ICRA Ratings sees significant challenges in the resolution of stressed construction companies, which has the likelihood of delaying the process and reducing the realisable value considerably. This is because while the implementation of the Insolvency and Bankruptcy Code, 2016 (IBC), has improved the situation, the smooth resolution remains a far cry. As many construction companies which were under financial stress have entered the Corporate Insolvency Resolution Process (CIRP) with a lag, the financial creditors are likely to face high haircuts. The numbers say it all, as of March 2019,
202 construction entities had entered the resolution process of which 59 entities have either achieved resolution or ordered liquidation while the balance 143 entities are into the on-going process. As per ICRA, a sample of 15 large companies which entered the resolution process where the financial creditors have made claims totalling Rs1.3 lakh cr. Many of these large construction entities have either crossed the 270-day deadline or are close to the deadline but no resolution plan is in sight, which is likely to result in some of the companies being liquidated. The liquidation value of a construction company is expected to be very small (less than 10% of the financial creditors) in most of the cases as construction companies do not have sizeable fixed assets and a large part of their borrowings comprise working capital debt. Some entities have got the resolution plan approved; however, the haircuts to the lenders in most of the cases have been significant.
Shubham Jain, Senior Vice-President and Group-Head, Corporate Ratings, ICRA: “Timely initiation of the resolution process is critical for a construction company to realise maximum value for its creditors. Weak liquidity during the interim period could result in deterioration in operational performance, leading to cost overruns, termination of contracts, liquidated damages, penalties, the invocation of bank guarantees etc., which will further increase the financial liability.”
One key factor, which severely impacts the resolution of construction companies is the sizeable non-fund based exposure. Construction entities have to give bank guarantees (BGs) to clients for performance, against mobilisation advance, etc. The BG exposure is typically much higher than the fund-based exposure. For the stressed construction entities, the risk of invocation of a guarantee is also higher as the stretched financial position constraints their execution capability, which could lead to underperformance as per contractual obligations. The invocation of the BG converts a non-fund based exposure to a fund-based one and increases the overall liability for the company, thus aggravating the stress faced by the entity.
Leaving aside the legacy projects and stressed companies, ICRA’s outlook on the construction sector remains stable. Most construction companies have an adequate order book, which supported execution growth in the past and provided revenue visibility over the medium term. Construction activities witnessed a healthy growth of 8.7% in FY2019 as per the advanced estimates, primarily supported by increased public spending on infrastructure. The private sector capex, however, has remained muted during the last few years, which can be attributed partly to stalled projects, slower private sector capex and limited private sector willingness to take up risks in PPP projects.