Stressed firms coming back on track: RBI

Stressed companies are deleveraging fast and the number of ‘weak’ companies in the economy is declining, according to the bi-annual report of the Financial Stability and Development Council (FSDC), released by the Reserve Bank of India (RBI).

‘Weak’ companies are those that have interest coverage ratio of less than one. Interest coverage ratio is profit before interest and tax divided by interest expense.

Despite this, the risks to the banking system have “worsened significantly,” the report noted, as companies may not be paying back loans fast enough. “Risks to the banking sector have sharply increased since the publication of the previous stability report in December.” The report added that this was due to deteriorating asset quality and lower profitability.

RBI conducted its asset quality review (AQR) last year to make banks disclose bad loans and make provisions for them. This increased the quantum of non-performing loans and provisioning significantly in the December 2015 and March 2016 quarters.

While the deleveraging process of corporate borrowers has begun, the capacity of companies to repay would move up only gradually, given the slow increase in income and business growth.

The report analysed 1,800 to 2,600 listed private non-financial companies to capture the trend. It says within the sample size, the proportion of leveraged companies that have negative net worth or debt-to-equity ratio of more than two declined sharply from 19 per cent in March 2015 to 14 per cent in March 2016. These companies’ share in total debt also declined from 33.8 per cent to 20.6 per cent.

Similarly, the proportion of ‘highly leveraged’ companies, those having debt to equity ratio of more than three, declined from 14.2 per cent to 12.9 per cent in the sample size, with the share of these companies in the total debt coming down from 23 per cent to 19 per cent, the report said.

However, a more detailed analysis of the corporate sector’s performance with a larger sample of companies obtained from Ministry of Corporate Affairs showed that profitability of both public and private companies improved in 2014-15, compared with 2012-13, while the leverage ratios increased.

“Debt servicing capacity measured in terms of the interest coverage ratio (ICR) improved for private limited companies whereas it remained almost the same in case of public limited companies,” the report said.

The analysis also shows that the share of ‘weak’ companies declined to 15 per cent as on March 2016, compared with 17.8 per cent in March 2015.

The share of debt in these companies fell to 27.8 per cent of total debt in the second half of 2015-16 from 29.2 per cent in the second half of 2014-15. However, the debt-to-equity ratio of these companies increased to two from 1.8 during the period.

After the Reserve Bank of India acted strictly against errant promoters and forced banks to mark highly leveraged companies with irregular debt servicing pattern in the caution list, companies have started aggressively selling their non-core assets to bring down stress in the books to get out of banks' watch list.

Companies that have a debt-to-equity ratio of more than two fell in proportion sharply to 1.6 per cent from 2.3 per cent, while the share of debt of these companies declined to 8.5 per cent from 12.4 per cent.

State Bank of India (SBI) chief economist Soumya Kanti Ghosh agrees with RBI's findings and said Indian companies would be deleveraging even faster in the present financial. The bank had written in a report recently that highly leveraged firms are selling their non-core assets to pare down their debt.

Prabal Banerjee, group CFO of Bajaj Group, however, does not agree much with this assessment. "There are only a few sectors - IT, pharma, health care and automotive - that are doing relatively good, but they were not stressed to start with. In stressed companies, I do not see any improvement in investment, employment or finance. Industries that were in bad shape are not really coming out of it," Banerjee said.

The Financial Stability Report said Iron and steel industry had the highest leverage and interest burden, while "construction, power, telecommunication and transport industries also had relatively high leverage".

While overall risks to the corporate sector showed some moderation in 2015-16, the "risks due to lower demand and liquidity pressure remains," the report said. Among public companies, the percentage of 'leveraged weak' companies was relatively higher in the case of electricity, construction, iron and steel, real estate, textiles and paper industries. In case of private companies, the weakness was observed in electricity, construction, real estate, mining, paper, aviation and cement.

"The leveraged weak companies, with lower debt servicing capacity and high leverage, may exert pressure on the already deteriorated asset quality of bank loans in adverse situations," the report noted.

The credit extended by scheduled commercial banks to all private non-finance companies was about 40 per cent of the total credit as at end March 2015. In case these weak companies default, the overall impact could be about 10.4 per cent of total bank credit, while the impact could be about 8 per cent in case of default by weak and leveraged companies, the report said.

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