Crisil’s analysis shows banks may have to take a haircut of 60%, worth Rs 2.4 lakh crore, to settle 50 large stressed assets with debt of Rs 4 lakh crore. These 50 companies are from the metals (30% of total debt), construction (25%), and power (15%) sectors, and account for half of the Rs 8 lakh crore non-performing assets (NPAs) in the banking system as on March 31, 2017.
 

Crisil estimates banks have provisioned for ~40% of this exposure.
 

“We used the economic value approach to assess the haircuts,” said Pawan Agrawal, Chief Analytical Officer, Crisil Ratings. “This is a combination of market value multiples and cash flow estimation. The final haircut, however, will also be influenced by the expectation of lenders, valuation of subsidiaries, and the price outlook for commodity-linked sectors.”
 

The sources of stress are policy or demand (power plants), lower capacity utilisation (steel plants), and over-leveraged balance sheets (construction companies).
 

The restructuring tools facilitated by the Reserve Bank of India (RBI) that the indebted companies had availed of earlier did not help because of very high debt levels that underscore the magnitude of stress.
 

The government recently promulgated an ordinance empowering the RBI to issue directives for faster and optimum resolution of stressed assets so that they become viable. The focus now is on optimum debt reduction including through potential transfer of assets to a different management that can bring in the resources needed to scale up cash flows.
 

Crisil has classified the haircuts into four categories – marginal (<25%), moderate (25-50%), aggressive (50-75%), and deep (>75%). A quarter of the debt analysed needs marginal or moderate haircuts, while a third needs aggressive, and nearly 40% deep haircuts.
 

“Companies from the power sector would require moderate haircuts, while those from the metals and construction sectors would need aggressive ones,” Agrawal said.
 

Majority of the debt requiring deep haircuts belong to companies with unsustainable businesses so asset sales are necessary to recover monies. Companies needing moderate or aggressive haircuts had gone for debt-funded capex but then demand slumped or had projects that ran into regulatory issues leading to significant time and cost overruns that made them unviable. Companies needing marginal haircut are those facing temporary setbacks, which could be corrected over time.
 

Says Ramesh Karunakaran, Director, Crisil Ratings, “Some of these assets offer M&A opportunities for companies with strong credit profiles. Also, potential synergies could allow for a significant reduction in haircut – an aspect that has not been considered in our analysis.”
 

Crisil believes it would be in the larger interest of the economy to pop the bitter pill of a haircut than kick the can down the road.