39% Of Debt Still With Companies That Can’t Cover Interest: Credit Suisse

The turnaround in the health of corporate balance sheets remains painfully slow with a large proportion of debt still in the hands of companies that barely earn enough to cover their interest payments.

According to a report by Credit Suisse, the share of debt with companies having an interest coverage ratio of less than 1 inched up to 39 percent at the end of the first quarter compared to 38 percent in the previous quarter. Interest coverage ratio is a measure of a company’s ability to make interest payments through its earnings.

However, the share of debt lying with loss-making companies fell to 30 percent from 34 percent in the previous quarter, according to Credit Suisse, which first highlighted corporate debt concerns in India through its ‘House of Debt’ report in 2012.

The aggregate interest coverage ratio for the 3,700 firms analysed by Credit Suisse has improved marginally to 2.4 times at the end of the first quarter compared to 2.1 times in the previous quarter.

The report also points out that the extent of leverage on corporate balance sheets is yet to come down, which means that a large proportion of debt is still with highly leveraged firms.

Fifty-three percent of debt is with companies that have a debt-to-EBITDA (earnings before interest, tax, depreciation and amortisation) ratio of more than 12 times.

Metal Sector Improves; Power Worsens

The government’s decision to impose a minimum import price (MIP) to protect the domestic steel industry from cheap imports has helped improve the performance of firms in that sector to some extent.

Still, banks will need to take haircuts on the debt outstanding with metal firms, said Credit Suisse.

“Even as steel prices are up 15 percent post MIP in Q3, over 50 percent of steel debt is with companies with debt/EBITDA of more than 12x and 66 percent with interest coverage less than 1. Recognition of steel sector stress at banks has improved over the past two quarters and 40-50 percent of steel sector exposure is now already recognised as impaired at most banks,”said the report.

The share of metal companies in the set of companies which have an interest coverage ratio of less than one has come down from 26 percent in March 2016 to 18 percent in June 2016. This was largely on account of Tata Steel exiting the list in this quarter, following the exit of Vedanta, Hindalco, and JSW Steel in the fourth quarter of last year, said Credit Suisse.

The situation in the power industry, however, has worsened and Credit Suisse expects bad loans from this sector to rise. Unlike in the case of the steel sector, banks have recognised only 3-5 percent of loans to the sector as bad debt, the report noted.

Will Bad Loans Rise Further?

Given the slow turnaround in corporate balance sheets, stressed loans for the Indian banking sector may continue to rise.

Impaired assets at banks are now at 12 percent, with non-performing loans accounting for 8.6 percent and restructured loans accounting for the remaining 3.5 percent. Credit Suisse expects the overall ratio of impaired assets to rise to over 16 percent.

“We estimate that another 4.5 percent of loans are stressed (with a large share from the power sector) and therefore expectations of a turn in asset quality cycle are premature,” said the report. As such, Credit Suisse remains negative on undercapitalised and under-provided corporate lenders and has an underperform rating on Punjab National Bank and Bank of India and maintains a neutral rating on State Bank of India.

The brokerage house also pointed out that 43 percent of restructured loans have slipped into the bad loan category.