‘The promoter of an SME has high skin in the game’

Small businesses have fared better during the economic slowdown than large companies. They have also kept debt problems under check, says R Vasudevan, Senior Director, Crisil Ratings – SME, in conversation with BusinessLine .

How many SMEs does Crisil rate? Are the ratings driven by statutory requirements? If not, why seek ratings?

Crisil has rated about one lakh Micro Small and Medium Enterprises (MSMEs); majority of them have engaged us on a voluntary basis. We have MoUs with over 40 banks and financial institutions that cover both entities rated under the NSIC’s Performance and Credit Rating scheme and others. These lenders usually extend interest rate concession to borrowing entities subject to a minimum threshold rating. Under the NSIC scheme, MSMEs gets a 75 per cent subsidy on the rating fee for the first year, subject to a cap, based on turnover. This helps too. We, however, do try to convince all our clients that ratings cannot be a one-off exercise and that undertaking annual assessments helps build credibility of the business.

What challenges do you face as a rating agency, in assessing SMEs?

Information is often the biggest challenge. SMEs do not monitor their operating or financial parameters on a high frequency basis. Nor do they invest in business process management systems. Information on geographical distribution, customer-wise revenues/receivables pending, for example, may not be readily available.

This makes it difficult to assess risk at a given point of time. Transparency can also be an issue. For example, the promoter’s personal net worth is quite important in the credit assessment of SMEs, but firms often do not appreciate the importance of such disclosure and may not be willing to share this.

There is not much information in the public domain about the financial performance of SMEs. How does it compare to India Inc?

There are many definitions of the term SME. For our purpose here, I define SMEs as firms with annual revenue of less than ₹50 crore. We have received limited data for 2015-16 so most of this analysis is based on the previous year. In 2014-15, we have seen SMEs deliver far better sales growth than the mid- and large corporates. The topline growth for Crisil Rated SMEs in manufacturing segment was about 13 per cent and about 20 per cent in services segment, compared to just 1-2 per cent for mid and large corporates.

Given initial trends, I believe that SMEs will continue to outperform large and mid-corporates in revenue growth in 2015-16, and this year as well.

Aren’t large companies expected to do better in a downturn?

Our experience has been to the contrary. There is a boom in service sectors like travel, hospitality, and healthcare. You can also see this being reflected in bank credit growth to services and trade. Food processing and pharmaceuticals have done well. Some engineering goods makers, who supply to exporting principals, have demonstrated double digit growth. But those in steel or auto parts have shown patchy growth.

What is your observation on the debt profile of SMEs? What is the resolution/restructuring experience?

SMEs appear to be better placed on their debt position. Their debt-equity ratios and interest cover are better at 1.5 and over 4 times respectively, far superior because of substantial funding by promoters. If you are a large company burdened by debt, the promoters’ ability to put in additional capital is limited. There are several stakeholders with conflicting pulls and pushes, which affects the restructuring process.

But this is not the case with SMEs. If you see cases that are resolved in ARCs, resolution is much quicker because SMEs have fewer stakeholders. You can easily get the promoter and the lender to the table to negotiate. The number of suppliers is also likely to be a handful. The promoter of an SME also has high skin in the game. He would have given property or even his primary residence as collateral for the loan. He would attach a high emotional value to it. The willingness to get out of the mess is thus far higher in small credits. It would be a loss of face for the promoter, if he loses his collateral.

RBI’s Financial Stability Report also suggests that overall debt and stress are lower in the SME segment, than in large companies. Why?

SMEs mainly obtain working capital loans from banks and financial institutions. The financial difficulties SMEs face usually arise out of temporary cash flow mismatches, stretched receivables and so on. The promoter often sets this mismatch right through equity infusion or unsecured loans from own sources, as obtaining bank funding quickly remains a challenge. SME stress levels are comparatively lower, as their external borrowing levels are lower.

Today, with overall credit growth slowing and large corporate books under pressure, banks are looking to expand their SME books. What changes would banks need to make to their lending practices to make this shift?

Banks would need to recalibrate their basic framework for SMEs credit assessment. A one-size-fits-all approach will not work with SMEs and you need to look deeper into the business to identify risks upfront. For example, customer concentration or a regional concentration could be considered very high risk for a mid-size corporate. But for a SME while it is good have diversity, you would also need to look at the realistic customer base and regional diversity that the firm can handle.

Two, in large or mid-sized firms it is easy to make comparisons of financial parameters or debt-equity with a peer group, because industry data is publicly available. But you cannot compare parameters for SMEs with the public industry data that pertains to mid or large corporates. Also, there may be sectors represented among SMEs which may have unique characteristics. Say, a good SME basmati rice exporter may make a 3 per cent operating margin. You cannot say the margins are too low, based on a comparison with a large size food processing firms making sizeable margins. At Crisil, over the years we have built up a large SME data pool with a cross-section of sectors represented in it to make any such comparisons, and these peer sets helps us in ensuring a robust rating assessment.

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