The Approach: Coverage of 3+2 financial ratios and 26 sectors
The scheme is limited to Covid-19 impacted borrowers, remaining standard as at 1st March 2020, and not for accounts in SMA-1&2 categories before enforcement of economic lockdown. It considers differentiated approach for sectors – partially impacted & heavily impacted, leaving out borrowers that wouldn’t need restructuring support remaining unaffected during lockdown phase. Financial ratios are diluted in 2-phase approach (a) ability to meet enhanced debt servicing phase by FY22 (b) retained cash to reduce debt leverage by FY23. Needless to say, it’s common sense & practical approach without going big-bang while seeking banking sector support with higher risk assumption during this stop-gap arrangement.
Financial Ratios: Combination of sustainability and continuity
The two phase approach is to give one final opportunity to impacted borrowers to sustain in business through lenient liquidity ratios (on Current Account) for adjustment of cash erosion and to enable to stay in business. The 3 ratios are Current Ratio, Debt Service Coverage Ratio and Average DSCR. This would need to take into account deferred payment dispensation of obligations due from 1st March to 31st August 2020 for repayment on or before 31st March 2021. If the borrower’s business stays sustainable and afloat by March 2022, then the other 2 ratios for continuity in business will kick-in, namely Total outstanding liabilities to adjusted tangible net worth and Total debt to EBITDA. All looks well on paper, will the scheme turn effective or go behind as another well-intended attempt?
Cash flows irritants in Phase I for migration to Phase II? Will assumptions stand valid?
It’s good to assume that one-third of economic capacity is in business as usual mode, which includes agriculture & allied businesses and those that engaged in critical & essential services got benefited from Covid-19 impact. Out of remaining 65%, it’s possible that 15-25% can fend for themselves without getting into rigmarole of restructuring exercise, bringing the focus to 40-50% of borrowers in the wholesale segment, while it could be 50-65% on retail, MSMEs and high risk sectors of real estate, infrastructure, transport, tourism, hospitality etc.
It will be wishful to assume that all that begins well will end well, more so when the start is loaded heavily on optimistic assumptions and adjustment of carry-over baggage of lockdown impact. There will be need to work backwards to make the restructuring process work for most borrowers to turn this as meaningful exercise, to avoid spike in NPA numbers – gross & net and low PCR. Once the restructuring terms is agreed, execution becomes major challenge when none is sure of estimate of FY21 GDP target and time of worst behind on C-19 and the system is preparing for living with Covid to avoid elongated lockdown that would harm the economy beyond repair. So, there’s big uncertainty to get comfort that borrowers that have gone into restructuring phase would be firm on feet till end of FY22. At this point, it doesn’t make sense to go into the merit & demerit of set limit on the 3 sustainability financial ratios.
The most critical ratio (at start and beyond FY22) is Total Outside Liabilities to Adjusted Tangible net worth. It’s make or break determinant factor. It’s the ability & capacity of the borrowers to bring cash despite the long rope provided in the scheme for sectors that are in verge of collapse. The elevated ratios also make the lenders taking high risk exposure than the promoters – kind of “heads I win – tails you lose” in favour of equity holders for peanut fixed rate return for lenders. The next ratio of Total debt/EBITDA is 2nd step to ensure continuity, whether the company can sustain profitability growth to repay principle & interest, which is not easy task when total outside liabilities is high to cover higher interest obligations.
What’s the take-away?
To be frank & realistic, there’s nothing optimism to cheer about when loaded with high execution and performance risk. There’s no clarity on the quantum of the portfolio (across sectors and size) that would go under the process. There’s no comfort on how many will get through to Phase 1. Need to stay fingers crossed till the process is behind, on or before 31st December 2020.
Concluding part: Ball pushed to taxpayers
Will the Government step in to “credit underwrite” to bridge gaps on risk assumption by lenders? So, back to the concept of “Bad Bank” to make the reconstruction scheme work?
What matters is the end result, not the intent and efforts!
Let’s hope for the best!
Moses Harding
