Big Steel Question – How steel companies got banks into a mess

In the past few months three independent pointers have once again raised the specter of bank loans to the steel sector. A report by a leading brokerage has raised serious questions about the steel exposure of Indian banks, which runs close to $45 billion. In another event, the highly conservative HDFC Bank preferred to hive off its Rs.550 crore loan to a steel company at a discount rather than participate in a recast. A few days ago, the Finance Secretary sent an SOS to the Steel Secretary on the exposure of Indian banks to steel companies.

History has a weird way of repeating itself. Back in 1998, banks were neck- deep in steel company debt. Fortunately, those were early days for the steel super-cycle. A revival in steel prices combined with banks expanding their balance sheets solved the problem. This time around, banks and steel companies may not be that lucky. Demand has been slackening, China has been dumping and Indian steel companies are struggling due to non-availability of iron ore. Banks may manage to dress up their books by elongating the tenures under the 25:5 Scheme. But that is not an answer!

Same story all over again

This happens very often with commodities; be it steel or oil. Most of the steel companies in India expanded capacities indiscriminately over the last few years. Bank funding was easily available as steel prices were strong. Things have deteriorated in the last few years. 50% of the leading steel companies are under severe stress. When most companies are having debt which is 7 times EBITDA, you know that the problem is serious. And despite all these apparent issues, the loans to steel companies have grown at a CAGR of 21% in the last 5 years. Banks, sadly, continue to lend in the hope of a recovery in steel prices.

A discouraging environment

Most steel projects are stuck either because of project delays or due to delays in environment clearance. A slowing China accounts for 50% of the world steel capacity. Not surprisingly it is trying to dump steel across the world, depressing prices further. India’s problem is that iron ore is scarce and hence prices are high. This makes Indian steel uncompetitive in the global markets. With high debt and low prices, there is no way steel companies can repay their debt to Indian banks.

Most banks are trying to adopt the 25 year scheme for steel companies. But that is not the solution. The fact is that steel companies were given more loans than they deserved. Betting on a demand and price revival may not be too smart. It is time to take a dent in the books and move on. It may be harsh, but there is really no choice! ©

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