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The Insolvency and Bankruptcy code (IBC) has been a landmark legislation which completed two years in December 2018. ICRA notes that the IBC’s success has been a mixed bag so far. While it was a much-needed legislation to resolve the growing non-performing assets (NPA) in the banking system, the implementation has faced several challenges owing to the lack of adequate infrastructure to handle the increasing number of cases referred to the National Company Law Tribunal (NCLT) and the inability to honour the timelines, primarily because of the litigations resorted to by various stakeholders.

As per ICRA analysis, as on December 31, 2018, 898 cases were awaiting resolution under the corporate insolvency resolution process (CIRP), an increase from 768, as on September 30, 2018. Almost 68% of the cases exceeded the 270-day timeline allowed under the IBC, and even for the 12 large defaulting accounts identified by the RBI in June 2017, only five have been resolved so far. On the positive side, the Supreme Court has recently upheld the validity of the IBC in its entirety.

We also look at the Monetary Policy announced in February. The 25-basis points rate cut by the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) is aimed to boost growth as inflationary indicators continued to remain benign. However, ICRA believes that the transmission of the policy rate cut through lower bank lending rates may be delayed, given that banks would not be able to reduce the rates until their own deposits become cheaper. It may be highlighted that the credit-to-deposit ratio of the banking system touched a high of 78.7% as on December 2018. Also, increased competition in the sector leading to faster transmission of rate cuts, can, in ICRA’s opinion, happen only when more PSBs exit the prompt corrective action (PCA) framework and the NBFCs have access to adequate funding at reasonably competitive interest rates.

Lastly, we examine the prospects of the construction sector which looks favourable, given the Government’s focus on infrastructure development, which has resulted in a sizeable boost to the order book of most construction companies. Within the overall space, ICRA’s analysis indicates that mid-sized companies, with operating income of between ₹ 100 to ₹ 500 crore, are growing at a faster rate because of relatively lower leverage and lesser legacy issues. At an aggregate level, the credit metrics of a majority of the companies showed improvement, which is also reflected in a higher credit ratio (defined as the number of rating upgrades to downgrades) However, we note the challenges arising from high capital intensity in the business and the ability to secure bank guarantees required for supporting the increasing scale of operations, remain.

The issue concludes with the regular features: monthly rating updates, upcoming ICRA events, and news features related to the company.

I hope you will find this newsletter useful and informative.

Best Regards

Anjan Ghosh
Chief Rating Officer, ICRA Ltd

 
 
  From ICRA Research
   
  Transmission of Policy rate cut through lower bank lending rates may be delayed
 

karthik The 4:2 vote in favour of a front-ended 25-bps rate by the Monetary Policy Committee(MPC) of the Reserve Bank of India (RBI) accorded greater focus to growth in the last bi-monthly MPC statement of FY2019 as inflationary indicators continued to remain benign. While the RBI expressed hope that banks would pass on the benefit to the borrowers, which can boost investments and private consumption, we believe the transmission as in the past would happen only with some lag. The lending rates of the banks are outcome of their own borrowing costs, primarily the deposit costs and unless their deposit become cheaper, it may be difficult for banks to reduce their lending rates. Accordingly, borrowers may need to wait for cuts in benchmark lending rates of the banks and lower EMIs.

For the nine-month ending December 2018, the incremental growth in bank deposits stood at ₹ 3.43 lakh crore as against an incremental credit growth of ₹ 6.75 lakh crore and the credit to deposit ratio of the banking system touched a high of 78.7% as on December 2018 as against 74% in March 2018. The pace of deposit accretion with banking system at 15.1% y-o-y as on December 2018 has not kept pace with credit growth of 15.1% over the same period. To improve transmission of policy rates, competition among various lenders needs to be increased, which can happen when more PSBs exit the prompt corrective action (PCA) framework and non-banking financial companies (NBFCs) have access to adequate funding at competitive rates. With some of public sector banks (PSBs) coming out of PCA framework, cleaning up of balance sheets of many other PSBs, the competition in both lending as well as deposit activity is expected to place an upward bias on deposit rates rather than a reduction and cut in lending rates will mean sacrificing profit margins.

Given the need and relevance of NBFCs for the Indian credit markets and improving their access to funds, the measure to align the of the risk weights for bank exposures to NBFCs (excluding core investment companies) on their external is a step in right direction. We estimate banks’ exposure to NBFCs at ₹ 5.7 lakh crore of which exposure to asset finance companies, infrastructure finance companies and infrastructure debt funds is already risk weighted based on their ratings. Based on our assessment, the revision in risk weights on exposure to NBFCs should help banks release capital of nearly ₹ 125 billion (estimated at around 0.125% of risk weighted assets) which now can be used for incremental lending or bolster the existing capital ratios. While incremental credit supply for NBFCs is expected to improve, reduction in rates would depend on banks willingness to do so. Accordingly, unless NBFCs can avail fresh funding at competitive rates, their ability to lower the lending rates for end borrowers may remain constrained.

To ease out liquidity deficits and prevent a sharp rise in interest rates amid the overhang of high borrowing programmes of the Central and state governments, the RBI has been involved in largescale open market operations and has been purchasing government securities worth ~₹ 2.75-lakh crore during April-February 2019, however, the liquidity conditions have continued to remain in deficit mode since June 2018. Attracting foreign flows and easing liquidity conditions are some of the factors that can support the lower cost of funds for banks and NBFCs and support their abilities to reduce their benchmark lending rates. Sans this, another rate cut may not result in reduced borrowing costs.

With India entering an uncertain election cycle, foreign investor demand will also remain muted until there is clarity on the next government and its likely macro-economic policies. Hence, despite, a general wave of bullishness towards emerging market assets on the softening stance of the US Federal Reserve, India is unlikely to be a key beneficiary till at least May 2019. Nonetheless, the change in stance to ‘Neutral’ from ‘calibrated tightening’ would aid the RBI to cut rates again next fiscal if the inflation estimates for FY2020 remain under 4%.

However, given a divided vote and the impending general elections, we expect the MPC to adopt a wait-and-watch approach and assess the data related to agricultural output from the rabi harvest, the monsoon forecast, and fiscal policies adopted by the new government before any further rating action.

  Healthy order book enthuse mid-sized construction companies
 

Construction players are in for better times with significant opportunities ahead, supported by the Government’s push towards infrastructure development projects. While the general elections in 2019 can result in some short-term disruptions in the awards, the trend is expected to remain positive over the medium term. As per an ICRA note, the last three to four years have witnessed a quantum increase in the infrastructure capital outlay, particularly in the roads, railways and the urban infrastructure segments, and this is likely to continue over the medium term. This has boosted the order book of the construction companies significantly, with most having an order book of over three times last year’s operating income. With the expected strong focus on infrastructure development by both the Central and the state governments, the construction companies should continue to see a healthy influx of new orders.

Several mid-size construction companies (with operating income between ₹ 100-crore to ₹ 500 crore) have grown at a faster rate than the large construction companies supported by increased opportunities, relatively lower leveraged balance sheet and lesser legacy issues. With the improvement in operating performance of the construction companies, including healthy growth in operating income, and increase in operating profitability, the credit metrics of majority of companies has witnessed a gradual improvement. This is also reflected in the higher credit ratio (ratio of number of rating upgrades to number of rating downgrades) for the sector which has been close to 1.2x in the last three years. The average credit ratio between FY2015 to four months of FY2019 stood at 1.2x, which is a significant improvement from the average of 0.4x between FY2011-FY2014.

In comparison with the credit profile of large construction companies, many mid-sized companies exhibit better coverage ratios because of lower debts in their books. As these companies have been focussing only on the construction business, the requirement is limited to working capital debt and equipment loans, compared to their larger peers, which have also ventured into developmental space like build-operate-transfer (BOT) projects, thereby blocking a part of the capital available for the construction business, resulting in higher leverage. Nevertheless, scale, regional concentration, and financial flexibility remain a challenge in comparison to the large construction companies which have better access to funds as well as credit terms. Apart from this, for mid-sized construction companies, availability of non-fund-based limits (primarily bank guarantees or BG) also is a constraint as with high growth in scale of operations, the BG requirement has also gone up considerably, however, the availability of the same and the company’s flexibility to provide sufficient collateral/margin money remains a challenge.

ICRA notes that a gradual improvement in the credit profile of construction companies, particularly the mid-size companies, is visible, many of which are graduating from sub-contractors to main contractors. Their focus on the core construction business, and taking on projects in geographies which are in proximity to their base, support execution.

On the flip side, the mid-sized construction companies remain exposed to challenges. With growth in operations, many companies plan to enter or have recently entered into asset-owning space, which being capital intensive can impact their balance sheet and liquidity positions over the short-to-medium term. Further, with the increasing scale of operations the working capital requirement, including BGs, could also become a key challenge for players, and constraints on banks to increase exposure to the sector.

  IBC’s timelines for corporate insolvency resolution process remain unmet still
 

The Insolvency and Bankruptcy Code (IBC) recently completed two years in December 2018. Looking back at the two-year journey, it can be observed that while on the one hand, the number of cases being admitted for the corporate insolvency resolution process (CIRP) have continued to grow quarter-on-quarter, the timely closure of CIRPs getting delayed due to various reasons and the number of CIRPs outstanding have only risen on the other. As per ICRA analysis, as on December 31, 2018, 898 CIRPs were awaiting a resolution as against 768 CIRPs as on September 30, 2018. The number of CIRPs outstanding are expected to only increase further at least for the next few quarters until adequate steps are taken to ensure that the CIRP does not significantly exceed the 180/270-day timeline prescribed under the IBC. Up to December 31, 2018, 79 CIRPs had yielded a resolution plan while 302 cases had entered into liquidation, which is a very high proportion. Even the CIRPs that are eventually yielding a resolution plan are witnessing an increase in the duration between the commencement of the CIRP and the final approval from the National Company Law Tribunal (NCLT).

Almost 68% of the cases exceeded the 270-day timeline allowed under the IBC. Furthermore, CIRPs which concluded in the quarter ending December 2018 took an average duration of 354 days compared to 340 days taken for CIRPs concluded in the quarter ending September 2018. Not only is the time being taken much greater than that allowed under the IBC but is also significantly higher than the time that was being taken a year back. The CIRPs for the pending seven corporate debtors from the RBI’s initial set of 12 large defaulter cases identified in June 2017, which are still on-going, have seen the average duration of the process now exceed 500 days, which does not help the investor sentiment. As per our estimates, the timely conclusion of CIRPs of these pending entities could have brought in an additional ₹ 650~670 billion to the financial creditors, which is equivalent to about 6.5% of the gross NPAs in the banking sector. This is a sizeable figure when we consider that the 79 CIRPs that have yielded a resolution plan so far have helped the financial creditors realise an aggregate amount close to ₹ 650 billion, to be received either upfront or in a staggered manner.

Further, the haircuts taken by the financial creditors have also seen a mixed trend, depending on the present state of the respective industry, the relative health of the corporate debtor’s assets and the willingness of the applicant to enter a particular geography etc. The haircuts have been as high as 94% for certain corporate debtors, while in some other instances, there have been no haircuts realised by the financial creditors. On an average, the financial creditors have taken a haircut of 52%.

ICRA notes that the delay in the CIRPs for the large-scale entities is even more astonishing. Of the 12 large defaulting accounts identified by the Reserve Bank of India (RBI) in June 2017, only four have had resolution plans approved and one entity entered into liquidation. The fate of the remaining seven entities remains unknown as their CIRPs have been delayed due to multiple factors such as late bids by resolution applicants, varied interpretation of Section 26A on the eligibility of applicants, challenges made by original promoters, challenges by the operational creditors etc. Even amongst the completed CIRPs, one corporate debtor (namely, Amtek Auto Limited) faces an uncertain future as the successful resolution applicant (Liberty House Group) failed to make the necessary payments as per the resolution plan, and the matter is thus being taken up with the NCLT once again. The delay in the CIRPs is also pushing lenders to look at outright sale of their loan exposure, with the State Bank of India recently willing to auction its loan exposure to Essar Steel Limited, and thus even take a higher haircut rather than wait for the CIRP to get completed.

It is nonetheless encouraging to note that despite the elongating period of concluding the CIRP and arriving at a resolution, the operational creditor continues to take the lead in triggering the CIRP. Of the total cases admitted up to December 31, 2018, the operational creditors had referred 50% of them, while the financial creditors had referred 38% of the cases with the remaining referred by the corporate debtor itself. In addition, the introduction of Section 12A to the IBC in August 2018 that allows for withdrawal of the corporate debtor from the CIRP with at least 90% vote of the Committee of Creditors (CoC) is a positive step to achieve a speedier closure when a corporate debtor is in a position to repay its outstanding dues. Up to December 31, 2018, already 63 CIRPs achieved closure under Section 12A. Also, in a recent ruling, the Honourable Supreme Court has upheld the ban on promoters’ bids for the defaulting company undergoing the CIRP would also help in providing more clarity regarding Section 29A of the IBC.

ICRA notes that the IBC’s success has been a mixed bag so far. While its constitutional validity itself was recently challenged, the Honourable Supreme Court has upheld the validity of the IBC in its entirety, in a recent important judgment, thus cementing the need and importance of the Code in the country. While the IBC undoubtedly was a much-needed piece of legislation to resolve the growing non-performing assets (NPA) crisis in the country, the fructification of its vision has faced challenges owing to lack of adequate infrastructure to handle the ballooning applications filed to the NCLT and the inability to honour the timelines mentioned in the Code, primarily due to litigations resulting in a lengthy judicial process. It remains important that adequate steps are taken to ensure that the CIRP does not significantly exceed the 180/270-day timeline prescribed under the IBC, else the number of ongoing CIRPs is likely to increase further.

     
 
           
 
   
Rating Updates for the month of January 2019
   
Upcoming Events
February, 2019: ICRA Conference on Indian Corporate Sector
February, 2019: ICRA Conference on Indian Auto Component Industry
February, 2019: Webinar on Two-Wheeler Industry; trends and outlook
February, 2019: Webinar on Trends and Outlook on Indian Aviation industry
ICRA in News
Financial Express: 16th February, 2019: Sugar MSP Hike To Improve Mills Profit Margins By 6%
Hindu Business Line: 15th February, 2019:Revenues of Auto parts cos to grow 125 over four years
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