Limited relief seen from Sebi's new equity conversion norms

India Ratings says changes would address only 10% of total debt in question; suggests liquidation better in many of these cases

Lenders will have an easier time in trying to convert their bad loans to equity but this will help ease only a tenth of the stressed loans in the system.

This is because the total debt owed by stressed and vulnerable companies to financial institutions is eight times the market capitalisation of these companies, according to analysis by India Ratings and Research.

“The debt-to-market capitalisation (median) for these corporates is currently around 8.0. Thus, theoretically, even if existing shareholders are wiped out and equivalent debt is converted into equity, it would address only 10-12 per cent of the total debt,” went a report by the agency.

Earlier this week, the Securities and Exchange Board of India (Sebi), in consultation with the Reserve Bank of India, relaxed the norms for conversion of the debt of distressed listed companies into equity by banks and other financial institutions, to help ease recovery in non-performing assets (NPAs).

The capital markets regulator allowed for changes in the pricing structure, helping lenders saddled with bad loans to improve their balance sheets. As on December 2014, total gross NPAs at banks had swelled to over five per cent of all advances.

The detailed framework to enable banks to convert debt into equity is yet to be made public by the markets regulator.

India Ratings says lenders who become shareholders in a distressed company by converting the debt into equity might have to choose between maintaining their corporate control and optimal usage of their resources, if the company decides on new equity issuance.

Besides, the conflict of interest between existing equity shareholders and the lenders as debt holders could hurt the growth prospects. Equity holders generally prefer higher earnings to improve the equity valuation and growth prospects; debt holders would prefer certainty in cash flows, often at the cost of chasing growth opportunities.

The report suggests liquidation of some of these companies would be a better option for banks struggling with NPAs. The book value of a lot of these assets would correspond to around 30 per cent of the debt, assuming all existing shareholders are wiped out, even in cases where the book value might not fully reflect the market value of a lot of these assets.

“The regulators and government should consider ways to liquidate at least some of these corporates,” the report said. And, that minority shareholders should not have to wait for the annual report in case of default by companies.

“Default and delinquency are major corporate events and minority shareholders may like to be aware of such developments immediately,” it said.

The report is based on 120 companies, with debt amounting to Rs 4.26 lakh crore.