Edward I Altman, Professor-Emeritus, NYU Stern School Of Business (Courtesy: Peter Foley/Bloomberg)

Bankruptcy Expert Edward Altman Says It’s Too Easy To Get A High Credit Rating In India

In the midst of India’s struggle with large-size bankruptcies, including recent ones emerging from AAA-rated firms, comes a warning. It is too easy to secure a high credit rating in India which can mislead investors, said Edward Altman, creator of the Altman-Z score for predicting bankruptcies.

Going by the Altman-Z score, India’s 10 largest stressed companies would not have qualified for more credit at least two to three years before they went in for resolution under the Insolvency and Bankruptcy Code, Altman, professor emeritus of finance at New York University’s Stern School of Business, told BloombergQuint in an interview.

Size is not a proxy for credit worthiness. I think there is an issue in India where it is too easy to get a AAA and AA rating. The financial community, investors, maybe even banks, are being misled by those high ratings. The system has to understand why we have so many AAA and AA bonds and relatively high number of bad loans.
Edward Altman, Professor Emeritus of Finance, Stern School Of Business

While India has good models to predict default and good credit analysts, their voice is often not heard, Altman said.

Indian banks are sitting on more than Rs 10 lakh crore in bad debt, a large proportion of which is being resolved under the IBC. In recent months, credit markets too have been rattled by defaults and credit weakness in companies that have large amounts of outstanding bonds.

India’s struggles with bad debt are typical of emerging economies which have been growing fast for an extended period of time, said Altman. High growth rate ensures easy credit availability for companies, even when their fundamentals may not have been sound.

In 1968, Altman first published a paper after having developed the Z-score, modeled around predicting probability of bankruptcies in companies in the United States. More than 50 years later, he is now in India, looking at developing a local version of the score to help banks take better credit decisions.

Assessment Of India’s Bankruptcy Code

The Indian bankruptcy law, which came into existence in 2016, is currently grappling with judicial delays in concluding the process within the 270-day timeline.

Of the 12 large corporate accounts that were slotted for insolvency proceedings in June 2017, only three have been successfully resolved. Altman said that delays in resolution and a high rate of failure is to be expected in a new law. However, Altman said that he was surprised with the high proportion of cases where liquidation has been initiated.

Data collated by the Insolvency and Bankruptcy Board of India (IBBI) showed that 1,484 companies had been admitted for insolvency proceedings as of December 2018. Of these, 302 companies had received liquidation orders from the National Company Law Tribunal (NCLT), while only 79 had seen successful resolution, while 63 accounts were withdrawn due to settlements with creditors.

Keeping Defaulting Promoters Out

Following an amendment, the IBC does not permit defaulting promoters to be part of the bidding process until they repay their dues.

Altman thinks this approach is justified. According to him, these promoters had already displayed their inability to run their companies successfully and that it is only fair that they make way for new management.

Our experience has shown that very rarely does the owner of a company who was responsible for the financial distress in the first place have the ability to turn around the company and take control after it goes bankrupt. Let’s face it, they have proven in the past that they are incapable of running the company. Why give them a chance again? It also alleviates the problem of going bankrupt on purpose to get the company back at a much cheaper price and get rid of a lot of debt.
Edward Altman, Professor Emeritus of Finance, Stern School Of Business

India Needs A Distressed Debt Market

Altman believes that India desperately needs a strong distressed debt market, which could help better deal with the problems on bank balance sheets. A healthy distressed debt market could help banks offload stressed assets from their books and free up capital for more efficient lending.

“Set up war rooms for sharing information, have local people act as advisers to the investor and have a fair amount of pressure on banks to liquidate those loans even if they feel that the price is a hard pill to swallow. In the long run the bankers will be better off. Even if they take an initial hit, they can reinvest the amount in new loans with hopefully better credit assessment tools and move on,” Altman said.

One possible innovation could be to allow banks to participate in the upside after they have sold the loans to a distressed asset fund, he added. If the fund is able to make more money a few years down the line, a small percentage of that upside could be shared with the banks. “This would encourage banks to be more transparent while the sale process is going on,” Altman said.

While many international distressed funds have shown initial interest in India’s pool of stressed loans, not many have actually purchased these accounts from bankers.