Source: Reuters/Vivek Prakash
To see the digital version of this report, please click here.
When national carrier Air India finalised a jumbo Rs224.68bn (US$4.2bn) debt restructuring in April this year, one thing became abundantly clear – India Inc needed some major surgery.
Air India’s restructuring was far from a surprise. The carrier has not posted a profit for the past five years and operates in an ailing industry suffering from intense competition, but what shook the corporate world was the sheer size of the loans involved.
The carrier’s workout is the largest in India to date and the government’s need to turn around an inefficient national champion has clear implications for other companies across the public sector.
Rating agency Crisil has hiked its earlier estimates on problem loans in the Indian banking system, saying restructured borrowings may reach Rs3.25trn in the two fiscal years from April 1 2011 to March 31 2013, up from earlier estimates of Rs2trn made as recently as April.
Since April 2011, loans totalling Rs1.6trn have already been restructured, according to Crisil. These huge numbers not only hint at the extent of the toxic assets in the Indian banking system, but also reveal a determination to act. After years of simply rolling over bad loans – masking problem ones and allowing inefficient, loss-making companies to outlive their natural lives – lenders are finally taking action.
The repercussions of a surge in restructurings have set alarm bells ringing all the way up to the Ministry of Finance.
Concerned over the rise in the number of restructuring proposals and worried about potential abuse of the system, the government has introduced stricter rules for creditors and borrowers wishing to use the Corporate Debt Restructuring cell.
In a directive to the CDR cell – a Reserve Bank of India-recognised restructuring forum backed by 55 Indian banks – the MoF’s department of financial services has proposed some immediate measures to ensure that debt restructuring is offered only in “viable” cases. The proposals are expected to come into force before the end of September.
Any borrower can refer a proposal to the CDR cell once it wins the support of lenders representing a stake of at least a 20% in the total working capital or term loans of the company. This mechanism has become the preferred restructuring route in India, as it gives lenders an option to restructure an asset before it goes into default, while promoters view the CDR package as a lifeline.
The government, however, is now asking the promoters to put up a greater amount of equity in return for additional working capital from lenders. Also proposed is a requirement for promoters that use the CDR cell to pledge 100% of their shares and provide unconditional personal guarantees. The government also wants lenders to do more due-diligence work before recommending a company for the CDR package. Lenders are also urged to consider a change in the management.
Lenders are also asked to consider conversion of debt into equity only as a last resort. That option should be agreed only for listed companies and subject to a cap of 10% of total debt.
The monitoring mechanism for companies taking CDR packages is also set to be tightened, while it is recommended that entities performing better than CDR projections, but refusing to exit from the CDR cell, need to be charged commercial interest rates.
Banks may find some solace in the latest MoF missive, which stresses the need to establish the real cause for the restructuring – such as inefficient management, promoters diverting money or a cyclical downturn beyond a company’s control – before any case is even referred for such a move.
The MoF has also asked banks for an immediate increase to 5% from 2% in their capital provisioning for restructured loans.
While the measures will ensure that only the right candidates use CDR cells, they will also make banks even more reluctant to admit that a loan has run into trouble.
“Every financial transaction is prone to restructuring because, ultimately, it is an outcome of a cash-flow mismatch that can happen a any time for various reasons. However, restructuring has to be minimal, otherwise we [lenders] will all soon be queuing to restructure ourselves,” said a banker from a state-owned bank.
State-run banks are clearly taking a more severe hit than their private counterparts. (See Table.)
“It is clearly observed that public sector banks share a disproportionate burden of such [restructured] accounts. If the reason for the recent increase in restructured accounts is indeed the economic downturn, then it should have been reflected across all bank groups and not just public sector banks,” RBI deputy governor KC Chakrabarty said at a conference in August.
“The trends are arguably a reflection of the fact that public sector banks have not been as judicious in the use of restructuring as a credit management tool as the private sector and foreign banks,” he added.
Crisil expects most of the restructurings to involve loans to state power utilities, and the construction and infrastructure sectors. The rise is due to higher interest costs and refinancing challenges facing companies with huge debt burdens.
“In recent months, the availability of unsecured short-term loans from Indian banks has diminished. This is exacerbating refinancing and liquidity pressure, especially for SPUs. This will lead to a significant increase to nearly Rs1.5trn in restructuring of loans to SPUs. So far, SPU loans of Rs0.6trn have been restructured”, Crisil senior director Pawan Agrawal said in a note.
The restructuring of most loans related to SPUs is likely to happen through a government-co-ordinated centralised scheme. However, the problems do not end here, as the tight liquidity in India’s capital markets is compounding the problem.
“Inability to raise adequate equity in a timely manner is straining the balance sheets and financial flexibility of developers in the infrastructure and construction sectors, resulting in an increased likelihood of restructuring,” Agrawal said.
Other vulnerable sectors include iron and steel, textiles and engineering.
Solutions on runway
India’s lenders are slowly realising that their hesitance to declare bad debts as non-performing assets may potentially become a malignant problem. Some are even calling for the adoption of internationally accepted bankruptcy laws.
Even though such laws may conflict with the traditional approach to restructuring in India, there is a gradual change in mindset that is leaning towards a framework resembling the US Chapter 11 regime.
The excesses of the past also provide important lessons for the future.
“In most cases of restructuring, the common mistake of the managements was aggressive bidding for acquisitions and expansions. I’m sure others would learn from these mistakes as the problems deepened as economic downturn hit at the same time,” said Vishal Gupta, vice-president, project advisory and structured finance, at SBI Capital Markets.
Another banker pointed out that lenders were now more cautious about approving new loans as recent trends had shocked them more. “We have seen cases of companies resorting to the CDR cell within 15–18 months of raising fresh loans. There is indeed something seriously wrong somewhere,” said the banker.
All eyes are again on Air India as the carrier nears another milestone in its restructuring. Air India proposes to replace Rs74bn in short-term loans with a 19-year bond before September 30. Bankers believe the bond issue – with the backing of a government guarantee – is doable, but is unlikely to be distributed well.
“We don’t doubt the government guarantee, but we have absolutely no faith in the operational efficiency of the airline,” said a buy-side banker.
Critics argue that the government is setting a bad example with its rescue of Air India at a time when it is calling for tougher private sector restructurings.
“The restructuring (of Air India) is a classic case of good money chasing bad. I am more worried about its impact reaching my portfolio,” said a New Delhi-based DCM banker.
The restructuring comes at a time when other private players, such as Kingfisher Airlines, are in severe distress and may even file for bankruptcies.
Indeed, Air India is leaning on the government as it looks to clean up its act. Along with long-term borrowings for aircraft purchases, Air India’s total outstanding debt stood at an unsustainable Rs431.12bn as of September 30 2011.
Its financial turnaround includes a Rs300bn equity infusion from the state, staggered until 2020. This amount includes Rs67.5bn upfront, Rs190bn towards aircraft purchases and Rs45bn to make up a shortfall on wage bills and interest payments.
On top of the equity, Air India is converting Rs214.98bn of debt facilities into three – Rs46.20bn of cash credit limits, Rs104.48bn of long-term loans and Rs74bn of short-term loans.
Besides the unflinching government support, also in Air India’s favour is that its 19 or so lenders, are mostly public-sector banks. They have agreed to provide relief to carrier with haircuts and payment delays.
On the long-term debt of 15-years, Air India will be given a moratorium on interest for a year, as well as a two-year moratorium on the principal. The long-term debt has also been re-priced to pay a uniform 11% interest rate to all lenders. That is 100bp–125bp less than most existing bank loans.
If the financial workout seems straightforward, the airline’s return to profit may be far harder. Without some significant operational changes, the carrier may well be back for another bailout further down the road.
Air India’s employee cost per average seat kilometre is around US$0.8, nearly double the industry average. The company says it will rectify that with the deployment of proper planes on different routes, a strategy known as network modelling.
SBI Capital Markets advised on the restructurings of both Air India and Kingfisher.