Friday, July 16, 2010

Corporate Defaults- Hiding the truth

See this article ( in the Business Standard. It talks about Indian companies that had raised convertibles at fancy prices and are now looking down the barrel. In the first place, at the point of placement itself, the pricing for most did look ridiculous, casting doubts on the analytical abilities and/or integrity of the investing entities.
Now, the hour of reckoning is at hand. It is in the interests of both to keep the charade going. If the investor were to press for repayment, most companies would have to face liquidation proceedings. And in a liquidiation proceeding, India is notoriously slow. The courts and the legal authorities will tend to favour the domestic companies due to the promoters clout. The legal system will stand thoroughly exposed. In India, it is impossible to recover money. If you have to recover any money, you need cooperation of the promoter. Of course, there are other lenders too, but all can be ‘handled’ by the promoters in case of need. We have only to look at the convenient mechanism called “Asset Reconstruction Companies” which have been used as a conduit by the promoters to cheat on debt, legally. The opacity of these ARC’s will get bust soon.
Here, the role of rating agencies comes in to question. Why are they still keeping quiet? It is obvious even to a mathematically challenged person that most of these companies can never hope to repay. Conversion is also not on, given the huge gap between the market price and the strike price. And, a rating should only focus on the assumption that debt has to be repaid. Otherwise, the rating is only a speculation based on a random event of conversion. If there is restructuring of the instrument, it is akin to a default. In such a case, the rating needs to be pushed to the last slot, indicating that the company is in default. That is what honest credit rating is all about.
In fact, each and every company on the list is worth watching. Maybe about ten percent of the companies will be able to generate money to repay. But, if you have to reschedule, you are junk. Alas, the banking system in India will not look at them as such. Some of them are marquee names, with tremendous clout in the banking system. They will be ‘prime’ borrowers. The bankers simply have to keep pumping in more money in to these companies, in the interest of protecting their own balance sheets. In the event of a default, these companies can put the whole banking system in to danger. Perhaps, there lies the answer. These banks will leave no stone unturned to ensure that these companies health status remains unimpaired, even if they have to pump in more money by helping them to pay of the FCCB’s and pump in local loans. The leverage of most of these companies is alarming and they all look like big default candidates.
The credit rating agencies are smug. They know that the system will bail them out, so ratings will not be changed. After all, there is no difference between a BBB and a AAA unless there is a default! Statistically, they will be on par.

1 comment:

Frustrations Amalgamated said...

PS: This kind of loan is routinely given by most banks and is nothing special to IDBI Bank. PSU Banks are treated as a political arena for dishing out favours and siphoning of funds. In this, the bank executives surely take their cut. If not, they would be pretty dumb or incompetent.
The credit quality is a myth and most PSU banks have a fair share of irrecoverable loans, which are ever greened and sold between banks at year end, purchased back in the first quarter etc.