Corporate defaults hit a 10-year high

Corporate credit defaults surged to the highest in a decade last fiscal, at 188 cases, with textiles, steel and construction & engineering sectors accounting for a quarter, rating agency Crisil said on Tuesday.

Credit quality pressures accentuated in the second half of last fiscal as corporate profitability remained subdued and liquidity pressures emerged, it said.

Indeed, as many as 107 of the defaults came in the second half of the fiscal, which saw 292 downgrades by Crisil as against 266 upgrades.

A surge in rated entities in the lower rating categories, which have been more susceptible to defaults, also contributed to the rise in the default rates, Crisil noted in a report.

According to it, the downgrade in textiles was due to slowdown in the euro zone, while the construction sector witnessed liquidity crunch and weak demand on the domestic front. As for steel, the sector faced higher input costs and sluggish demand on both domestic and international fronts.

The power sector too faced headwinds, said Agrawal, but added that though there were a few restructurings on the generation side, the liquidity pressure was greater on entities manufacturing transformers and other equipment used in power generation.

Around a third of the downgrades by Crisil Ratings were in the default category.

The rate of default, at 3.4% for the fiscal, is likely to remain high going forward, Crisil noted. It expects banks’ cumulative NPAs to be 3.1-3.3% this fiscal, and growth in advances to remain around 17.0%.

“Weak liquidity caused by elongation of working capital cycles is the primary reason for the defaults,” said Roopa Kudva, MD & CEO, Crisil.

“This trend is likely to persist with slowing demand,” she said.

In fact, rising non-performing assets (NPAs) and increase in the quantum of debt restructurings, could dent the banking industry’s profitability and return on assets this fiscal, said the report.

Between March 31 and December 31, 2011, banks saw gross NPAs rise to 2.9% of advances from 2.3% even as the quantum of debt restructured moved up to 3.3% of advances from 2.5%.

This could force banks to set aside a higher amount of provisions against NPAs, hitting their profitability and capital levels, said Pawan Agrawal, director, Crisil Ratings.

“Restructuring will require some losses to be taken, either on principal or interest, which will lead to lower profits for banks. Impact on each bank will depend on the level of provisioning, profitability, exposure to stressed sectors, etc, but it is clear that the banking sector will remain under pressure assuming interest rates remain unchanged,” said Agrawal.

But these negative factors may be compensated to an extent as interest rates and commodity prices decline, he said.

A rate cut could increase banks’ treasury incomes.

“There is also potential likelihood of commodity prices declining, which will help companies maintain their margins,” said Somasekhar Vemuri, head, Crisil Ratings.

“Profitability (of Indian companies) which were under severe pressures, we believe that the pressures may not intensify as there is an expectation of decline in interest rates during the year,” he said.

The saving grace could be the telecom companies, which are witnessing asset growth and improvement in financial health, said Crisil, adding that sectors benefitting from high commodity prices will also see growth.

Services are also expected to do reasonably well. The sector, which logged a 9% growth last fiscal, is expected to grow 8.7% this fiscal.