After the RBI identified 12 big defaulters for immediate resolution of bad loans under the Insolvency and Bankruptcy Code 2016, there has been a new urgency among banks to deal with these stressed assets. SBI, the largest lender, is said to have referred three large steel accounts — Bhushan Steel, Essar Steel and Electrosteel Steels — to the National Company Law Tribunal (NCLT).

However, the high debt to market-cap levels of some of these indebted companies are over 60 times, which may prove to be a stumbling block for banks to take haircuts. The RBI allowing phasing out of bad loan provisioning on such accounts will now hold the key for quicker resolution, say bankers.

In the first stage of the resolution process, banks will hire insolvency resolution professionals to initiate the process through an application filed with the NCLT. The resolution plan is then drafted which could include a turnaround fund investing money in the company if there is still some potential. Or, it could be in the form of an ARC investing in the company or a strategic buyout.

But in finding ready takers for businesses or selling bad loans to asset reconstruction companies, lack of concurrence on the serviceable portion of debt has impeded resolution.

For instance, under S4A, banks were allowed to break up the debt into sustainable or serviceable and unsustainable. However, the sustainable portion of the loan could not be less than 50 per cent of the total debt. In many cases, bankers felt that the sustainable portion of the debt was below 50 per cent. In effect, banks needed to take more than 50 per cent haircut on loans by converting unsustainable debt into equity to be issued to them, thus downsizing loans to attract buyers.

How big?

So, how big of a haircut do banks need to take on these accounts? Most of the 12 big accounts identified by the RBI are highly overleveraged. A look at the few names that have been doing the rounds in various reports, suggests that some of these companies have high debt to market-cap levels of over 60 times that could be a stumbling block for banks to take haircuts.

For instance, Alok Industries has total debt of around ₹23,000 crore as of March 2017. Even if one assumes, say a 50 per cent haircut, it would be way above the existing market capitalisation of the company which is about ₹380 crore (the stock is trading at ₹2 per share). The company, however, does have some fixed assets to show for, which stood at around ₹16,000 crore as of March 2017.

But then there are many companies such as Era Infra Engineering whose huge debt is not backed by sufficient fixed assets. The company’s debt that stood at around ₹10,000 crore in FY17, has a current market cap of ₹47 crore and fixed assets of just a little over ₹1,000 crore. ABG Shipyard that had a debt of ₹8,700 crore in FY16 (FY17 numbers not available) has a current market cap of ₹67 crore. Jyoti Structures has a debt of about ₹3,300 crore and fixed assets of ₹378 crore as of March 2017 and a current market cap of ₹121 crore. Most of these indebted companies also have negative net worth (book value).

Given that the tale is similar for other large defaulters, banks will be required to take very steep haircuts. Bankers believe the RBI will need to step in to offer some leeway like allowing banks to stagger the provisioning requirement over several years.

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