How concerned are you about the indebtedness of companies that you have invested in? If you are wondering how you should determine the impact of COVID-19 on the debt servicing abilities of companies in your portfolio, you might find this article interesting!
With a few exceptions, coronavirus pandemic has affected the cash flows of all businesses, irrespective of their scale of operations. Their debt servicing ability will be largely influenced by the strength of their balance sheet and revival of business operations, going forward.
Now that the moratorium is over, it’s imperative for banks to swing into action, take appropriate steps to contain bad loans and yet lend without getting too risk averse. After all, an economic recovery at the current pace of credit growth would be a tall order.
The magnitude of the potential challenges is anybody’s guess at this juncture.
In a circular dated August 06, 2020, RBI communicated its intent to create a window under the prudential framework to allow banks to restructure corporate loans. On August 07, 2020 RBI appointed an expert committee seeking recommendations on financial parameters that shall be taken into account for restructuring loans.
A five-member committee headed by Mr KV Kamath presented its report recently. The report offers a restructuring framework for COVID-related stressed assets.
The committee has found that the on-going pandemic has affected even the best of companies. The total outstanding loan-book within the universe of companies which might qualify for loan restructuring is Rs 15.52 lakh crore. In an independent note released last month, India Ratings estimated that banks might restructure loans worth nearly Rs 8.4 lakh crore— close to 7.7% of the loan book of the entire banking system.
And let’s not forget this resolution plan excludes major borrowing groups such as financial institutions including NBFCs and MSMEs, else this number could be even bigger.
Further the K.V. Kamath Committee suggested five ratios to be used for the evaluation framework. They include:
1. Total Outside Liability / Adjusted Tangible Net Worth (TOL / Adjusted TNW)
2. Total Debt / EBIDTA
3. Current Ratio
4. Debt Service Coverage Ratio (DSCR)
5. Average Debt Service Coverage Ratio (ADSCR)
If you carefully observe, the above ratios complement one another. For instance, TOL/Adjusted TNW ratio helps determine the level of stress due to existing leverage. Importantly, it excludes intangible assets such as goodwill. This may reduce the chances of Kingfisher-like fiascos.
Ratios such as total Debt/EBITDA and DSCR give an idea about company’s liquidity position and ability to service debt obligations through its cash flows.
On the other hand, current ratio hints at the immediate stress—i.e. (in)ability to honour short term debt obligations—those falling due in the next one year.
KV Kamath committee has assigned different threshold limits for various sectors. For example, it has suggested that aviation sector companies shall have TOL/adjusted TNW ratio of less than or equal to 6 but a mining company shouldn’t have this ratio in excess of 3, and so on. The committee has allowed more lenient thresholds to companies engaged in commercial real estate. It has also specified timelines for achieving these ratios.
On the lines of KV Kamath committee recommended ratios, we analyzed NSE 500 companies to gauge the level of stress. Below is the list of companies that have witnessed a fall in the revenue in Q1FY21 and have also reported a net loss in the quarter gone by. They had a net Debt/EBITDA in excess of 4 as on March 31, 2020. If you observe carefully, some of them are already in the news due to their fragile financial condition.
If you have any of the above companies in your portfolio, you should carefully monitor their Q2FY21 numbers. Unless there’s a substantial improvement in the cash flows, their financial position is likely to be affected adversely. You see, ratios recommended by the K V Kamath Committee would not only help bankers but may act as a guiding force for investors as well.
COVID-19 might have affected good companies temporarily but it has possibly opened Pandora’s box. A whole host of companies that were facing some difficulties even during pre-COVID times might see their situation getting exacerbated.
Thus, you may now want to check not only the level of leverage on company’s books but may also take into account its liquidity position and the ability to service short term debt without any trouble.
You may also like to read: Will Indian banks pass the COVID-stress test?
Disclaimer
We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:
Consult your financial advisor before taking any investment decision.
We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflicts of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.
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