The Reserve Bank has estimated in the Financial Stability Report that bad loans with banks will rise from 4.6 percent currently to 4.8 percent by September this year and then maybe recede to 4.7 percent by March 2016. But a lot of experts believe neither is the loan default problem so small nor is it receding so easily.
Credit Suisse for instance has studied the debt of 3700 companies amounting to USD 505 billion or Rs 32 lakh crore. It says 37 percent of these companies have interest expenses which are more than their EBITDA that is earnings before paying taxes and interest. The reports says that 30 percent of this debt or nearly Rs 10 lakh crore is with companies where EBITDA is less than interest for the past four quarters. USD 55 billion of debt or Rs 3.5 lakh crore is with companies where the interest outgo is more than EBIDTA for the past 12 quarters and these are still standard in the books of banks.
The Reserve Bank of India (RBI) itself admits that power and steel companies are huge areas of worry: power distribution companies got Rs 53,000 crore of loans restructured in 2013 with a moratorium on principal repayment for two years. The two years is up and the state governments are in no position to repay the principal. Rs 43,000 crore of debt stands ready to slip into NPAs.
The situation is worse with steel, says Credit Suisse. After the 4th quarter, 52 percent of the debt of the steel sector is with companies whose debt is 12 times their EBITDA. For companies like Usha Martin and Bhushan, the debt per tonne of installed capacity is USD 1000-1400 while it is USD 400 for robust players like Tata Steel.
Also, these companies, that is Usha Martin and Bhushan are operating at 30-50 percent because of cheap imported steel competing in the economy. So paying such huge interest cost is unsustainable. But the questions is: Will band-aid solutions like lengthening loan tenures or restructuring suffice or do we have to resort to surgical solutions like nationalising some steel companies and auctioning them?
Credit Suisse analyst Ashish Gupta believes it will be naive to look at stress only in terms of NPA. "One has to look at the other two buckets (restructured loans and 5/25 refinance loans) and there is no doubt and I am sure that Reserve Bank of India (RBI) would concur that if we look at aggregate this number will still be rising at least for the next two years," he told CNBC-TV18.
Diwakar Gupta, retired MD and CFO of State Bank Of India too concurs with Ashish's views and adds in the past at least the base was growing. "If you are able to arrest the absolute number, percentages would fall. I don’t think we have the luxury of that this time around," he adds.
Moving on to the problem of NPAs and the current provision which allows the selling of NPAs, Deep Mukherjee, Senior Director, India Ratings says the first move will be to tag companies as NPAs. "Unless you recognise the NPA problem and keep on sort of as they say extend and pretend with various form of restructuring you cannot sell it to asset reconstruction companies. So the first thing is you have to identify and tag them as NPAs, then you have to sell them to asset reconstruction companies."
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Below is the edited transcript of Ashish Gupta, Diwakar Gupta and Deep Mukherjee’s interview with Latha Venkatesh, on CNBC-TV18.
Q: Do you think you share this positive thought that it rises to 4.8 percent of total loans by September but by March it can fall?
Ashish: A lot will depend on the measures we look for. So today one measure of asset quality problem is non performing assets (NPAs) and another measure is restructured loans. Now we will soon have a new category called the 5:25 refinance loans. It will be naive to look at stress only in terms of NPA. One has to look at the other two buckets and there is no doubt that Reserve Bank of India (RBI) would concur. The aggregate number will still be rising at least for the next two years.
Q: What are your thoughts, do you think for the next two years we are going to live with the burgeoning problem?
Diwakar: I think so, I would agree with Ashish Gupta because in the past what has happened is that at least the base was growing. If you are able to arrest the absolute number, percentages would fall. I don’t think we have the luxury of that this time around.
Q: Because there is no capital with the banks?
Diwakar: I don’t think credit growth is being stymied for want of capital. It is just that there is no demand and therefore while the increase is more or less a given for it to thereafter decrease as the RBI reports says needs a lot of positives to fall in place together. That is not a very likely scenario.
Q: The bigger question is can this debt be brought down in some other fashion? Your report is on whether we can match the debt with equity. What is your sense you say that for 500 companies that you have covered to get back to the normal average debt to equity ratio which you say is 2.3 times debt to equity is going to take 4 years. What is your sense? Is it going to be four years?
Mukherjee: Assuming we grow at a gross domestic product (GDP) say in the old base, 2004-2005 base, all of us are adjusting to the new base, at least at a 7-8 percent growth rate then it would take a good 4-6 years to moderately reduce the leverage. The leverage in FY14 was at a 10 year high. The median leverage of 500 largest borrowers was 4.7. To pre 2008 it was below 2.5. We are saying if we have marginally reduced the leverage to 3.3 median which is the FY11 level, it will take Rs 7 lakh crore of equity infusion in this 500 companies.
Q: The point is the kind of companies which Ashish Gupta is talking about with 12 times debt to EBITDA will they ever be able to raise equity?
Ashish: It is going to be a challenge and in fact in our analysis we don’t as much focus on the averages because as we all know the company which has less leverage is not going to pay that debt for the company which has higher leverage. Today if you look at debt equity or debt to EBITDA of certain companies, it is much higher than the averages. More importantly even as we are seeing some improvement in economic growth and corporate earnings growth the profitability of these over leveraged companies is still contracting.
Q: Like for instances steel?
Ashish: Steel, but even more generically, so the numbers you mentioned about company that have interest cover less than one so when we did the study for the March quarter for these companies that had interest cover less than one, EBITDA growth during the quarter was minus 44 percent. So these companies are performing much more poorly than the broader corporate sector.
Q: So by the time we come to the end of this quarter it is quite possible that their debt will be may be 16 times their EBITDA, it is quite possible. Then in that case do you think that these are normally resolvable? Because in your report you also point out that about Rs 3.50 lakh crore, 55 billion debt is with companies which are still considered standard in banks books. Do you think these can be resolved by lengthening tenure like 5/25 or do you think the big question I am asking that we have to do something else just sell this debt to somebody else, put it in a bad bank, is this normally resolvable?
Ashish: I don’t think so. In our analysis, what we have focused on is which are the companies that have ability to make that interest payment. In a 5:25 structure you are not helping them out. You don’t give them any moratorium on interest payments. You do not drastically reduce their interest rates; you are just increasing the tenure of the loans. In fact what we read in the newspaper many of these 5:25 cases have gone through with banks given additional credit lines to these companies. So, increasing debt for these companies I don’t think is a solution.
Q: If an eight year loan is recast as a 20 year loan or an 18 year loan that is a substantial reduction in interest.
Ashish: You increase the principle repayment term. The interest part is not being eased. In fact because you are giving them more loans, the interest is actually going up.
Q: For instance, in a steel company, what is the landed cost of steel – USD 360, how much of it is interest component?
Ashish: We have seen steel companies last year who had a debt of almost USD 3,000 per tonne of steel they made. If we look at 12-13 percent as the cost of debt in India today, the interest cost these companies are already bearing is USD 360-370 which is the landed price of steel. If you look at EBITDA, these companies have made last quarter has been in the tune of USD 26-40. So even if we look at some improvement in the steel cycle, the gap that has to be made up, EBITDA has to go up from USD 30 to USD 300 plus. This was debt that was as of March ’15 and these banks are giving them additional debt during the course of this year the interest payment for these companies will go up.
Q: How does this work at all, if interest cost is going to be the cost of the landed steel then are we looking at a resolvable problem or do you think we have to just do some surgery, cut out these loans, nationalised these companies, sell it to somebody – I don’t know – these maybe legally untenable?
Diwakar: Different companies or different segments suffer in different ways. Cyclicals are cyclical and today in a world which is so coupled, the steel industry is suffering for no fault of its own. It is really that you have replacement product which is at much lower. You hope that this will go away once you kick start the several billion dollars worth of infrastructure projects that the government has announced. You need to figure out how these companies will sustain till then.
Q: At the moment USD 700 of steel is looking fairly distant number.
Diwakar: I am a very firm believer that you should not get distracted by short-term numbers.
Q: How do you get it right for a company where the interest cost is equal to the landed cost of the product?
Diwakar: There are various ways; we just talked about 5:25. 5:25 is not give relief on interest, 5/25 is to conserve cash to not disrupt your working capital cycle by reducing your outgo on principle repayment. The underlying principle is sound, you have an asset which has got a 25 year life, you are trying to repay it in eight years. That is not sustainable in today’s environment because you are not so profitable.
Therefore, you are given more time to pay off your principle. The question we are grappling with is how do you take care of interest? So, if the economy improves, your realisations will improve, so your EBITDA will go up.
Q: We assume that that number is not going to be possible, USD 700 is at least not going to be possible, so what do you do? Is there a natural resolution or an unnatural or an interventionist resolution?
Diwakar: If we go a little beyond steel and see sectors where there has been a holding cost which is not the doing of the promoter at all - infrastructure, power, ports.
Q: The blame game is different; I am just asking how do you solve it?
Diwakar: My point is that if this were to happen in the first world your holding cost would have been 1.5 percent per year. In the Indian context your holding cost is 12 percent, now in many cases this 12 percent per year for two or three years has been caused by government departments who have not paid. They have not called upon to ask how they will share this cost.
So, this cost then has to be written off. However, it is done, banks may have to take a haircut on this interest but you need to therefore make the whole economic viable. Sale is not always panacea because sale can be considered where there are malafides.
Q: Your point is that some of the debt has to be just written off?
Diwakar: It just has to be written off. You can do it with any comparison but it has to be written off today. I come back to my very pet theme, you have heard me saying this very often, it has to be done as of yesterday. You don’t have the luxury of deciding what you will do over the next 15 months.
Q: In a situation like today to expect the government to write off loans for those who have been defaulters is going to raise a huge public outcry?
Diwakar: But you have to, I think the question is whether you are worried about an outrage or whether you want to set things right.
Q: Punishing promoters will be unfair that banks have to take a haircut in which case the tax payer is picking up the bill? Is there any other solution to this problem?
Mukherjee: Loans have to be written off having said that, as several RBI Governors and Minster have said there are no sick promoters only sick companies. So it is unthinkable that PSU Banks effectively financed by tax payers money will take all the hit. Now a surgical measure would be required because if overall group of companies would take 4-5 years to recover. If I just focus on the distressed companies which may be formally tax distress or as Ashish Gupta has identified, with EBITDA cover below one these companies would take even the robust economic growth rate 5-10 years, which is to say the current NPA problem will haunt Indian bank balance sheet for 5-10 years. So, banks again are clearly not above the board because in 2010-211 when there was revival in the Indian economy under the assumption that India is decoupled; they have given loan assuming 8 percent growth year-on-year (YoY).
Q: What I am saying is the promoters may be to be blamed; the banks may be to be blamed, what is the solution?
Mukherjee: The current provisions allow for selling NPAs so first you have tag companies as NPAs. Unless you recognise the NPA problem and keep on sort of as they say extend and pretend with various forms of restructuring, you cannot sell it to asset reconstruction companies. So the first thing is you have to identify and tag them as NPAs then you have to sell them to asset reconstruction companies. Now, given the size of the problem, restructuring companies don’t have that much of balance sheets so what we possibly would require is something of a special mega asset reconstruction company. It has to be thought for the first time, unlike the sovereign wealth fund in other nations we need to have sovereign distress asset fund for India which will take over these companies, liquidate, where they have to infuse capital where they have to and free up banks balance sheet.
Q: Can we isolate it to steel companies for the simple reason that power is different kettle of fish altogether. It is entangled in some many ways with power purchase agreements (PPAs) signed with several State Electricity Boards (SEBs). To sell off power companies to other power companies may be more difficult or to auction them. Would you think that it is possible in steel?
Ashish: I would not think so in fact I would concur with Diwakar Gupta here that it is wrong to put the blame on anyone person whether the government, whether the promoter or even the banks. So, as you also said that all of us had different expectations and this has come through.
What Deep Mukherjee also said that you need a bank out there to takeover these assets but it will not be one shoe fits all. You will have to look at different solutions for different people. Steel companies will have a different solutions may be you can have auction of steel companies as a solution. Power may be a different solution that you can have. Say theoretically NTPC taking over some of the problem companies. So in my view probably you need to make 4-5 bad banks with sectorally focus on companies and take over the assets.
In my view with the policy maker the choices are two either you directly put capital in the banks or you provide capital to these asset reconstruction companies or the bad bank to takeover these assets from the Bank balance sheets and free up their balance sheets to lend to the best companies.
Q: What do you think is the easier solution? Do you agree that you have to compartmentalise sectorally?
Diwakar: I agree, we are just doing blue sky thinking because we don’t know what to do? I would do a model which would be a mix and match of what Ashish Gupta said what Deep Mukherjee said. Let us take an example today the government said they will give Rs 14,000 crore of capital this year, Rs 22,000 next year.
Effectively banks are writing off a Rs 1,000 crore they are being recapitalised for Rs 1,000 crore. If there is a mechanism by which this Rs 1,000 crore can go to the industries to make them, more economically viable then in a Rs 1,000 crore you could save Rs 5,000 crore of assets. I am not a particular votary of a bad bank because that takes the owners away from the banks to resolve their current portfolio. There has to be a focused initiative to de-bottleneck and resolve what is currently existing as stressed and it will have to have an element of write off whichever way you do it.
Q: So it has to be a write off which will be partly borne by the banks, partly borne by the government and partly borne by the promoter you think?
Diwakar: Absolutely. Nobody is saying you let the promoter go away but don’t brand a promoter as malafide or dishonest in every case. There are things which go wrong beyond his control.
Q: Who sits in judgment that this promoter did not gold plate while this promoter did gold plate?
Diwakar: Judgment is essentially part of any management. The fact that you give credit to a promoter is a matter of judgment. Nobody can come as a matter of entitlement to say I have a unit, therefore you give me money. If you are not able to exercise judgment you don’t have a management, then you are going by a template and you can actually run this through a model and you continuously write off according to a percentage.
Judgment will have to be an integral part I have been saying this again and again. Public sector banks are suffering the consequences of not being allowed to exercise judgment through regulatory over reach. That needs to be addressed.
Q: What is your suggestion to bring down the NPLs to RBIs level of 4.8 percent?
Mukherjee: Within the next 6-12 months we either need to recapitalise banks so that they can become normal or we have to remove the bad assets – lock, stock and barrel out of it in the single entity owned by the government with authority to decide on who will be liquidated.
Q: What should be the capital of that, what is the government’s bill?
Mukherjee: That can be in the structure of a fund. It would have exceptional legal power that will be a structure of a fund and he is not supposed to sort of buy from the banks as the way ARCs does. They will be issuing notes.
Q: How much of capital do you think banks will need or what is the other way to resolve it?
Ashish: Our entire assessment is that state owned banks need over the next four years almost USD 40 billion of capital and part of it is for cleaning up the balance sheet and for making the balance sheet strong again because many of these banks have 7 percent year one, they should at least be at 9-9.5 percent. They need capital to give more loans.
The other thing, the starting point of any solution has to be recognising the problem. Through the regulator recognition of the problem has to happen because as long as the problem is not recognised, as Diwakar Gupta says the debt of these companies is getting larger and larger. So, these steel companies, two years ago did not have USD 3,000 of debt on their book per tonne of steel; it has increased. The more we delay the recognition, the larger the haircut that will be needed.
Q: What is your last word?
Diwakar: I am all for execution. You need to set up an empowered committee which will segment the currently stressed units into those which have malafides, those which are beyond any fault on their part, those where the managements competent and not competent. Thereafter whatever this empowered committee says, must be abiding decision on all lenders – it could mean a haircut, it could mean a change of management, it could mean conversion of debt into equity maybe with recourse to the promoters to get it back when the units are healthy. However, these need to be done quickly. As I said recapitalising banks is no solution, today you don’t have a problem of hidden NPAs coming out, it is fresh NPAs which are getting created quarter-on-quarter.
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