ET BureauNo other intermediary gets to look into the corporate world like rating companies. For the woes of companies, some blame policy makers, some the banks. Naresh Takkar, CEO of ICRA Group, the Indian unit of Moody’s, in an interview with ET, says the problems ailing corporates and banking system are of their own making. Edited excerpts:
What is your assessment of corporate strength? Are they out of the woods?
The overall business growth is still sluggish. If you look at most corporates where we have seen the results for the last year, their topline growth has been flattish, basically about 2 per cent or thereabouts. Profitability has not improved, but it has been maintained. But if you look at the return on capital employed, for example, it is about 12 per cent, and for many of these companies’, interest costs are around 12-14 per cent.
What about the operating leverage many were expecting?
Operating leverage benefits have not come in simply because the growth conditions are still very moderate. As far as the benefit of commodity prices is concerned, sluggish demand and high competitive intensity have meant that most of the benefits from commodity or import cost have been passed onto the consumers rather than adding to the profitability of the companies.
Many were complaining about the liquidity conditions and the payment cycles. Have they improved?
Sub-contractors, suppliers, particularly vendors, smaller vendors & corporates still have issues relating to the cash flow cycle, though conditions have improved a bit. Conditions are very stressful and they have only marginally improved, so to that extent, cash flows item is still a bit of a concern. Importantly, if one were to look at some of the large leveraged-led growth, say close to about 50-odd large corporates, the total outstanding debt for the banking sector is about Rs 4.5-lakh crore. For a lot of these companies, the leverage is high. And 65 per cent, or almost 70 per cent, of their debt is still standard. It could be vulnerable. If you look at the debt numbers, one-third of these companies’ market capitalisation is one-eighth of their debt. Interest coverage for almost 60 per cent of these entities is less than one, which is a concern. For half of these companies, in 2014-15, net debt went up by about 20-25 per cent.
Does that mean that the state of the banking sector is far worse than what is believed now?
It is a reflection of what the situation in the real setup is. If you have issues relating to, for example, the iron and steel sector, which is definitely the biggest sector, almost 50 per cent of the iron and steel exposure is to companies with a debt by EBITDA of more than 12 times, and the total debt of steel companies is about Rs 2 lakh crore. So if 50 per cent of both exposures has debt by EBITDA of more than 12 times, it is a big concern. Obviously, for banks exposed to this sector, it is a big concern, and, importantly, many of these assets are yet to be notified as non-performing assets.
The next big worry is steel sector?
Moratorium gets extended or interest has been capitalised due to implementation delays to the level where if you go by the existing price levels, which are dictated by international prices, the projects are unviable. Many of these projects are clearly not viable. You may have early warning signals, but unless the banks are prepared to take a big haircut, it won’t help. Banks are not in a position to take such haircut. But somebody has to recognise the fact that by pushing the burden to the future, we are not possibly creating confidence in the system whereby these banks are able to attract capital and at least grow better assets.
There is an argument that lower interest rates can help corporates come back to life. Is that a panacea for leveraged companies?
It is a question of various things. Definitely a bit of reduction in interest rates will provide some respite, but at the end of the day, interest is also supposed to be providing for the risks that the banks take. The debt positions are so high that marginal reduction in interest rates is not going to be helpful. There are viability concerns. International prices have come down, demand is sluggish, capitalised values are very large. Interest rate is very insignificant. Yes, interest rate would help possibly revive the demand in the business indirectly from which they would benefit. It would possibly provide some relief to entities experiencing significant working capital issues.
Did banks take ratings into account before disbursing loans? Or did rating companies fail in seeing the stress?
In many cases, banks do take into account the ratings to determine interest rates. But it is not just one-on-one because banks also look at the underlying value of the relationship. But that is not unique to India. It happens even internationally. There would never be a situation where interest rates are directly one-on-one linked with rating. They do have competitive pressures on lending rates. Rating agencies do not give ratings to the underlying collateral.
Were you blind to the stress building up in the system?
Blind, I think, is a very strong word to use because if you look at many of these projects, our various ratings were showing inadequate safety. What has happened is that the way the rating gets computed, if it is an unrated exposure, the risk weightage is actually lower. So, many banks have almost taken a view, including the corporate borrowers, that if they were to be accepting the rating views, they would be at a disadvantage. As a result, for many of these projects, ratings may not be there in the public domain because they are not rated at all, simply because if they are unrated, the risk weightage is 100 per cent and if we have rated them, the risk weightage could have been 150 per cent or thereabouts.
If the attitude is to avoid recognising the risk, the hopes of more companies coming to bond markets may not become a reality.
I do not think we have a situation where those can be directly raising funds at this stage from the bond markets. However, refinancing is something that is already happening to a large extent and could pick up further. This may further impact banks’ profitability of the banks simply because the good accounts are going to move out, though not fully, but to that extent that they use the credit substitute.
So, clearly, to address your question, we would definitely seek significant growth happening in the bond markets but not possibly so much for funding the projects but possibly refinancing where the projects have been completed.
What is your assessment of corporate strength? Are they out of the woods?
The overall business growth is still sluggish. If you look at most corporates where we have seen the results for the last year, their topline growth has been flattish, basically about 2 per cent or thereabouts. Profitability has not improved, but it has been maintained. But if you look at the return on capital employed, for example, it is about 12 per cent, and for many of these companies’, interest costs are around 12-14 per cent.
What about the operating leverage many were expecting?
Operating leverage benefits have not come in simply because the growth conditions are still very moderate. As far as the benefit of commodity prices is concerned, sluggish demand and high competitive intensity have meant that most of the benefits from commodity or import cost have been passed onto the consumers rather than adding to the profitability of the companies.
Many were complaining about the liquidity conditions and the payment cycles. Have they improved?
Sub-contractors, suppliers, particularly vendors, smaller vendors & corporates still have issues relating to the cash flow cycle, though conditions have improved a bit. Conditions are very stressful and they have only marginally improved, so to that extent, cash flows item is still a bit of a concern. Importantly, if one were to look at some of the large leveraged-led growth, say close to about 50-odd large corporates, the total outstanding debt for the banking sector is about Rs 4.5-lakh crore. For a lot of these companies, the leverage is high. And 65 per cent, or almost 70 per cent, of their debt is still standard. It could be vulnerable. If you look at the debt numbers, one-third of these companies’ market capitalisation is one-eighth of their debt. Interest coverage for almost 60 per cent of these entities is less than one, which is a concern. For half of these companies, in 2014-15, net debt went up by about 20-25 per cent.
Does that mean that the state of the banking sector is far worse than what is believed now?
It is a reflection of what the situation in the real setup is. If you have issues relating to, for example, the iron and steel sector, which is definitely the biggest sector, almost 50 per cent of the iron and steel exposure is to companies with a debt by EBITDA of more than 12 times, and the total debt of steel companies is about Rs 2 lakh crore. So if 50 per cent of both exposures has debt by EBITDA of more than 12 times, it is a big concern. Obviously, for banks exposed to this sector, it is a big concern, and, importantly, many of these assets are yet to be notified as non-performing assets.
The next big worry is steel sector?
Moratorium gets extended or interest has been capitalised due to implementation delays to the level where if you go by the existing price levels, which are dictated by international prices, the projects are unviable. Many of these projects are clearly not viable. You may have early warning signals, but unless the banks are prepared to take a big haircut, it won’t help. Banks are not in a position to take such haircut. But somebody has to recognise the fact that by pushing the burden to the future, we are not possibly creating confidence in the system whereby these banks are able to attract capital and at least grow better assets.
There is an argument that lower interest rates can help corporates come back to life. Is that a panacea for leveraged companies?
It is a question of various things. Definitely a bit of reduction in interest rates will provide some respite, but at the end of the day, interest is also supposed to be providing for the risks that the banks take. The debt positions are so high that marginal reduction in interest rates is not going to be helpful. There are viability concerns. International prices have come down, demand is sluggish, capitalised values are very large. Interest rate is very insignificant. Yes, interest rate would help possibly revive the demand in the business indirectly from which they would benefit. It would possibly provide some relief to entities experiencing significant working capital issues.
Did banks take ratings into account before disbursing loans? Or did rating companies fail in seeing the stress?
In many cases, banks do take into account the ratings to determine interest rates. But it is not just one-on-one because banks also look at the underlying value of the relationship. But that is not unique to India. It happens even internationally. There would never be a situation where interest rates are directly one-on-one linked with rating. They do have competitive pressures on lending rates. Rating agencies do not give ratings to the underlying collateral.
Were you blind to the stress building up in the system?
Blind, I think, is a very strong word to use because if you look at many of these projects, our various ratings were showing inadequate safety. What has happened is that the way the rating gets computed, if it is an unrated exposure, the risk weightage is actually lower. So, many banks have almost taken a view, including the corporate borrowers, that if they were to be accepting the rating views, they would be at a disadvantage. As a result, for many of these projects, ratings may not be there in the public domain because they are not rated at all, simply because if they are unrated, the risk weightage is 100 per cent and if we have rated them, the risk weightage could have been 150 per cent or thereabouts.
If the attitude is to avoid recognising the risk, the hopes of more companies coming to bond markets may not become a reality.
I do not think we have a situation where those can be directly raising funds at this stage from the bond markets. However, refinancing is something that is already happening to a large extent and could pick up further. This may further impact banks’ profitability of the banks simply because the good accounts are going to move out, though not fully, but to that extent that they use the credit substitute.
So, clearly, to address your question, we would definitely seek significant growth happening in the bond markets but not possibly so much for funding the projects but possibly refinancing where the projects have been completed.
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