New accounting standard may hit banks' lending to infra, realty firms

Switch to IndAS may increase debts on the books of firms

The adoption of the new Indian Accounting Standards (IndAS) might compel banks to cut down on the quantum of loans they dole out to companies. 

IndAS will result in a change in the debt-to-equity ratios of companies as capital structures and financial instruments get reclassified, increasing debts and compelling banks to reassess the way they lend to companies, particularly in sectors such as power, infrastructure and real estate.  

“Banks and financial institutions will have to consider how IndAS has potentially changed the balance sheets of companies and relook at the way they review a loan application, test loan covenants and evaluate restructuring proposals,” said Ashish Gupta, director, Grant Thornton Advisory. 

According to Sai Venkateshwaran, partner and head-accounting advisory services at KPMG India, several companies in sectors such as power, infrastructure and real estate use structured instruments for their funding requirements ranging from simple preference shares to more complex instruments, and most, if not all, of these instruments will be classified as debt/liability under Ind-AS, rather than equity/share capital. This will impact both the debt-equity ratio, as well as the finance costs and the resultant earnings per share. 

Companies in these sectors also operate using a number of special purpose vehicles (SPVs), and the new rules on consolidation may impact the consolidation perimeter for these groups, with either some entities which were previously not consolidated being considered as subsidiaries under IndAS, or some other entities which were previously consolidated as subsidiaries now being considered as joint ventures or associates under IndAS.  “This will impact the balance sheet size of the entities and the quantum of debt reflected on these consolidated balance sheets, with the corresponding impact on the earnings,” said Venkateshwaran. 

“Most banks are yet to come to terms with the changes the new accounting guidelines will bring. IndAS is based on fair-value accounting principles and it may be necessary to train employees or seek help from consultants to understand the overall impact,” said R K Bansal, former executive director at IDBI Bank. 

Banks generally look at ratios such as debt-equity, current ratio, quick ratio, Ebitda (earnings before interest, tax, depreciation and amortisation) to total debt, interest service coverage ratios, tangible assets coverage ratio, return on capital employed and cost to income ratio before deciding on lending to companies. The transition to IndAS may impact all such ratios, reckon experts. 

Here’s an example. Suppose company A issued redeemable preference shares to investors at 11 per cent compounded dividend. Neither the investors nor company A has an option to convert such shares into equity shares of company A. Under India’s generally accepted accounting principles (GAAP), such preference shares were part of equity capital and the 11 per cent dividend has treated an appropriation of profits not effecting the net profit earned for the period. 

Under IndAS, such redeemable preference shares shall be treated as a loan and the 11 per cent dividend as interest cost (including dividend distribution tax thereon). This will essentially change the debt-equity ratio of company A and its net profits earned for a period. Accordingly, the banks will have to re-visit the overall loan position and revise the terms of engagement with company A.

Furthermore, non-compliance with a relatively significant covenant of a loan agreement would make the entire loan as current, directly impacting the current ratios and the drawing power of the borrower. A low drawing power would make the loan out of order and lead to increased provisioning.

Some experts observed that conversion from the existing GAAP to IndAS is an accounting change and may not change the creditworthiness of a borrower.
 

“Banks will have to assess whether the changes in the ratios are solely due to accounting changes or whether they actually impact the credibility of the borrower. In case of the latter, banks will have to take adequate steps and measures to cover their increased risks. In the case of the former, banks will have to modify their existing covenants in the loan agreements, amend their credit and risk management policies to factor in the changes brought about by IndAS,” said Charanjit Attra, partner at an Indian member firm of EY Global.

The Insolvency and Bankruptcy Code, 2016, is likely to enable banks achieve better recoveries from stressed loan assets. “It is likely that banks may review aspects such as covenant breaches, macroeconomic indicators and assets pledged as collateral on a more frequent basis as part of the credit risk management and financial reporting process,” said Venkateshwaran.