In This Issue:
- Editor’s Column – Most Important Lesson in Credit Risk, Buy the Business not the Implied Guarantor
- LIC takeover of IDBI Bank, Change in Ownership is not Rating Positive
- Weekly Issuer Data – AA and Below
- Rating Upgrades, Downgrades, and Other Data
- Current Quotes – Corporate Bonds
- Other Data
Editor’s Column – Most Important Lesson in Credit Risk, Buy the Business not the Implied Guarantor
Banks do not lend long term unsecured to corporate borrowers. However, despite the security of an asset, banks in India, especially government owned banks, are deep in the red due to bad loans. Banks are unable to sell assets to recover loans.
Banks owned by the government were highly rated by the rating agencies. The rating was largely due to government ownership, which offered implicit guarantee on the debt. However, banks ratings have been downgraded substantially due to weakening balance sheets on the back of high loan provisions and prices of bank bonds have fallen considerably on the back of the downgrades. The government may ultimately pay bond holders but till maturity of bonds, investors will not be able to sell the bonds if ratings are low.
Corporates with huge ambitions, leverage substantially to feed the ambitions. Many of these corporates may initially have a good business model with stable cash flows and debt ratios but growth ambitions lead to sharp rise in debt with no immediate cash flows to service the debt. Investors should be wary of such companies leveraging heavily for growth, as even a minor delay or hiccup in projects will throw the whole finances out of gear, leading to downgrades and higher cost of borrowings that could further hurt the company.
Credit risk is the highest form of risk and returns are not usually commensurate with the risk as it is fixed, unlike equity. Hence credit investors must be wary of many issues that can develop over time, which could place their capital in danger. Credit investors can take protection in form of security, guarantee, covenants etc but ultimately the only protection is the financial health of the entity that is borrowing. Financial health stems from the way the business is run.
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LIC takeover of IDBI Bank – Change in Ownership is not Rating Positive
IDBI Bank credit rating, which is just barely at investment grade, will not change on LIC takeover. The bank has a long way to go, first to recapitalize then to clean up its books and then to start doing business. Other NPA ridden banks too will not really see sudden upgrades in ratings, either on recapitalization or on ownership change.
Changing ownership from the government to LIC is akin to the bank being held by the government indirectly. Despite government ownership, bank ratings have dropped to just at investment grade. However, given ownership of the government or LIC, bond holders will be guaranteed repayment of bonds.
Recently board of LIC approved a proposal to buy 51% stake in IDBI Bank, The board of the IRDAI has already permitted LIC to increase its stake from 10.82% to 51% in IDBI Bank. However, the proposed deal will also need a nod from the Government and the RBI.
LIC has been often regarded as the ‘white knight’ of the disinvestment programmes of the government and has been used by the government several times in the past to bail itself out because of LIC’s huge cash pile.
IDBI is the most toxic bank in India, with gross non-performing assets of 27.95%. (Chart 1) IDBI had a monstrous Rs 555.88 billion in bad loans at the end of the March 2018 quarter.
IDBI Bank net loss widened in FY-2018 to Rs 82.38 billion from a net loss of Rs 51.58 billion in FY-2017 on weakening asset quality and rise in provisions. In FY-2018, IDBI Bank provisions for non-performing assets rose by 62% to Rs 191.26 billion as against Rs 117.69 billion in the year-ago period.
As of March 2018, IDBI had a core equity tier-1 ratio of 7.42%, just marginally above the minimum requirement of 7.375%. (Common equity Tier 1 comprises of a bank core capital and includes common shares, retained earnings, common shares issued by subsidiaries and held by third parties).
Similarly, the percentage of gross non-performing assets (NPA) jumped to 27.95% in FY18 compared to 21.25% a year ago. Net NPA also jumped to 16.69% in FY18 over 13.21% a year ago.
Rating agency ICRA said the deal is good from IDBI point of view as it will get the much-needed capital. However, IDBI bank rating would not immediately be impacted since a high level of capital support would be factored in from LIC.
Why is LIC Buying IDBI Bank
P J Nayak committee, had recommended that the government should exit its majority stake in state-run banks to kick off the next round of banking reforms. However, there is no interest from private players to take ownership of NPA ridden banks. Hence government asked LIC to takeover the bank.
LIC as an IDBI Bank promoter can cross-sell its products to bank customers, and the bank will get benefit from a bancassurance tie-up with LIC as it could contribute to the bank revenues. IDBI Bank will also get a large amount of capital, which will keep it afloat.
IDBI Bank is under PCA and LIC;s immediate task will be to cut down the NPA on IDBI Bank books.
How will the Deal Work
LIC will acquire a 51% controlling stake in IDBI Bank, as a Promoter through preferential allotment of shares/open offer. The bank will now seek government approval for the deal.
Along with IDBI Bank, LIC holds stake in almost all PSU Banks (Table 2). After IDBI Bank, Indian Overseas Bank has the 2nd highest gross NPA of 25.3% followed by UCO Bank, United Bank of India, Dena Bank and Central Bank of India which have gross NPAs of 24.6%, 24.1%, 22%, 21.5% respectively. LIC holds more than 5% in all these banks.
Above given bonds are offered by Synergee Capital Services Pvt. Ltd on 19ththJuly
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