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Bad debt or death bed?
Evergreening of loans is keeping several over-leveraged companies alive. What could be the endgame?

Jitendra Kumar Gupta & Jash Kriplani

Just a year before liberalisation, a few enterprising men decided to enter the business of steel making. These men borrowed monies from banks and then kept on borrowing. One fine day, the bankers realised that the promoters had no way of making good on their debt obligations. But accepting financial loss — or losing face, for that matter — was not an option for these banks.

So, the largest lender called upon the other smaller banks and told them to ease the payment obligations so that the loan remains good. A smaller bank was willing to accept the loss and did not want to support these enterprising men anymore but the largest bank used its mighty clout and made almost all of them fall in line. Is this a true story or a figment of someone’s imagination? Your guess is as good as ours.

Recently, HDFC Bank sold its Essar Steel exposure of ₹550 crore to an asset restructuring company, while an SBI-led joint lenders’ forum restructured the company’s ₹30,000-crore exposure. Reports suggest that the loan was sold at a 40% discount. Industry insiders believe that refinancing and rolling-over are going to be commonplace in the banking system, which is short on ideas but big on its set of problems.

In a study of highly leveraged business groups, analysts at Credit Suisse say that $15 billion worth of long-term debt is due next year and would need to be refinanced. Additionally, another $20 billion of short-term debt would need to be rolled over. With these stressed groups’ total outstanding loans at a staggering ₹730,000 crore (see: India’s debt and mighty), banks will have little or no choice but to support these groups’ debt-ridden balance sheets. With some of the banks already stretching to meet the Basel-III capital requirements, supporting these groups would put additional burden on their capital base.

India's debt and mighty

Debt servicing ability has worsened for most business groups

According to Saurabh Mukherjea, head of institutional equities at Ambit Capital, the genesis of the problem is politically directed loans made in 2009 and 2010 and genuine errors of judgment made in 2008. Over the past eight years, corporate debt of the top 10 over-leveraged corporate groups covered by the Credit Suisse list grew by a whopping seven times (see: The show must go on). “Clearly, what happened during UPA-II was that the promoter community realised that foreign investors were bending over backwards to give them equity funding and that the political class would help them procure funding from PSU banks on the premise that it is the only way long-term infra funds could be funded. Using that as a genuine pretext, politically directed loans were made with very little prospects of repayment, either because the projects were wrongly structured and planned or because there were mala fide intentions at the outset,” he says. “A whole ecosystem of people cropped up, which included but was not restricted to politicians, who were complicit in using both the debt and equity layers to line their pockets,” he adds. 

The show must go on 
Debt ballooned as banks evergreened loans

In Outlook Business’ own study, which we conducted over the past few days (see: Dead man walking), we threw a net with a stringent set of debt ratios over the familiar ocean of the BSE universe and 20 companies got caught in our net. We first fished for companies with debt-equity ratio of more than 2.5x. Within this flock, we culled out companies with interest coverage ratio equal to or more than 1.5x, with opening cash plus CFO/interest cost equal to or more than 1.5x and a market cap: debt of less than 100%. Then, we looked at common companies across these four filters and finally ranked them on the basis of their individual ratios to find the worst of the lot; the total outstanding debt of these companies stood at ₹406,000 crore. Six companies on our list incidentally also belong to the four stressed corporate groups that have been covered by Credit Suisse analysts in their House of Debt report. These 20 companies are vulnerable to debt troubles, as they face a highly challenging environment in meeting their debt obligations. 

Wishing it away 
Unsurprisingly, we found that rating agencies and the banking system were yet to ring the alarm bells on several of these companies. Although the corporates servicing these loans face a worrisome situation, rating agencies so far don’t seem to think that these companies could be headed for a default-like situation. For 12 of these debt-burdened companies that landed in our net, their ratings have not been lower than BB. Of this, 10 were investment grade, that is, BBB and above. Only in six instances has the rating been pegged at D, that is, default.

As per a study done by Nomura, corporates’ balance sheets (consolidated debt-to-equity greater than 1.3x) are today more leveraged than in any other past cycle. Some of the companies that are currently finding it difficult to even pay their monthly interest expenses from their operating cash flows have been assigned A- or higher ratings, indicating adequate to high degree of safety. This set of companies include names such as Tata Teleservices (Maharashtra), Adani Transmission, Adani Power, Sadbhav Engineering, IL&FS Transportation Networks, JBF Industries, Century Textiles and Industries and Dalmia Bharat. Companies such as Tata Teleservices and IL&FS Transportation Networks’ ratings may be supported by the ratings of their parents Tata Sons and IL&FS, although one might question to what extent the parent will support the child.

According to Pradip Shah, chairman of IndAsia, who in his stint at Crisil introduced the concept of credit rating to India, “While it is not right to paint all the rating agencies with the same brush, certain rating agencies are giving out as much ratings as they can without doing due diligence. How can these rating agencies justify investment grade ratings (i.e. BBB-)? This is like a speculative trade; if the company is lucky it will be able to pay off its debt but on the basis of hard numbers it doesn’t look likely. Certain agencies are reluctant to detect stress as money matters dictate their business approach.” About 13 companies on our list are yet to enter bankers’ intensive care unit — CDR or 5/25. These include Adani Transmission, BF Utilities, Bombay Dyeing & Manufacturing Company, Century Textiles and Industries, Dalmia Bharat, Jaiprakash Associates, Jaiprakash Power Ventures, JBF Industries, Jet Airways, KSK Energy Ventures, Sadbhav Engineering, Sadbhav Infrastructure and Tata Teleservices. 

Incidentally, in case of Jaiprakash Associates and Jaiprakash Power Ventures, restructuring has not happened even though the company has been assigned a D rating, indicating that the company is in default or expected to default. The company was downgraded by CARE Ratings in October to D from BB. Up until February 18, when it was downgraded from BBB to BBB-, it was still investment grade. Subsequently, the rating was taken down a couple of notches lower to BB in July, before the D rating was eventually assigned. Gayatri Projects is another interesting case study of a company quickly getting downgraded to D.

Dead man walking 
Liquidity and asset-based ratios indicate that some companies may find it hard to survive

In the month of February, CARE actually upgraded the infrastructure player from D to B+, citing regularisation of debt servicing. CARE analyst Radhika Ramabhadran in her note said that the ratings are underpinned by the track record of the company and promoters’ experience and satisfactory order-book; albeit certain stalled orders and weak order inflow exist. In May, the rating was reaffirmed. In November, the company was reassigned the D rating citing delay in debt servicing. Monnet Ispat is another example which saw a quick downgrade. On April 21, the company was downgraded to B+. Up until that time, the steel company enjoyed a BBB- rating, that is, investment grade. In July, the rating was cut from B+ down three notches to D.  

Why bad won’t turn good 
Of the ₹406,000 crore of outstanding loans detected in our screening, 12 infrastructure companies accounted for 77% of the loans. These debt-burdened companies were involved in power, construction and roads businesses. Companies in textile, aviation, steel and telecom made up the balance. Experts don’t seem to think that a benign interest rate cycle is going to help improve matters. “Stress is unlikely to come down for many of the companies that you have identified in your analysis. Rate cuts are not going to help matters much so far as improvement in fundamentals is concerned,” says Sanjay Bakshi, widely followed value investor and adjunct professor at MDI, Gurgaon. He sees a negligible impact on these companies’ large interest outgo due to the RBI’s recent 50 basis points rate cut. 

Power and steel sectors face a daunting task ahead, with macroeconomic conditions clearly not in their favour. Take the case of Adani Power: despite booking compensatory tariffs (the matter is currently sub judice), the company reported losses to the tune of ₹815.6 crore in FY15. Its total outstanding debt stood at ₹44,741 crore and its net worth has already fallen by 13% to ₹5,724 crore in FY15. Girish Nair, power analyst at BNP Paribas, feels the company could see a net loss to the tune of ₹3,821 crore over FY16-18 due to higher interest costs. Nair was earlier working with a net loss estimate of ₹2,221 crore for the same period but believes that if reports of Adani Power looking to refinance the debt of its loss-making plants at Mundra, Tiroda and Kawai are right, it would translate into lower debt repayment and a higher interest rate. 

Adani Power and other private power generation companies have been struggling to keep their projects viable, with the issue of compensatory tariffs still sub judice and state discoms struggling to honour the payment obligations under the power purchase agreements (PPA) due to their own problems. Take the case of Rajasthan Rajya Vidyut Prasaran Nigam. According to reports, the state transmission utility scrapped seven PPAs signed with power producers such as Lanco Babandh, PTC Athena (Chattisgarh), SKS Power, PTC-MB Power and KSK Mahanadi, as it was unable to meet the payment obligations. 

Power Finance Corporation’s FY12-14 report on the financials of state electrical boards puts the rot in perspective. The distribution companies’ combined losses for FY14 stood at ₹62,100 crore, with their debt rising to ₹330,000 crore from ₹270,000 crore. Discoms’ combined net worth is a negative ₹220,000 crore. As for the power companies — Adani Power, Adani Transmission, Jaiprakash Power Ventures, KSK Energy, Lanco Infratech and BF Utilities — that have shown up on our list, servicing their combined debt of ₹140,000 crore seems to be beyond their power unless state discoms repair their own balance sheets and are in a position to buy power from independent power producers (IPPs). 

Due to the lack of demand from discoms and lack of fuel availability, these IPPs are operating at low plant load factors (PLF). Jaiprakash Power Ventures’ PLF in FY15 was 55.36%, while for Adani Power the average PLF was 70% during the same period. The average PLF of KSK Energy Ventures and Lanco Infratech are 53% and 51%, respectively. A recent report called Power Sector Compendium by Crisil observes that domestic coal availability is still below what is required to operate these installed capacities at the normative PLF of 85%, as stipulated by the Central Electricity Regulatory Commission. The report adds that “India’s coal-based power generation plants require about 713 million tonne of coal in FY15 to operate at 85% PLF. But domestic supply stood at 451 million tonne and 90 million tonne was imported — totaling 76% of what was required — because of which the all-India thermal PLF declined to a decadal low of approximately 65% in 2015.”  

In a bid to address the liquidity crunch faced by the discoms, the government recently launched a project called UDAY. The project would essentially entail the state governments taking over 75% of the discoms’ debt by FY17 and the interest cost for the balance debt would be lowered by 25%. While the relief package looks good on paper, there is still a question mark over whether state governments will be willing to play ball, as power is a concurrent subject.

The government hopes UDAY will bring the losses down from 22% to 15% and completely remove the gap between the cost and revenue deficit by FY19. Even if things go as planned and discoms start buying incremental power from IPPs, there are certain sticky issues that the power generation companies need to get around.

According to a Crisil study, even as poor demand remains a concern, out of the 46,000 MW (funded through debt of ₹210,000 crore) of power projects that are facing viability issues, close to 26,000 MW face the hurdle of inadequate feedstock (coal and gas). The study estimates that another 20,000 MW of capacities are under pressure due to tariff under-recoveries, which have been complicated by escalation in the cost of Indonesian thermal coal. The IPPs were not prepared for this, as this cost escalation was not built into the tariffs fixed in their power purchase agreements (PPAs). 

Apart from the power sector, steel is another sector that is in a precarious state. Overcapacity, low commodity prices and continued import pressure from China has led to the corrosion of the net worth of steel companies. The government’s strategy to curb imports from China by implementing a safeguard duty also seems to be unraveling. Analysts at ICRA say that while the imposition of the duty had reduced the differential between domestic and international hot-rolled coil prices, with international prices falling around 5% after the duty was imposed, domestic prices are likely to remain weak. A banking analyst with a foreign brokerage says, “While it is easy to blame the problems in steel to the prevailing down cycle, a lot of these companies would not be able to service their debt even in a moderately bullish steel cycle, as the quantum of debt is very large.”

The near future looks bleak. “We are actually going through disinflation. Our nominal GDP growth rate in Q1FY16 was 8.8%, the worst in 13 years. The real GDP growth seems to be reviving, but our nominal GDP growth rate has been nose-diving. If disinflation persists for another year, the situation will have lot of symptoms comparable to a balance-sheet recession,” says Deep N Mukherjee, visiting faculty with IIM Calcutta and previously with Fitch Ratings. Adds Sudip Sural, senior director at Crisil Ratings, “The leverage problem is persisting because demand is not catching up. That is why it is going to be an L-shaped kind of a recovery, where we are going to see the downturn continuing for some time.” 

A combination of an extended working capital cycle and a dried-up cash flow stream has put many of these companies in a liquidity crisis. “Many companies, especially those that were granted a moratorium by the CDR cell, are now facing pressure from the banks. Like in our case, at the time of restructuring our debt, we thought two years will be enough to ease liquidity pressure and thus the extension of maturities and subvention of interest was a big relief. But the problems have not gone away and companies with poor fundamentals are facing the bankers’ heat,” says Praveen Sood, group CFO, HCC.

Pradip Shah, chairman, IndiaAsia Fund Advisors Slowly but surely, debt has eaten into the equity of these companies; particularly in the case of infrastructure and power projects, which were built at debt-to-equity of 70-30 and are now at 90-10. In case of KSK Energy, the market cap-to-debt is 90:10; in the case of Jaiprakash Associates and GVK, the ratio is 95:5. In certain cases where the market cap is about 2-5% of the total enterprise value, the value of equity is on the verge of becoming zero. Take the example of Bhushan Steel. Taking into account the replacement value (₹6,000 crore for 1 million tonne), Bhushan Steel’s over 5-6-million tonne capacity is valued at around ₹36,000 crore. After adding another ₹3,000 crore of capital work-in-progress, the total value of the company comes to around ₹39,000 crore. However, gross debt itself has gone up to ₹40,000 crore from ₹30,000 crore in FY13, thus leaving very little on the table for equity holders, as reflected in the company’s ₹1,000-crore market cap. 

No takers
Such companies are now finding it hard to get buyers to come in and put some equity on the table. “There are no deals happening as there are too many sellers in the market and buyers have become choosy and greedy. Also, the assets that are being put on sale are not really good assets. They have their own set of issues and sticky liabilities that may put off any interested parties,” explains Sood. Even as a sluggish order-book amid weak demand has jammed the wheels of recovery, banks’ largesse seems to show no signs of abating.

As per a UBS report, there was an 85% increase in estimated loans to potentially stressed corporates since FY12. With large banks now facing dissent from capital-starved smaller banks on refinancing at joint lenders’ forum (JLF), the stressed companies are trying to tap the primary market to fund their mismatch in cash flows. But they are not finding many takers there either. For instance, finding lack of investor appetite for debt-burdened real-estate companies, HCC is unable to list Lavasa. “A large part of our debt, or 1.2-1.3x, can be attributed to inventories and debtors. We have close to ₹10,000 crore of settlement claims. Of this, ₹3,000 crore worth of claims are recognised and only ₹450 crore of that has been paid. We have been trying to list Lavasa, which can ease pressure, but there is little appetite for real-estate IPOs as of now,” Sood adds.

GMR’s bid to list GMR Energy has also seen a delay. The latter, which accounts for about half of group debt and operates about 2,500 MW, is facing challenges due to non-availability of fuel for its gas-based power plants of 1,300 MW. Through this listing, GMR Infra was looking at getting equity for its projects and also use ₹400 crore towards debt repayments. As market cap of these companies have eroded and debt concerns have not eased, there now seems little point in dilution. Take Bajaj Hindusthan, sitting on a debt of ₹7,300 crore.

In the past three years, it has diluted its equity twice but that hasn’t helped stem the deterioration in net worth from ₹3,926 crore in 2012 to ₹1,520 crore in 2015. IL&FS Transportation Networks, which is a BOT- and annuity-based road project player, has diluted its equity twice in the past two years. While its net worth moved up from ₹3,639 crore in FY13 to ₹5,720 crore in FY15, debt went up by ₹10,000 crore to ₹24,000 crore; earnings per share also fell from ₹26 to ₹13 owing to the dilution.

The market cap of companies such as Bajaj Hindusthan, Adani Power, GMR Infra, Bhushan Steel and Jaiprakash Associates is 20% or less than their debt. Selling stake or converting debt into equity in some of these cases doesn’t seem to make any sense. “Bankers are unable to run banks efficiently, where they are fully qualified to do the job. What will they do taking over infrastructure assets,” asks Mukherjee.

Promoters are also trying to protect their companies’ net worth by pledging their holding with the banks: almost 100% of promoters’ equity has been pledged in companies such as Bajaj Hindusthan, IL&FS Transportation, Jaiprakash Power Ventures and KSK Energy. Over the past year, the 20 firms we mentioned have seen their net worth fall close to ₹10,500 crore; most of this is accounted for by companies such as Bajaj Hindusthan, Bhushan Steel, GMR and Jaiprakash Associates. Overall, the over-leveraged companies on an average have faced a market cap loss of 65% since 2009. “Clearly, internal accruals are falling short,” says Sural of Crisil. The 20 firms in all reported annual operating cash flow of about ₹27,000 crore, falling short of their annual interest outgo of ₹32,000 crore.

Finding it difficult to meet interest expenses, certain companies have also taken to financial engineering by capitalising their interest costs and inflating their assets. Companies like Bhushan Steel have capitalised close to ₹2,200 crore of interest in FY15. Companies such as HCC and Century Textiles have also followed suit.“Running out of options, corporates have had no choice but to let go of some of their relatively better assets,” adds Sural.

Companies such as DLF, Jaiprakash Associates, HCC, Lanco and others have already sold their core and non-core assets to make room for some breathing space on their leveraged balance sheets. Even companies with strong promoter backing are looking to lighten up their balance sheets. Tata Steel, Hindalco, L&T, Tata Power, Indian Hotels, Vedanta and Jindal Steel & Power are also looking to sell assets. However, these distress sales are creating a new set of problems for the companies.

Reason: to attract buyer interest, promoters are putting their healthy, Ebitda-generating assets on the block, which in some cases contribute as much as 70% to their operating profit. After these assets are sold, the companies’ debt-Ebitda, or interest coverage ratios are taking a hit. Recent sales of Jaypee Group and Lanco Group are cases in point. Jaypee has been the most active in selling its assets and will realise ₹22,000 crore from these sales. It has sold 8.4 MT of cement capacity for ₹5,000 crore and firmed up the sale of another 4.9 MT for ₹5,400 crore. 

Jaypee is also selling 1,391 MW of hydro plants to JSW Energy, which will bring down debt by approximately 30%. However, as these plants contributed 59% to FY15 Ebit, the debt-Ebitda would deteriorate post these sales. The group is also in talks to sell its 500-MW Bina project; PLF for its residual capacity is just 35%. In April, 2015, Lanco completed the sale of its 1,200-MW Udupi power plant to Adani. It was estimated that the transaction would cut down its debt by 15%.

This project contributed 69% to Lanco’s FY15 Ebitda and the sale is bound to have a negative impact on its debt-Ebitda. For the residual capacity, the PLF just stands at 40%. The value of assets on the books of these companies is also not enough to cover their debt obligations in case of liquidation. For example, Lanco Infra has a net asset value of ₹21,000 crore and after adding another ₹16,000 crore of capital work-in-progress, the value of its assets can go up to ₹37,000 crore. Even if all the assets are sold at book value, it will not be able to pay off its debt of ₹39,000 crore, forget about shareholders’ equity. Credit Suisse analysts in their House of Debt report note that cost overruns to the tune of 20-70% have meanwhile pushed up the capital costs and further weakened the viability of these projects. 

Deep N Mukherjee, visiting faculty, IIM CalcuttaThe assets left behind with the promoters are anyway facing operational challenges, rendering the future cash flows of little or no help in servicing the high debt level. For instance, most of the power projects that are now left with GMR Infra are facing operational challenges due to non-availability of gas and it would not be easy to find buyers for these assets. GMR Infra, which is into airport, power and road businesses, has divested several of its assets, including road projects and an airport in Istanbul. “Over the past two-and-a-half years, we have reduced the group liabilities by ₹6,200 crore through various divestments. The group is undertaking various initiatives to deleverage its balance sheet through a combination of fund raising, divestments and strategic investment. These initiatives would lead to reduction in debt, and thus lower interest payment obligations,” a GMR Infra spokesperson said.   

So far, the reduction is negligible as the company has ₹50,000 crore of debt on an equity base of around ₹8,000 crore. While its road and power businesses have been bleeding, its airport business has been doing relatively well. Thus, a stake sale or separate listing of the airport business has been talked about as a remedy but hasn’t happened so far. While time is running out for debt-troubled companies, the pressure to sell good assets to attract buyers is building up.

“The current economic conditions have made companies desperate. They are looking to sell their assets at any price. Banks are exhausted and are putting pressure on companies to sell assets. Asset sale is not of much help when the stress is too high; this is only a stopgap, short-term solution. You are only fixing your balance sheet for the next three or four quarters. It fixes near-term liquidity issues but viability issues remain,” points out Nirmal Gangwal, MD, Brescon. 

Endgame 
Mukherjea believes there is no reason to expect the debt woes to mitigate unless all the stakeholders (policymakers, banks and promoters) show a willingness to end the charade. “The only endgame is that FII debt providers or FDI can come in over the next two to three years. The foreign entity can say that its cost of debt is 4-6%, so it can infuse debt at 2-3% above the 10-year bond yield of 7.7%. Or the foreign entity can say that it wants to operate the project and is willing to work with 12% IRR; the promoter is bankrupt anyway. The new owner can give a token amount to the promoter. They can tell the debt providers that they are cleaned out anyway, so they can take a 10-20% haircut so that the new owners can get their 12-13% IRR. At the moment, bankers and promoters pretend that the assets have some value but we know that 80% of what is in CDR is a straight write-off,” he adds.

Mukherjea cites the ₹6,750-crore Brookfield-Gammon deal to show what this endgame looks like. In the month of August, Canada’s Brookfield took control of six road and three power projects. Under the deal, consideration towards equity comprised of cash consideration of approximately ₹192 crore and a waiver of advances to Gammon Infra of about ₹285 crore.

The fallen ones 
Over-leveraged companies have seen their valuation hitting new lows

According to Mukherjea, refinancing or rolling-over of debt is hardly a solution. “The banking regulator can come up with new structures and reasons to kick the can down the road, but that won’t help matters.” The foreign brokerage banking analyst says that it is only going to make the problems bigger. “As banks are not willing to realise the problems and take haircuts, the issues are only becoming larger.

For instance, say if Bhushan Steel had got sold earlier, banks would have had to take haircuts of ₹5,000 crore-8,000 crore. But if the company was to be sold now, bankers would need to take haircuts to the tune of at least ₹20,000 crore, if not more.” The analyst adds that 17% of total loans are stressed and, of this, 5% are NPAs, so some provisioning has been done for them, but the balance loans need haircuts if they stand any chance of recovery.

“It is not going to be possible without a haircut. Three to four years have passed already and in India, the cost of waiting is close to 12-13%, which is basically the additional interest that you end up paying on the debt because of the delay,” he adds. Even as companies such as Adani Power, Bhushan Steel, Lanco, Essar Steel and GMR have gone for restructuring under 5/25, Yes Bank’s president of corporate finance, Ashish Chandak is of the view that given the current environment, bankers are cautiously approaching the 5/25 restructuring window. “They are not doing recasts for any Tom, Dick and Harry. They are examining the underlying viability because 5/25 alone cannot make a project viable if the underlying strength not there,” he says.

Meanwhile, the government is planning to introduce a bankruptcy code to help bankers recover their investment faster so that there is efficient flow of capital across the economy. Industry veterans say they hope that the code is not a toothless mechanism and will deter erring promoters. “If there is a provision to change the management quickly, then that would be good. Additionally, new money would be required to turn around the distressed company. So, the law should have some built-in mechanism whereby the new lenders get priority over old lenders in repayments,” says Shah.

While it is anybody’s guess when this endgame will begin and a new generation of owners will bring in a sense of sanity, for now, bankers and corporates wistfully wait for the aurora of economic recovery. Mukherjee says, “These debt-related issues will take at least three to five years to iron themselves out, whether the bankruptcy code comes into play or not this December. The process of subsequent notifications and implementation of the code will take at least three to five years. If the code doesn’t get passed, we will have to wait for another three to five years for economic growth to come back so that the current crop of zombie loans gets mitigated. This three- to five-year period is assuming a best-case scenario, where there are no external shocks or further deterioration. In the meantime, the status quo will continue, where some banks would not recognise the NPAs, proactively restructure the loans or tap the 5/25 mechanism.” 

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