‘Titanic’ Defaults Loom on Restructured India Bank Debt

Titanic Defaults Loom on Restructured Bank Debt
A guard sits outside a Housing Development Finance Corp. (HDFC) bank branch in Jaipur, Rajasthan, India. Photograph: Sanjit Das/Bloomberg

India’s Kingfisher Airlines Ltd. escaped collapse in 2010 by restructuring 77.2 billion rupees ($1.4 billion) of debt it had run up buying airlines and adding routes amid the nation’s economic boom.

Less than two years later, the carrier controlled by billionaire Vijay Mallya was back in talks with creditors, while its net debt had increased by 9 billion rupees. The airline this month grounded its entire fleet after pilots went on strike to demand seven months of unpaid salaries, and was given time until the end of October by its creditors to submit a funding plan.

Kingfisher is among Indian companies resorting to an out-of-court loan-restructuring process that bankers and regulators say is too lenient on borrowers, leading to restructured debt that has more than doubled since March 2009. A fifth of the credit may sour as the economy falters and crimp profits at government-controlled lenders such as State Bank of India that account for three-quarters of the nation’s loans and deposits.

“No single lender can afford a large company going under, a la Titanic,” A.S.V. Krishnan, senior research analyst at Ambit Capital Pvt. in Mumbai, said in an interview last week. “Lenders have overdone restructuring, and it is coming to roost now on their balance sheets.”

Concern that the rise in restructured loans -- which give borrowers a moratorium on payments, longer maturities or lower interest rates -- will lead to deterioration in asset quality is weighing on the shares of state-run lenders this year, including Bank of India and Punjab National Bank. The six worst performers in 2012 on the Bankex Index, which tracks stocks of 14 Indian lenders, are controlled by the government.

Stressed Assets

The volume of loans that will be restructured may jump 71 percent in the year ending March 2013 to 2.05 trillion rupees from 1.2 trillion rupees a year earlier, according to estimates by Crisil Ltd., the Indian unit of Standard & Poor’s. That would mean 5.7 percent of India’s total bank loans will have been restructured over the two-year period.

Even with easier terms, borrowers have failed to make payments on 15 percent of these loans since 2009, a panel constituted by the Reserve Bank of India wrote in a July 20 report. The existing guidelines allow banks to restructure loans for debtors who don’t have viable plans to bolster cash flow, according to the report, delaying the inevitable collapse.

Companies may go on to default on as much as 500 billion rupees of restructured loans, Pawan Agrawal, a senior director at Crisil, estimated on Aug. 30.

The increase in the volume of restructured debt means that stressed assets, including restructured debt and gross nonperforming loans, may climb to a 12-year high of 11 percent of total loans for Indian banks in the year ending in March, Suresh Ganapathy and Parag Jariwala, analysts at Macquarie Group Ltd. in Mumbai, wrote in an Aug. 30 report.

‘Inevitable Downgrade’

India’s government-controlled lenders, led by Mumbai-based State Bank of India, the nation’s largest, and New Delhi-based Punjab National Bank, have the most at stake. The restructured debt probably would account for an average 8.5 percent of state-run lenders’ loans by the end of March, Macquarie estimated, based on Crisil’s forecast.

The restructured debt accounted for 5.92 percent of outstanding standard loans at state-controlled lenders as of the end of March, according to an Aug. 23 central bank report. The ratio was 1.08 percent on average for the biggest private-sector banks, including ICICI Bank Ltd. and HDFC Bank Ltd., and 0.14 percent for foreign lenders operating in India, the data show.

“Lenders are deferring the inevitable downgrade of many unviable accounts by restructuring,” Nitin Kumar, a Mumbai-based analyst at Quant Broking Ltd., said in a phone interview. “If the economic scenario worsens, a large portion of the restructured loans will turn bad.”

Credit Costs

Restructuring increases credit costs for lenders, which are required to set aside 2 percent of the value as provisions, compared with 0.4 percent for the original loan. New rules under consideration by the central bank would increase that to 5 percent, which may cut pretax earnings for state-run lenders by as much as 10 percent, according to estimates by Mumbai-based Edelweiss Financial Services Ltd.

More borrowers may default on restructured debt as the economy slows and companies struggle to raise funds amid the rout in capital markets and tightened credit from lenders. The slippage may climb to 20 percent because of the “aggressive restructuring” by state-run lenders and the faltering economy, Espirito Santo Securities wrote in an Aug. 30 note to clients.

Stalled Growth

The central bank on July 31 cut its forecast for expansion of India’s $1.8 trillion economy to 6.5 percent for the 12 months that began April 1. That would match last year’s pace, which was the slowest in nine years.

A squeeze on short-term financing has already exacerbated the pressure on power utilities run by regional governments. Last month, India’s cabinet intervened to rescue the largest electricity buyers, allowing them to raise rates and unveiling steps to reorganize their $30 billion of debt.

The slowdown also has led companies including GTL Ltd., Hotel Leelaventure Ltd., Hindustan Construction Co., 3I Infotech Ltd., KS Oils Ltd. and Jindal Stainless Ltd. to tap India’s voluntary debt-restructuring system.

The system, set up for large and mid-size companies in 2001 with guidelines issued by the central bank, allows borrowers to seek a moratorium on repayments, obtain new loans with extended maturities or lower interest rates, or swap debt for equity to avoid defaults.

Voluntary Program

The approval process for restructuring debt is set in motion by creditors who account for at least 20 percent of the loans. Each package can be implemented only after it wins the backing of lenders accounting for 75 percent of the debt, according to the Corporate Debt Restructuring Mechanism website. The process is overseen by a group of bankers, including the heads of State Bank of India, ICICI and Punjab National Bank.

The list of companies awaiting better terms for their loans at CDR Cell, the unit responsible for debt restructuring, is “a better indicator of the health of corporate India” than the banks’ reported bad-debt ratios, Hemindra Hazari and Manuj Oberoi, analysts at Nirmal Bang Group in Mumbai, wrote in an Aug. 21 note to clients.

CDR Cell received 433 requests for restructuring 2.27 trillion rupees in loans as of June 30, according to its website. That’s more than double the 958.2 billion rupees reported as of March 31, 2009. About 371.7 billion rupees in debt is in the final stages of being approved for restructuring, the data show.

‘Extraordinary Rise’

“We are seeing an extraordinary rise in the number and volume of loans being restructured,” Reserve Bank of India Deputy Governor K.C. Chakrabarty said in Mumbai Aug. 11. “It appears that the provisions of the corporate debt-restructuring mechanism have not been used very ethically and judiciously.”

Among the largest such transactions is a restructuring arranged by Mumbai-based Global Group, a provider of telecommunications infrastructure and network services.

The closely held company in December negotiated with a group of 25 lenders for 162 billion rupees owed by its GTL Ltd., GTL Infrastructure Ltd. and Chennai Networks Infrastructure Ltd. companies. Under the agreement, creditors would give up interest payments of 24 billion rupees. That was matched by the amount put up as a personal guarantee by Global’s controlling shareholder. Ramakrishna Bellam, a spokesman for Global Group, declined to comment on the restructuring.

Pending Restructuring

At State Bank of India, the volume of loans that deteriorated into bad debts during the first quarter climbed to a record 108.4 billion rupees, according to Mumbai-based Motilal Oswal Financial Services Ltd., more than double the previous three months’ 43.8 billion rupees. The gross nonperforming-loan ratio widened to 4.99 percent.

“We can only hope that the pain is behind us as far as asset quality is concerned,” State Bank of India Chief Financial Officer Diwakar Gupta said Sept. 24.

While the bank restructured about 5.6 billion rupees in loans during the three months ended June 30, matching the year-earlier level, almost 32 billion rupees in loans are awaiting approval at CDR Cell, Gupta said. About 20 percent of the bank’s renegotiated loans had soured by the end of June, he said.

Still, State Bank is in better shape than its smaller government-controlled rivals, according to analysts at Macquarie and Espirito Santo.

Oriental Bank of Commerce, based in New Delhi, has restructured as much as 8.3 percent of its total domestic assets since March 2010, compared with State Bank’s 1.7 percent, according to Saikiran Pulavarthi and Sri Karthik Velamakanni, analysts at Espirito Santo. At Mumbai-based Bank of India and Punjab National Bank, it was 6.7 percent, they wrote in an Aug. 30 note to clients.

Calls and e-mails to Oriental Bank Chairman and Managing Director S.L. Bansal, Bank of India CFO Gauri Shankar and Punjab National Bank Chairman K.R. Kamath weren’t returned.

Tightening Safeguards

The surge in restructured debt was triggered by one-time measures meant to help corporate borrowers and banks in the aftermath of the 2008 global financial crisis, according to the July 20 Reserve Bank of India report.

So-called restructured standard assets -- loans that have been renegotiated and on which borrowers are making scheduled payments -- climbed 77 percent over two years to 1.07 trillion rupees as of March 2011, surpassing gross bad loans of 940.9 billion rupees, the central bank panel reported. It didn’t provide more recent numbers.

“The data seems to suggest that restructuring on accounts is being resorted to, to avoid classification of accounts as nonperforming assets,” Chakrabarty told reporters.

Debt Limits

The panel recommended changes that aim to tighten safeguards against defaults for creditors while curtailing the “excessive risk-taking” and “lax business practices” by borrowers, according to the report.

In addition to increasing the provisions that banks must set aside for restructured loans to 5 percent from the current 2 percent, the panel also recommended introducing an unspecified limit on the amount of debt that can be swapped for equity at publicly held companies.

The debtor companies’ controlling shareholders, known in India as promoters, also should be required to contribute a minimum 15 percent of the reduction in value of the loans or two percent of the restructured debt, they said.

“The proposal is timely, as banks may end up restructuring more loans” in the two years ending March 2013 than they had in the previous 10 years, Ananda Bhoumik, senior director for financial institutions at Fitch Ratings India Pvt. and a member of the central bank panel, wrote in a July 25 note.

‘Slightly Excessive’

The recommendations face some criticism from bankers such as State Bank of India Chairman Pratip Chaudhuri, who described them as “slightly excessive” in an interview in Mumbai on Sept. 24. The central bank will determine the new guidelines after an analysis of comments from stakeholders, central bank Deputy Governor Anand Sinha said Sept. 6. The feedback period for the proposals ended on Aug. 21.

Proponents of tighter rules argue that investors and lenders would benefit from more transparency in asset quality.

“Treating restructured loans as nonperforming would help report the real credit cost of Indian banks and encourage them to price the risk into these loans more accurately,” Fitch’s Bhoumik wrote in the note.

Reduced Profit

The proposed increase in provisions may reduce pretax profit for state-run banks by as much as 10 percent, according to estimates from Nilesh Parikh, Kunal Shah and Suruchi Chaudhary, analysts at Edelweiss Securities in Mumbai. The worst-hit probably will be Indian Overseas Bank, Oriental Bank of Commerce, Union Bank of India and Punjab National Bank, while the impact for private-sector banks may be less than 1 percent, they wrote on July 20.

Indian Overseas Bank Chairman M. Narendra and Union Bank of India spokesman S. Aftab also didn’t return calls and e-mails seeking comment.

The current loan-restructuring process for large and mid-size companies arose from the Indian court system’s failure to handle company bankruptcies.

“The CDR Cell is the nearest approximation that India has to the Chapter 11 bankruptcy framework available in the U.S.,” State Bank’s Chaudhuri said in an interview in Mumbai on June 27. “Though the scenario isn’t ideal, we don’t have a choice but to work within the legal framework available to us.”

The differences between the two systems are significant for controlling shareholders. While a bankruptcy would wipe out equity owners’ investments, under India’s voluntary debt-restructuring program, they enjoy better protection.

‘Perverse Incentives’

If creditors are forced to write down debt by $100 million, the borrower’s controlling shareholder would be called upon to inject only $15 million of new equity capital. The contribution by the promoter can be made in the form of interest-free loans to the company or conversion of unsecured debt into stock, according to the central bank.

The current system creates “perverse incentives” by not inflicting enough economic pain on corporate owners, said Anish Tawakley, a Mumbai-based banking analyst at Barclays Plc.

Kotak Mahindra Bank Ltd., the only publicly traded Indian lender that hasn’t joined CDR Cell, said that the decision to stay out has helped to keep soured loans in check.

“We believe that if the loans go bad it is always better to accept them as a nonperforming loan and start working on recovering it,” Kotak Mahindra CFO Jaimin Bhatt said in an interview on July 19.

The lender, controlled by billionaire Uday Kotak, reported that 0.64 percent of its total loans had soured as of June 30, widening from 0.41 percent a year earlier.

Moral Hazard

Yes Bank Ltd., based in Mumbai, also has considered exiting CDR Cell, Chief Executive Officer Rana Kapoor said.

The central bank’s proposed changes are a “very good” development as they require owners to take a bigger hit, thereby ensuring a “serious commitment,” Kapoor said in a July 25 interview. The number of cases referred to CDR Cell probably will decrease after the new rules are in place, he said.

If banks use the corporate debt-restructuring mechanism to defer bad loans, it defeats the purpose of the system, Kapoor said in an interview.

The banks’ willingness to restructure loans without imposing substantial losses on shareholders “may be creating a moral hazard,” Tawakley of Barclays said in a phone interview.

“People know that you can take a risk and you won’t have to bear the costs of those risks as it will be borne by the banks,” Tawakley said.

Kingfisher Losses

Kingfisher’s Mallya, 56, founded the Bangalore-based company in 2005, naming it after his UB Group’s flagship beer brand. He then took on debt and switched strategies even as the carrier’s losses mounted. In 2008, the company completed a merger with Deccan Aviation Ltd., operator of India’s first low-cost airline.

Mallya said in a September 2011 letter to shareholders that banks had converted 30 percent of their outstanding loans into preferential and equity capital. Lenders were allotted 116 million shares at a price of 64.48 rupees a share on March 31, 2011, while the shares closed in Mumbai at 39.8 rupees apiece. The stock ended last week at 13.25 rupees.

In that round of debt restructuring, lenders had reduced Kingfisher’s interest rate by three percentage points to 11 percent, according to the firm’s annual report for that year.

Tougher Stance

Kingfisher’s financial woes continued even after the debt restructuring. In November, the carrier asked for another round of reductions in loan rates and an increase in credit limits to help meet operating costs and pay for fuel.

Kingfisher CEO Sanjay Aggarwal and spokesman Prakash Mirpuri didn’t return e-mails seeking comment. Mallya and UB Group’s CFO Ravi Nedungadi also didn’t reply to e-mails or return calls to their mobile phones.

The carrier had pledged its brand, a luxury villa in Goa, two helicopters, a Mumbai building and shares as collateral for bank loans of as much as 64.2 billion rupees as of Nov. 30, Junior Finance Minister Namo Narain Meena told lawmakers on Dec. 9. The total value of the collateral, including furniture and fixtures, was 52.4 billion rupees, he said.

This time, bankers are taking a tougher stance with the airline. State Bank of India sees “no room” for further lending to Kingfisher, Chaudhuri said in an Oct. 5 interview with Bloomberg TV India. The lender has already set aside provisions for its unsecured loans to the carrier, he said.

The airline has until the end of the month to provide a plan for an equity infusion to its banks, State Bank Managing Director A. Krishna Kumar told reporters in Mumbai yesterday.

‘Unchartered Territory’

On the same day, Kingfisher said it would extend the shutdown of its operations through Oct. 12. India’s aviation regulator is considering canceling or suspending the airline’s license, adding pressure on Mallya as he seeks investments to avert the carrier’s failure.

The carrier fell by the daily limit of about 5 percent for the eighth day in Mumbai trading to close at 11.40 rupees. It’s lost 46 percent this year, after plunging 68 percent in 2011.

The rating companies’ projections for debt restructuring aimed at such borrowers is “shocking,” said Hatim Broachwala, a Mumbai-based banking analyst at Karvy Stock Broking Ltd.

“We are treading unchartered territory with this unprecedented spike in restructured loans,” Broachwala said in a phone interview. “Nobody knows how much of this will go bad as the banks were very lenient. The regulator has to quickly come out with measures to disincentivize lenders from taking this escape route.”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE