The Reserve Bank of India has released the recommendations made by the KV Kamath Committee for restructuring loans of borrowers hit hard by the coronavirus pandemic.
It has listed financial parameters for 26 industries which needs to be taken into account by banks while drafting a resolution plan for borrowers.
The committee has suggested ratios for gearing, leverage, liquidity, interest and debt serviceability.
The financial ratios recommended by the committee are:
1. Total Outside Liabilities (TOL) divided by Total Adjusted Net Worth (TANW)
2. Total Debt divided by EBITDA
3. Current Ratio
4. Average Debt Service Coverage Ratio
5. Debt Service Coverage Ratio
All these ratios in some form or another are used by rating agencies and banks to evaluate the credit worthiness of borrowers.
TOL/ATNW is a better and a conservative ratio than Total Debt/TNW as many times buyers’ credit and Letter of Undertaking-backed financing is not shown as debt in books of accounts. It plugs this loophole.
TNW should exclude intangibles, not specifically mentioned, as some industries might have brand/goodwill as assets.
Ratios number 4 and 5 on Debt Service are almost identical and the committee could have looked at keeping one of them only and adding some other viability ratio like EBITDA margin versus Industry average, or Shareholder’s Funds divided by Total Assets. It could also have proposed interest coverage and debt service coverage as separate ratios.
The committee has identified 26 sectors which have been impacted by the pandemic and prescribed thresholds for each of the five ratios.
The gearing and leverage ratios have to be met by FY 2023 and the liquidity and serviceability ratios in both FY 2022 and FY 2023.
The loans can be restructured for a maximum period of 2 years. Any default from Sep 1 to Dec 31 for borrowers which were classified as standard and with arrears less than 30 days as at March 1, 2020 are eligible under the Framework.
For aggregate exposures greater than Rs 100 crore, an independent credit evaluation (ICE) needs to be obtained from any one credit rating agency authorised by RBI. All restructuring proposals north of Rs 1,500 crore will have to be validated by this committee.
The Current Ratio can be argued to be liberal but given the pandemic and its effects it is acceptable.
Otherwise, normally, 1.2x or 1.25x or 1.33x is used. The logic for using a higher than 1 ratio is that in case of default receivables and inventories could fetch only 60%-80% of their book value.
TOL/ATNW threshold for steel/mining and non ferrous metals is low as these are cyclical and fixed asset heavy sectors. Only an up-cycle in the metals sector can help to achieve these thresholds.
Aviation companies have not been prescribed thresholds for DSCR because their long term debt is mostly for refinancing. However, this logic may also apply to other sectors like metals, real estate, etc.
Interest service coverage ratio for trading companies is too high as they operate on very thin margins. The notable sector which is missing is the Oil & Gas sector.
According to K Shankar, an ex-power sector analyst, “Almost all private power generation/transmission companies would struggle to meet the first 2 ratio criteria.”
“Leverage is understandably high, as these companies are probably struggling, but doesn't leave much margin for error with respect to average and annual DSCR,” according to the Chief Risk Officer of a foreign bank in India who requested not to be quoted.
Essentially these thresholds become covenants for next 3 years up to FY 2023, but if not achieved, what action is to be taken by banks is not mentioned in the recommendations. Would they be downgraded to NPAs?
If yes, then is it effectively a 2 year push back of NPAs?
“Under the guise of restructuring (to help the companies to tide over the current situation), this shouldn’t ultimately become a recipe for passing on the stress to the banking system, unless the terms are now carefully calibrated on a case to case basis” says Srinivasan Govindan, ex-chief representative of Natixis.
“It would also be interesting to know how these ratios were arrived at? Were the latest financial ratios considered (if so as of which date), how did it look, and hopefully a viability simulation was undertaken to arrive at these industry-wise ratios to ensure serviceability of the bank finance? While certainly all the required support are to be provided to deserving companies, this exercise shouldn’t result in kicking the can down the road for others, or result in some taking advantage of the financial leeway provided,” adds Govindan.
Case in point is the high thresholds provided for real estate companies.
Most of the A rated, BBB- and BB+ companies could avail such restructuring plans. The committee was formed to bring discipline to the restructuring process and prevent banks from going on a reckless path.
However, no ratios have been prescribed on the current condition of the company and whether they are in a position to meet the end goals.
As India had started decelerating before the pandemic, how will banks determine whether the worsened profile of the companies is due to the pandemic?
“I feel the committee should have placed emphasis on companies genuinely impacted by covid as against promoters who want to take advantage. In this regard the committee should have placed some emphasis on the March 2020 financials as a starting point to identify eligible borrowers,” says a risk officer of an European Bank who didn't want to be quoted.
The risk is that this could become a template and everyone will work backwards. Companies would present turn around scenarios in a couple of years, and there is a risk that bankers could agree for these ratios and provide funds for the turnaround.
With past experience we all know how projections are made and how they have gone horribly wrong in earlier instances of NPAs shooting up.
Given the uncertainty due to the pandemic wherein even the RBI has refrained from providing growth projections, I wonder how would companies and bankers prepare and vet these forecasts.
“Instead, the ratios should be dependent on current condition, company wise, and the maximum leeway that bankers could consider based on their assessment, such that a common ratio is not available to an "incapable" company as well,” adds Govindan.
The provisions could be higher as slippages are expected to rise for banks. A good portion of these restructured accounts may eventually turn non-performing as per analysts.
“Governments in Europe are guaranteeing some of these loans, at least some portion. What is the government in India doing, leaving everything to banks, even promoters. .This government wants banks to do all the heavy lifting without putting absolutely zero accountability on itself or the promoters,” adds the risk officer of European bank.
That said, one can’t take away the hard work done by the committee to come up with such a detailed framework within such a short span of time.
The recommendations by the KV Kamath committee will improve the transparency of the loan restructuring process that the Indian banking system is about to undertake, said analysts in response to details released by the central bank on Monday.
However, they also add that provisions could be higher as slippages are expected to rise for banks. A good portion of these restructured accounts may eventually turn non-performing.
The jury is not yet out on this...