IBC is a welcome change, and RBI has tightened exposure norms but there are ways around this; so eternal vigilance is the key
Even as we near the second anniversary of the Insolvency and Bankruptcy Code (IBC), companies must gear up for a couple of changes in the loan market. Starting 2019-20, companies must access a fourth of their annual borrowings from the bond markets. The rule ties in with the new and somewhat stricter set of loan exposure norms that banks will need to follow from April 1. At a time when the environment in the loan and money markets is not hostile, but not too friendly either, India Inc, except for blue-chip firms, will feel the pinch. It might not have been so hard if corporate balance sheets had been in better shape; but, despite attempts to sell assets, companies remains over-leveraged.
While stress levels have certainly eased, the slowdown in the economy could contain the improvement. According to Credit Suisse, the share of debt having an interest cover (IC) of less than one declined to 41% in Q2FY19 from 43% in Q1FY19; the decline was aided by the takeover of Bhushan Steel debt by Tata Steel, which has an IC of less than one, and Adani Power exiting this list, thanks to a seasonally strong quarter. The trend has been partly offset by the merger of Vodafone and Idea, which resulted in debt increasing. However, a little over a fourth of the debt of $480 billion is with loss-making companies. The share of chronically stressed debt—defined as exposure for which the interest cover has been less than one for four of the last eight quarters—has also come down. But there could be some nasty surprises; the slowdown in real estate lending may hit the asset quality of NBFCs even though many may have tided over their immediate refinancing needs on the back of the improved macro liquidity.Little can be done about the debt, and that situation will reverse as the business environment improves.
However, it is important to ensure there is no recurrence of the wealth destruction of the magnitude seen in the last three years. The new legal environment—the corporate insolvency resolution process—will certainly help. The fact that the IBC works and that companies can be lost, a rare occurrence in Indian corporate history, will be rattling the business community. The courts have upheld the demands of operational creditors as we saw with Ericsson which was able to recover its dues from Reliance Communications.
But the fact is banks have recovered very little via the corporate insolvency process, and haircuts have averaged about 50%. The objective from here on out must be to prevent rather than cure. And the onus for this, as always, must be on the banks—and indeed all lenders and investors. Unlike in the past, they must make sure they are not ‘managed’ by promoters. This is not easy and can only be achieved by greater vigilance on the part of the risk and compliance team; merely putting in stiff prudential guidelines and checks and balances is not enough.
RBI has done its bit by tightening the exposure guidelines for large exposures—albeit very late in the day. From April 1, banks can lend 20% of their eligible capital base (or Tier-1 capital) to a single borrower and 25% to a group. While there has been a significant scaling back in the exposure for a group from the earlier 40%, 25% is nonetheless high. But banks can lower these limits and should do so. More importantly, they need to ensure companies draw up expansion plans that are not based on ‘blue sky’ projections but build in downsides. Lenders need to upgrade their appraisal skills so they are not carried away by exaggerated projections. The ambitious loan growth and profit margin targets—to please investors—must be tempered, else, they will once again end up with loan losses. While RBI’s February 12 circular is, and will be, a great disciplinarian, banks seem to be able to find ways of getting around it.
Most critically, banks must avoid lending to promoters so the latter can fund their equity contributions. The next investment cycle must see promoters putting in their own money into their companies and businesses. Promoters cannot also be funding equity contributions from the cash flows of another project. Too often has the ‘first’ project failed to throw up adequate cash flows to fund the next project, thereby jeopardising the project and bank loans. While the intention is not to hurt investments, it is important to keep track of borrowers; the recent instances of promoters borrowing against pledged shares, without the knowledge of lenders, is a serious concern. In many cases, the disclosures to the stock exchanges do not capture these borrowings as these have been routed through SPVs.
Also, the 70:30 debt-equity ratio needs to be revisited rather than using it as a rule of thumb because promoters have not had enough skin in the game and therefore have little respect for the debt contract. Those who argue this would stymie investments would do well to look at the loan losses of banks—some Rs 12 lakh crore and more.
With some of the action expected to move to the bond market, the credit rating agencies must up their game. Ratings need to be closely monitored and investors alerted well in time. Else, investors will shy away from the corporate bond market; it is important, over the longer-term, to ensure there are no defaults. A repeat of the recent situation in the money markets—where mutual funds found it difficult to sell paper and were forced to do so at very high yields—would be unfortunate.