Steel works operated by Tata Steel in U.K. (Photographer: Chris Ratcliffe/Bloomberg)

The Rs 1.25 Lakh Crore Loan Restructuring Dilemma

Banks are sitting in wait. At stake is more than Rs 1 lakh crore in loans. All given to iron and steel companies. A large part of this is now unsustainable due to cost overruns and the increased cost of raw material supply, complicated by an environment of weak global demand.

As banks await a new set of restructuring rules from the Reserve Bank of India, the first chunk of loans that lenders will try and restructure are those given to steel companies.

This could mean more than Rs 1.25 lakh crore in loans will be considered for restructuring should these companies be able to meet the recast criteria laid down by the RBI.

Among the largest loans that will come up for restructuring include those given to companies like Essar Steel Ltd., Bhushan Steel Ltd., Jindal Steel and Power Ltd. and Electrosteel Steels Ltd. – all of whom are looking for relief. Some have already reworked part of their debt under existing schemes like the 5/25 provision introduced for infrastructure projects but are looking to restructure further if easier provisions are introduced.

Current restructuring rules under the Scheme for Sustainable Structuring of Stressed Assets say that bankers can convert roughly half of this debt into equity-linked instruments (the part deemed as unsustainable) while companies need to continue servicing the other half of the debt through existing cash flows. However, the cash flow position of most of these companies is not good enough to support even half the debt. This has prevented banks from restructuring these accounts so far.

What The S4A Rules Currently Say?

  • S4A requires that at least 50 percent of the company’s debt should be seen as sustainable
  • The sustainable part of the debt should be serviceable with existing cash flows
  • The RBI did not allow any rescheduling of the sustainable portion of the debt
  • The unsustainable part of the debt should be converted into long term equity-linked instruments

If rules are eased and banks can restructure the sustainable part of the loans or the mandatory proportion of sustainable loans is reduced, restructuring proposals for these loans will once again come up for discussion.

More than 30 percent of the loans given to iron and steel companies had turned bad as of March 2016, according to the RBI’s financial stability report released in June.

“We are waiting to see what kind of restructuring is allowed,” said Nitin Johri, chief financial officer at Bhushan Steel while adding that some form of restructuring is essential for the steel industry at this stage.

“You need a combination of financial restructuring and government support to revive the industry. There is no other option. This is not one or two companies we are talking about. The pressure is being felt across the industry,” said Johri.

Jindal Steel and Power has restructured a large part of its debt under the 5/25 scheme and is in advanced stages of discussions for restructuring the balance debt in the coming months, said Ravi Uppal, managing director of JSPL in an emailed response.

Essar Steel is in the process of submitting a restructuring proposal under the S4A scheme to its lenders, said a spokesperson for the company in response to an email.

Each company argued that there are enough reasons to believe that a restructuring of these loans will mean sustainable improvement in the health of the industry rather than just provide short-term relief.

History suggests otherwise.

Back To The Future

This is not the first time that India will see a large-scale restructuring of steel credit.

Back in 2002-03, several steel companies were admitted to the corporate debt restructuring (CDR) cell. The RBI’s annual report of 2002-03 shows that 8 steel accounts with outstanding loans of Rs 28,000 crore were admitted to the CDR cell that year. At the time, a combination of low international prices, sluggish domestic demand and overcapacity had forced bankers to restructure and offer a life-line to these companies.

The situation now is similar, only more acute.

Overhang of excess capacity continues to put pressure on the global steel sector. There was massive capacity addition, largely in China during the 2000s. China’s domestic steel consumption lags behind its production share of almost 50 percent of global output. Slowdown in Chinese steel consumption without a corresponding fall in production has led to its surplus steel chasing global markets.
Anjani K Agrawal, Partner and Global Steel Leader, EY

As cheaper imports from China flooded the Indian market, the government stepped in by imposing a minimum import price on steel products. This has helped domestic producers stabilise, said Agrawal while adding that fresh concerns like an increase in coking coal prices and other inputs will limit margin expansion.

According to Agrawal, the global demand-supply situation is unlikely to improve soon due to sluggish global growth, which means that some form of trade protection measures are likely to stay in place to support the domestic steel industry.

Top steel sector executives share that view.

Weakness in investment globally continues to hold back a stronger steel demand recovery. However, a better than expected forecast for China, along with continued growth in emerging economies, will help the global steel industry move back to a positive growth path for 2016 and onwards. We expect this slight growth momentum to remain weak for the time being due to the continued rebalancing in China and weak recovery in the developed economies. Downside risks to this outlook come from the high corporate debt and the real estate market situation in China, Brexit uncertainties and possible further escalation of instability in some regions.
TV Narendran, Managing Director, Tata Steel (In October 11 Edition of World Steel Outlook Report) 

Unsustainable Business Economics

It would, however, be wrong to blame the mess in the steel sector only on global factors.

Despite certain inherent advantages India has, structurally, the steel industry has some challenges during slow economic growth, noted Agrawal.

It takes roughly Rs 5,000-6,000 crore to put up a one million tonne steel capacity in India. But the industry has a low ‘capital turnover ratio’ which means that the amount of revenue generated per unit of capital is low.

This low capital turnover ratio, coupled with the high cost of capital in India, leads to very high fixed cost burden that must be recovered by running to full capacity, explained Agrawal. This incentive to produce, at times of weak demand, further depresses price realisations and margins.

In addition, delays that plague many projects in India have also hurt steel firms which find it difficult to stick to the debt repayment schedule if commercial production is delayed.

To top it all, there have been concerns that many steel firms in India have been “gold plating” their projects to show inflated costs which allows them to borrow more and use those funds in other ways, said an industry expert who declined to be identified.

Does It Make Sense To Restructure?

Given these concerns, the question is whether it will make sense for banks to restructure a huge quantum of steel sector loans?

Rakesh Arora, managing partner at Go India Advisors and a long-time watcher of the metals sector says the big question is how much of this debt is sustainable.

Given the economics of the business, only about 30-40 percent of the loans given to many steel firms would be sustainable. This means that banks would ideally need to take massive writedowns on this debt.
Rakesh Arora, Managing Partner, Go India Advisors

Banks could get some relief if the RBI allows banks to extend the tenure of debt.

“The economic life of a steel asset is long. If for the techno-economic viability (TEV) study required under S4A scheme, some extension of tenure is permitted to address the immediate cash flow cycle, the sustainable part of the debt may rise and then banks can potentially benefit from a reduced write downs in value of their portfolio” said Vijay Pasupathy, director of transaction advisory services at EY.

The one difference this time around is that banks have the option to a convert a chunk of the loans (50 percent under current rules) into equity-linked securities. This will do two things – give banks greater say in the company’s operations and allow them an upside should the company turn profitable by the time they exit.

The flip side to this is that there would be massive dilution of the existing shareholders. That would raise the question of who will run these companies, said Arora.

“The best option is to take a writedown and sell it to a credible buyer. But that is not happening,” he added.

De Facto Nationalisation Of Steel Industry?

A final option, and one which the finance minister is considering, is asking public-sector undertakings (PSUs) to run these steel companies till a buyer is found.

Following a meeting between top bankers and PSU chiefs on October 24, Finance Minister Arun Jaitley said the government is looking at ways for PSUs to manage stressed assets as an interim solution until a buyer is found. Chiefs of PSUs, including Steel Authority of India Ltd., were present at the meeting.

“The concerned secretaries have been asked to coordinate between the banks and concerned PSU heads…I think they will start immediately,” Jaitley said.

This would essentially mean nationalisation of these steel assets since state-owned banks would own a large part of the equity and a PSU (such as Steel Authority of India) would run the operations...The positive part of this plan is that the issue of credibility of these deals will get addressed.
Rakesh Arora, Managing Partner, Go India Advisors
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