) which is likely to delay the private investment pickup and that could be a cause for concern for leveraged companies.Rakesh Valecha, Senior Director and Head-Corporate Ratings, India Ratings
The ratings agency analysed companies on the basis of the quality of their assets along with the strength of their cash flows and found that companies in the “risky corporates” category witnessed a decrease in productive fixed assets leading to uncertainty in generating periodic returns.
The analysis further found that 41 percent of the 500 companies under study had a fixed asset coverage ratio (FACR) of less than 1. In 2011, only 33 percent of these companies had FACR below 1x.
The FACR measures the broad debt repaying capacity of a company using its fixed assets. FACR below 1x could result in cash flow recovery challenges, India Ratings said.
Valecha said that many companies belonging to the “risky” and “cautious” categories were using a relatively low proportion of their borrowings to boost fixed assets, which could be a concern for the lender banks. One instance of borrowed funds not being used to boost capacity was seen in the aviation sector, where companies considered in the report used 100 percent of their borrowings to fund negative shareholders’ funds or in other words, cover their losses.
Race To Recovery
Priyanka Poddar, an analyst who worked on this report said that the agency is observing a “two-track recovery” when it comes to companies holding large debt.
“We are noticing that strong companies are getting stronger while those with weaker balancesheets are getting weaker. It is these weaker companies which are pulling down the industrial recovery,” Poddar said.
Podder added that industries like infrastructure, construction, sugar and consumer durables will face a challenge in revival even if the demand picks up due to their over-leveraged balancesheets.
Clearing debt overhang will be a major challenge for these corporates over the next several years due to capital structure challenges and timely equity infusion, which is unlikely in the near term. Ind-Ra believes that credit availability to these corporates would be limited. Ind-Ra doesn’t expect the credit metrics of these corporates to improve, even if their operating performance improves to the levels registered for FY10/FY11.India Ratings Report