IL&FS: A perfect storm
The infra-leasing firm’s saga puts into spotlight the failure of key stakeholders and governance standards in the financial sector, report Abhijit Lele & Raghu Mohan
If you are all things to all comers, you end up being a big nothing to almost everybody. The Infrastructure Leasing & Financial Services (IL&FS) affair tells us that the distance between the two can be short: going from being a triple-A rated entity to default grade in a matter of weeks.
Now that the mess has come out in the public view, inspiration comes in the form of the cop in the movie
Casablanca, saying: “Round up the usual suspects”.
This includes shareholders who took a cat-nap at the wheel and have been woken up to infuse ~45 billion by way of a rights issue to keep IL&FS afloat and which is to be closed out by October 30, 2018. It will be of interest to watch out for the response of two key shareholders in IL&FS to the offer: ORIX Corporation, Japan, with a stake of 23.54 per cent and Abu Dhabi Investment Authority (12.56 per cent), a sovereign fund which is in untested waters in the unfolding narrative.
State Bank of India and Life Insurance Corporation (LIC) were called on to throw in a lifeline of ~30 billion in loans but are having second thoughts given that they will, in effect, as equity holders be hiking their exposures. The IL&FS Group is to more than halve its debt to ~300 billion from the ~910 billion as of March 2018.
Nearly 25 projects are to feature in a fire sale over the next 12-18 months for which offers are on hand for 14 of them. It’s a no-brainer that these will be at basement-discount prices.
Shareholders, the board, regulators, internal compliance systems, and auditors (S R Batliboi & Co signed off on the 2017-18 accounts; it was Deloitte Haskins & Sells in the preceding year)— you name them, just about everybody slipped up.
The 2017-18 annual report says the risk management committee of the board never met (it last met in 20142015). Its chairman was S Bandopadhyay and the other members were R C Bhargava, Michael Pinto and Arun Saha.
Bandopadhyay resigned as director on April 3, 2017, and his place was taken by Hemant Bhargava, the LIC nominee, after a boardmeeting on August 24, 2017. Interestingly, the stakeholder relationship committee did not receive any complaints, so shareholders can’t crib now. And all of this happened right under the nose of the Reserve Bank of India (RBI).
If you can, wish it away
Ravi Parthasarathy, as the then chairman of IL&FS, said in his note in the 2016-17 annual report that “asset-liability management has been an area of focus in the context of the preponderance of investments on the company’s balance sheet as a CIC (Core Investment Company) and the need to maintain a consistent liability profile. Resource mobilisation has accordingly been concentrated on the issuance of securities on the longer term, and mismatches maintained well within regulatory limits.” The same statement finds place in the 2017-18 annual report that was signed by the new chairman Hemant Bhargava. No alarm bells in either case.
What was more worrisome was the company’s stance when the RBI—late as it was—went in for a special audit of its books after the delay in the repayment of inter-corporate deposits raised from Small Industries Development Bank of India. IL&FS came across as contesting the audit’s “special” status and, in a communication to employees, stated the regulator’s move was routine in nature.
A line of defence by IL&FS is that mounting dues (~ 160 billion) from various agencies was the prime reason for its liquidity woes—a burden many others also shoulder in the infrastructure financing space. However, the company could have been more forthcoming — when the refinancing to elongate the debt maturity profile and reduce the cost of funds took a hit as interest rates began rising during the OctoberDecember 2017 period.
There is a sense of déjà vu. On October 23, 1997 (a week ahead of Diwali), the fire crackers went off when CRISIL, in one fell swoop, downgraded the debt of 14 non-banking finance companies (NBFCs) in the aftermath of the CRB Capital fiasco.
IL&FS is not a deposit-taking NBFC, but it is a ‘systemically important’ entity; it can more than scratch institutions—banks and mutual funds—with the twist in its fortunes. Incidentally,
IL&FS never went in for a CRISIL rating though it had from others such as CARE, ICRA and India Ratings.
What now?
Nomura, in a note, said a good part of the IL&FS group’s exposure would be standard assets for most banks, except for dud-loan recognition of its power loans. “The slippage risk remains high after the recent rating downgrades.”
It added that an analysis of bankwise exposure to the group shows Punjab National Bank, Bank of Baroda and Union Bank of India with a relatively
higher exposure, equivalent to 50-100 basis points of their March 2018 loan book. A complete rehaul of IL&FS may be on the cards. This needs to be seen in the light of the fact that the RBI, in its inspection report, wanted IL&FS Financial Services (IFIN) to consider exposure to group firms as per the Companies Act for determining ‘companies in the same group’.
It had impacted the computation of net-owned funds and the capital adequacy ratio of IFIN. The RBI had given time till March 2019 to comply with these norms.
The bigger picture: IDFC turned into a bank. So did erstwhile term-financing institutions like ICICI and IDBI, even though none of them had a similar model when compared to IL&FS. Perhaps a fresh look at the Nachiket Mor Committee Report (2016) may be worthwhile as it made a case for strong NBFCs to enter as “differentiated banks or national banks, without abandoning their core capabilities”.
At the same time, it might be a bit late in the day. For now, it’s time to round up the usual suspects.