The amount is equivalent to an equity write-down of about 1.7% of the banks' risk weighted assets (RWA), and represents the loan haircut that banks may face to revive the financial viability of distressed accounts. Most exposures are treated as performing and carry minimal loan loss provisions.
The shortfall may increase the government's equity injection requirement from the INR700bn announced on 31 July 2015. The access to equity will be a critical input to Ind-Ra's rating of additional Tier 1 bonds, as these instruments carry loss triggers linked to the bank's common equity tier 1 ratio.
Ind-Ra has used present interest rates for the purpose of this analysis. If corporates are able to reduce borrowing costs by 100bp, the shortfall may reduce to INR760bn from the estimated INR1trn. While Ind-Ra's analysis indicates a potential haircut on a blended basis at around 23%-24%; banks may also consider a senior-subordinated structure for the current exposure. Under this, banks may decide to structure their exposure, particularly to infra projects, with 80% in senior debt (to be backed by cash flows) and the remaining 20% as subordinate debt (which can potentially get written off but at a later stage)
Ind-Ra analysed 30 large stressed corporates, each with individual bank debt of over INR50bn aggregating to about 7%-8% of the overall bank credit. Bank loans to all these corporates are accounted as performing (most of them figure as SMA1/SMA2 accounts). The power and other infrastructure sectors account for 50% of this exposure while the iron & steel sector accounts for another 32%. Aviation, ship-building, sugar and textile bring up the balance. These companies have seen a significant increase in their leverage over the last few years during a period with a weak operating environment. The median debt-to-equity ratio for this set increased to 4x-6x in FY15 from just under 2x in FY10 while the median market-cap-to-debt ratio contracted to 5%-7% from 35%-50%.
While most of these accounts could be the likely beneficiaries of The Reserve Bank of India's 5/25 scheme targeted at providing liquidity support, Ind-Ra's analysis attempts at estimating a viable leverage level for them. The analysis takes the current enterprise value for these corporates as a starting point and assumes a pick-up in the operating performance close to their respective peak capacity utilisation. This is to estimate the level of debt these corporates would be able to service even when the macro environment picks up.
The study reveals that banks would need a 24% reduction in their current exposure to ensure reasonable debt servicing (1.5x interest coverage) by these corporates on a sustained basis. For PSBs which have about 90% share of this exposure, this amount comes to around INR930bn or about 1.7% of their FYE15 RWA. Assuming the banks provide for this haircut either as a provision ramp-up or by building additional capital buffers, this exposure can add significantly to Ind-Ra's estimate of INR2.4trn of CETI needed for the Basel-III transition.
If we also include the seven distressed state electricity boards in this analysis, it would add another 30bp (of PSBs' RWA) to this estimate. We expect private sector banks and large PSBs to be better placed in handling potential credit cost hikes from these large stressed corporates, given their sufficient operating and capital buffers. However, mid-sized PSBs will be the most affected, given their thin operating margins and weak capitalisation.
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