During the last decade the focus of most Indian corporates has been on asset growth, which in turn was expected to enable sales growth and the consequential growth in profits. While this might have happened in some cases, it appears that the growth processes and plans for most corporates have been rather traumatic and financially disastrous. In fact, there are many companies with under-utilised and unutilised fixed assets that eat into their profits. Particularly, during the last two years the problem has become more acute. As a result the industrial economy seems to have gone into a bind.

The growth plans of many of the corporates were financed by different lending agencies. In a bid to participate in the economic boom the financial institutions at the national level, some of the nationalised banks, most of the non-banking finance companies, and state-level finance corporations have lent very aggressively to the growing corporates. The capital structuring of the corporates was based on the assumption that a significant portion of the capital would come in as equity from the market and the residue would come in as debt from some lending agency or the other. However, the equity market saw a downturn for an extended period of time which made access to equity capital for these corporates very difficult and, in most cases, impossible.

But market momentum had not reduced and the lending agencies lent money much beyond their share resulting in highly leveraged capital structures. In fact, the lending was more euphoria-based than appraisal-based. These funds saw the completion of many projects with a high debt component with the concomitant interest cost, even as some of the projects were left unfinished. By the beginning of 1996, the corporates were finding the projects either unviable or difficult to operate due to non-availability of fund for working capital. Whatever the problem, the consequence was the drying up of cash-flows of firms and an increase in the risk of default.Defaults became a reality by the middle of 1996 and most of the lending agencies found the wolf of non-performing assets at their doorstep.

By now it was obvious that the permissive lending climate of the early 90's had led to a situation of corporate financial sickness with very few solutions in view. Although most of the lending agencies were attributing the whole problem to lack of liquidity in the system it was becoming clear that the diagnosis was inaccurate and the real problem was unplanned growth in asset creation leading to inappropriate allocation of financial resources. The responses to this problem of NPA management has been as varied as the nature of the lending agencies is. The all-India financial institutions went in for what they know best - rescheduling; the state-level financial corporations have treated it as a revenue collecting function and therefore have gone for seizure of mortgaged assets; the NBFC's which have the least importance in the whole debt structure have either use section 138 of the Negotiable Instruments Act or the winding up route of the Companies Act.

The commonality in the approach is that it is of a money-lender somehow trying to get his money back. Unfortunately, the Reserve Bank of India has not manifested a better understanding of the problem. The underlying assumption of all the lenders whose loans have become doubtful is that the borrower is necessarily a cheat and is not paying the money willfully. And, in cases where the exposure is very large the response has been to lend further with the hope that the increased liquidity will make the unit viable. Instead of taking a holistic and an organic view of the whole problem, the lending agencies have reduced it to a question of managing NPA's as an accounting number. The actions of these agencies reflect this belief.

In this misadventure NBFC's also had a significant share. Confusing speed for efficiency these entities lent to everybody and anybody in an irresponsible manner without following any serious credit process. While most of the NBFC's are perceiving such a situation as a problem and seeking solutions from the viewpoint of funds availability, it may be useful to look at the problem differently from the perspective of a comprehensive financial sustainability.

Some key issues which appear to be common to most of the NPAs are the low operating cash generation, poor contribution on sales, growth in sales not commensurate with growth in assets. The problem could be on account of quantity of capital used, the cost of capital or both. Fixed asset creation has led to liquidity problems and, therefore, resulted in inadequate build up of current assets for operations.

Operating cash flows have been negative for many companies in the last few years thereby getting companies into debt traps. Sudden growth in the asset base has rendered the corporates weak in terms of management capability and most of these corporates need inputs in the area of financial management, and access to the market as a consequence of corporate restructuring activity. Some of these companies require inputs in the area of working capital management and even production management so as to reduce costs through optimal capital utilisation. In some cases it may happen that the problems lie in pricing or product - market strategy.

The lending agencies instead of diagnosing the problems for identifying research and reason-based solutions have unsuccessfully relied on coercion and courts for recovering their money in an indiscriminate manner. Perhaps, an alternate approach may help the whole process of NPA management become more realistic and grounded in economic logic.

The alternate approach: The problem needs to be conceptualised based on three aspects of the borrower-lender relationship, namely, willingness to pay, ability to pay and enforceability of contracts.

The willingness to pay can be established based on: transparency in information sharing, standardisation of accounting norms and practices, presenting the true state of affairs without resorting to window dressing, intentions of the top management of the defaulting company, and remedial measures being initiated in the defaulting company.

The ability to pay by the borrowing company will be determined by: the adequacy and stability of the cash flows, the management capabilities to withstand and overcome crisis, the product market situation keeping in view the company in the context of the industry.

The enforceability of contract will be dependent on the: quality of documentation done at the time that the contract for lending was entered into and type of transaction between the lender and the borrower.

Usually the diagnosis will result in emergence of options for enabling the company to come out of its problems. The options that are likely to be considered are: revival of operations, sale of the company or a part of the company as individual assets.

Revival of operations: Revival of the company's operations will need clear articulation of genesis of the problem so that the solutions are appropriate. The problems in the company nee to be understood in terms of timing and mismatch of funds; inappropriate capital structure with debt replacing equity as capital markets did not support equity offerings; short term funds being deployed for long term requirements; inadequate funds for working capital, or a lack if appreciation of the product market situation.

The revival process revolves around the company's ability to generate sustainable operational cashflows. Further the sensitivity of the cash flow to the price and quantity variations in sales and different capital structures needs to be ascertained. This brief exercise is likely to give the analyst a quick understanding about the viability of the company under consideration.

For ensuring the operational viability in the sort run it is essential to make the company work to a cash budget which has to be dovetailed to a production plan and a sales plan. In fact, the whole exercise borders on the discipline that the company can adhere to in working to plan.

From the nature of this exercise it is obvious that its success depends on the company's willingness to respond to critical feedback and be subject to conditionalities set by any outside advisor. It is the case of this article that such an effort can be initiated by an investment banker in the present context of the Indian markets.

Sale of assets or company: The other option namely the sale of assets can either be through the sale of the company at a price acceptable to the buyer or sale of a some of the assets of the company. The sale of the company can be essentially through an acquisition mode or a merger methodology based on the economics of mergers or acquisitions as the case may be.

The sale of assets can essentially comprise sale of tangible assets in the form of sale of other fixed assets. Similarly the sale of intangible assets can be through the sale of brands or the sale of technology know-how or the sale of patents and registrations. Therefore, it is obvious that the sale of asset is on a best user basis, whether it is a tangible asset or an intangible one.

However, all these actions are possible only if all the creditors to the company see the same picture of the future as drawn by the investment banker.The creditors, amongst others things,should: enable the company to build up operational surplus, adjourn legal proceedings, consider a repayment schedule linked with sustainable cashflows, facilitate the cost of funds to be lower than returns generated from operations, by offering concessions on the loan rates.

In sum it appears that it is possible to convert some of the NPAs into performing ones if all the constituents look at the NPA, as a firm which has assets which need to be utilised, rather than just as a loan to be recovered.It is time for the participants in the Indian financial system to realise that there is more to be realised from enhancing asset utilisation of existing assets than by continuing to create newer assets which get to be under-utilised. Also, it may be useful to understand that the lender is as much at fault when loans go bad as the borrower is although in the present scenario this may be less obvious due to the agency problem in the case of lending companies, more so the government owned ones.

And, when the sensitivity to NPA's moves from that of an accounting number to one of an organic entity the difference between money lending and corporate finance will be clear to the financial sector.

The author is executive director of Times Guaranty

Copyright © 1997 Indian Express Newspapers (Bombay) Ltd.