All the companies presently under the SDR scheme are from capital-intensive sectors such as metals and mining, infrastructure and oil & gas with their FY15 EBITDA margins ranging between negative and 6%, consolidated debt levels of INR506bn and leverage levels above 100x. While the conversion of debt into equity would help underlying entities by lowering cash outflows on debt servicing, the long-term viability of the assets would critically depend on the extent of improvement in cash flows that can be achieved under the new management. However, low commodity prices will act as a significant constraining factor.
The agency has analysed four scenarios (break even, optimistic, most likely, and worst case scenarios) to understand the impact of SDR on the debt and market capitalisation of these entities. For banks to recover their entire debt and equity investment, revenue will have to grow by 2.5x and median EBITDA margins would have to reach 15%, leading to a leverage ratio of 4x, and the valuation multiple (enterprise value (EV)/EBITDA) will have to be close to 9.0x. Obviously, new buyers will be interested only if there are upsides to these assumptions.
In an optimistic scenario with assumptions similar to the break-even numbers except for the multiple being assumed at 6x, Ind-Ra estimates the residual debt, post conversion into equity by banks, would necessitate no reduction but a market cap of 40% of the book value. In the most likely scenario with revenue increasing 2x and median EBITDA margin of 10%-12%, total debt would need to be reduced by 34% from its par value while market cap would be 25% of the book value. However, in a worst case scenario (existing numbers showing no improvement), total debt would need to be reduced by 90% while market cap would be 95%-100% lower than the book value.
To recoup their equity and debt investments made in stressed assets, banks/financial institutions or potential investors will have to resort to write-offs. However, in all these assumptions debt levels have been considered to remain the same though they may increase with a ramp up in revenues. Liquidation values in certain cases may provide better realisation than on a going concern basis; alternatively, the value proposition to a buyer as part of the value chain could provide for higher valuations than presently assumed.
RBI introduced the SDR scheme in June 2015 where lending banks would invest equity in restructured loans with a controlling stake of 51% for the revitalisation of distressed assets. The assets acquired shall be assigned a 150% risk weight for a period of 18 months. Post 18 months, the lending banks would require selling off the assets and in the likely scenario, the capital allocated would in all probability fall short of the haircut required. The decision to convert the whole or part of the loan into equity shares should be approved by a minimum of 75% of creditors by value and 60% of creditors by number. The non-performing assets of scheduled commercial banks increased 26% yoy in June 2015 to INR3.30trn (4.99% of total advances) and 6.6% qoq. Also, restructured standard advances had increased during March 2015, pushing up scheduled commercial banks' stressed advances to 11.1% of the total advances from 10.7% in September 2014. Public sector banks recorded the highest level of stressed assets at 13.5% of the total advances as of March 2015, compared with 4.6% in the case of private sector banks.
The full-fledged implementation of the SDR scheme will take significant time given the sluggish regulatory system. However, to make these assets viable a significant debt reduction and infusion of additional equity would be warranted to improve their capital structure. While SDR could provide an opportunity to correct issues relating to management and business, in the interim, absence of direct control on operations could lead to dissatisfaction for minority holders and could be counterproductive to companies' operations.
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