Crisis at IL&FS once again exposes fissures in the financial sector, which needs long-term solutions rather than short-term rescue packages.
Crisis at IL&FS once again exposes fissures in the financial sector, which needs long-term solutions rather than short-term rescue packages.
Finally, there was light at the end of a dark tunnel for Infrastructure Leasing & Financial Services (IL&FS). After months of living on the edge, Mumbai-headquartered IL&FS got a much-needed breather from its shareholders. A long-overdue bailout for IL&FS at its annual general meeting (AGM) last month seemed to end the nightmare for the debt-battered infrastructure developer.
After the company's AGM in Mumbai, IL&FS Vice-Chairman and Managing Director Hari Sankaran outlined a three-pronged strategy to return the company to normalcy. "IL&FS is considering three instruments of financing - a rights issue, a short-term bridge financing either through cash infusion or creditors' moratorium and asset monetisation," Mr Sankaran revealed.
The first part of the strategy will be to complete the Rs 4,500-crore rights issue by the end of October and enable the company to re-capitalise itself, Mr Sankaran added. IL&FS' two top shareholders, Life Insurance Corporation of India (LIC) and Orix Corporation of Japan are learnt to have committed to subscribe to the rights issue.
The company is also in the process of divesting some 25 projects to pare its debt by up to Rs 30,000 crore in the next few months. There are also unconfirmed reports that the infrastructure developer is looking at selling off its plush headquarters in Mumbai's Bandra-Kurla Complex.
The much-anticipated bailout of IL&FS by its shareholders is set to calm the frayed nerves of its inves-
tors and lenders. In fact, a spate of defaults and delayed payment of debts by IL&FS and its subsidiaries had spooked stock and bond markets for the most part of last month. The crisis at IL&FS, credited with building some of the country's iconic projects, came to light in June this year, when it defaulted on repayment of inter-corporate deposits and commercial papers worth Rs 450 crore.
In early September, the infrastructure financier and developer defaulted again on a short-term loan of Rs 1,000 crore from Small Industries Development Bank of India (SIDBI). IL&FS Financial Services (IFIN), one of IL&FS' main subsidiaries, engaged in infrastructure financing, delayed repaying money raised through commercial papers twice in August and once more last month. IFIN has since been barred by the Reserve Bank of India (RBI) from accessing the commercial paper market until February 2019.
Such successive defaults and delayed repayment of debt brought serious asset-liability mismatches to the fore at the infrastructure developer. The IL&FS Group, which is saddled with a whopping debt of over Rs 91,000 crore, had approached the National Company Law Tribunal (NCLT) - the agency designated to resolve bankruptcy of companies - to seek relief from being dragged into insolvency proceedings by lenders.
The defaults also resulted in a series of rating downgrades of the company's debt instruments. In March, ICRA had assigned an A1+ rating to IL&FS' Rs 2,500-crore commercial paper and provided a stable outlook on its long-term rating. Over the last month however, the company's long-term ratings were downgraded by multiple notches from AA+ to BB and then to D or sub-investment grade rating. Similarly, its short-term rating was also downgraded from A1+ to A4 and then to D. ICRA cited recent irregularities in debt servicing by the company, challenging liquidity position at the group level, delay in raising funds from promoters, deterioration in credit profile of key investee companies and sizeable debt repayment obligations for its rating revision.
Meanwhile, the Securities and Exchange Board of India (SEBI), the RBI, the Corporate Affairs Ministry and the Finance Ministry had received complaints about alleged wrongdoings, such as corporate governance- and disclosure-related lapses at the infrastructure financier and its associates. The RBI had already cautioned the IL&FS Group against circulating funding and also asked it to reduce intragroup exposure. The central bank had also initiated a special audit of the company's finances.
In fact, the first signs of crisis at IL&FS surfaced way back in July, when its former chief Ravi Parthasarathy put in his papers, citing poor health. Mr Parthasarathy's
"IL&FS is considering a threepronged strategy - a rights issue, a short-term bridge financing and asset monetisation - to return the company to normalcy."
VC & MD, IL&FS
exit was indeed a big jolt to IL&FS as the veteran chairman was associated with the infrastructure behemoth since its inception in 1987. Hemant Bhargava, who succeeded Mr Parthasarathy as non-executive chairman of IL&FS, was at the helm for a mere two months. Mr Bhargava, the managing director of Life Insurance Corporation of India (LIC), was replaced by S B Mathur, the former chairman of LIC, at the company's board meeting on September 15.
There were more exits at subsidiary IFIN last month, following the delay in meeting its commercial paper obligations. Ramesh Bawa, the CEO of IFIN, its independent directors Renu Challu, Shhubhalakshmi Panse, Uday Ved and S S Kohli and the company's non-executive director Vibhav Kapoor resigned from their respective posts last month.
As IL&FS grappled with multiple woes, the string of bad news flowing out of the premier infrastructure company unnerved lenders and investors alike. The panic among investors was further intensified amid likely assetliability mismatches in other nonbanking finance companies (NBFCs) leading to their debt repayment default and fears of liquidity crunch.
Incidentally, some of the big names in the world of finance - such as LIC, Orix Corporation of Japan, Abu Dhabi Investment Authority, HDFC, State Bank of India (SBI) and Central Bank of India, among others - are the top shareholders of IL&FS. But despite such a privileged pedigree, an inordinate delay by its shareholders to bail out IL&FS had intrigued the markets.
As uncertainty loomed large over IL&FS' bailout, the financial crisis of the project developer and financier was threatening to destabilise the country's financial markets. Sounding a warning on the liquidity crisis at the IL&FS Group, rating agency Moody's had noted that it was credit-negative for banks and the debt market in India. The group's defaults would affect mutual funds, pension funds and insurance companies, the rating agency had added.
The IL&FS Group is sitting on a consolidated debt of more than Rs 91,000 crore, of which about Rs 57,000 crore is owed to banks as loans. The remaining debt is in the form of debentures and commercial papers. The company's outstanding bank loans of Rs 57,000 crore work out to around 1 per cent of the entire banking system loans, and, according to sources, they are all standard loans.
In spite of the small percentage of the outstanding loans, which are stress-free currently, IL&FS' lenders were a worried lot amid a spate of its defaults. Their worries grew bigger as the infrastructure development company stared at an estimated over Rs 5,750 crore of debt that has to be repaid in the next one year. And with the group's finances remaining strained, the creditors were concerned that these loans could turn into non-performing assets (NPAs).
Bankers were not the only ones worried with the deteriorating financial health of the IL&FS Group. Mu-
tual funds, which have emerged as a major player in the capital market with around Rs 25,00,000 crore of assets under management (AUM), too were bracing up to take a hit as the project developer and financier went on a debt-defaulting spree. Fund houses, which manage about Rs 13,75,000 crore of fixed income assets, including debentures and commercial papers, were hit by downgrades of IL&FS' debt instruments.
In fact, the IL&FS Group's outstanding debentures and commercial papers accounted for 1 and 2 per cent respectively of the domestic corporate debt market as of March 2018. Though minuscule in terms of percentage, IL&FS' debt instruments have been one of the sought-after investment options in the market, given the conglomerate's strong and stable performance in the past. However, recent defaults by the group had shocked fund managers. They feared that a prolonged crisis at IL&FS could spread negative sentiments in the market and lead to a wave of redemptions by mutual fund investors. "The industry is facing sporadic redemption in debt funds, but it has not reached a crisis level," points out Lakshmi Iyer, the chief investment officer (debt) and head (products) of Kotak Mutual Fund.
A similar fear of IL&FS' weak financials having a contagion effect on the markets was keeping pension funds and insurance companies on the edge. "The cost of borrowing for NBFCs is going to shoot up, and they may face challenges in raising money in the light of recent news on IL&FS," opines Hitesh Agrawal, the executive vice-president and head of retail research of Religare Securities.
Genesis of crisis
For over three decades now, IL&FS has been at the forefront of the country's infrastructure development. The Chenani-Nashri tunnel, India's longest highway tunnel in Jammu and Kashmir, the FIFA-compliant sports facility in Thiruvananthapuram, restoration of the 300-year-old Jal Mahal palace in Rajasthan and transforming lives of rag-pickers and paddy farmers - IL&FS has left its imprint of impeccable execution in each of these and many more projects. Besides, the infrastructure developer is executing the Zoji La Tunnel in Jammu & Kashmir, which will be Asia's longest, bidirectional tunnel.
Just as IL&FS lorded over the infrastructure sector, it also called the shots in the capital market. For years together, investors in the bond market and the stock market to some extent (unlisted IL&FS has three major, listed subsidiaries - IL&FS Transportation Networks, engaged in development of transport infrastructure; IL&FS Engineering and Construction Company, engaged in infrastructure development; and IL&FS Investment Managers, engaged in private equity investment) -flocked to the infrastructure conglomerate's instruments for healthy returns.
Sadly, the darling of the investors has shrunk into its pale shadow today. So, what factors have actually precipitated the crisis at IL&FS? The factors that have affected most infrastructure companies in India have played a vital role in hammering down
IL&FS to its present state. A recent drying up of new infrastructure projects and a delay in monetising completed projects have severely dented the company's earnings. Simultaneously, soaring interest rates and cost overruns amid a delay in land acquisition and approvals have in- creased the company's expenses multifold.
Besides, disputes with concession authorities of projects have badly affected the infrastructure financier's top line as well as bottom line. The company claims that if Rs 16,000 crore of its funds stuck with concession authorities were released on time, it would not have landed in the mess it currently is in. In its 2017-18 annual report, IL&FS notes: "Another hurdle has been the delay in decision-making, passing of the buck at the relevant authorities, especially with regard to compensating the concessionaire or contractor for delays and defaults on the part of the authority."
The external factors have indeed put IL&FS in a spot and dragged down its growth. However, that would be only a part of the story. The villain in the other part of the story is IL&FS itself which has reduced to what it is today.
To begin with the other part of the story, IL&FS, like many other infrastructure companies, expanded too rapidly in the boom years. However, a subsequent slowdown in the pace of project execution led to the current debt pile-up. The infrastructure company aggressively pumped in more than Rs 9,000 crore into its subsidiaries between 2013-14 and 2015-16 to execute a huge number of projects that they had taken up.
A large part of these projects were funded through debt, leading to a rise in its debt-to-equity ratio. By March 2018, IL&FS' consolidated net worth was Rs 5,430 crore, while its debt had zoomed to over Rs 91,000 crore. As a result, the company's debt-to-equity ratio shot up to 16.8 times as against the sector average of around 6 times.
With a rise in debt, the borrowing cost for the company also doubled from Rs 3,971 crore in FY14 to Rs 7,992 crore in FY18. The rising debt burden for IL&FS has left it in a rather precarious financial situation. And with interest rates also rising in the domestic economy, viability of its infrastructure projects is adversely impacted.
If debt has played a major part in the undoing of IL&FS, its complex corporate structure is no less responsible for its sorry state of affairs. With 169 subsidiaries - including 24 direct subsidiaries, 135 indirect subsidiaries (including some 50 overseas arms), six joint ventures of 50:50 equity ownership and four associate ventures of varying degrees of equity ownership - it was but natural for the infrastructure development company to have lost the plot. The nature of the corporate structure also made it impossible for IL&FS to come under strict regulation. As IL&FS has been a non-deposit-taking NBFC, it has only been loosely monitored by the RBI as a systemically-important institution. Similarly, with parent IL&FS and many of its subsidiaries unlisted, they are not regulated by the SEBI either. A lack of accountability and transparency seems to have provided the IL&FS Group with ample opportunities to take unwarranted risks - there have been many allegations of wrongdoing by the infrastructure conglomerate.
"The industry is facing sporadic redemption in debt funds, but it has not reached a crisis level."
CIO, Kotak Mutual Fund
Meanwhile, a shift in business model too has contributed to the mess that IL&FS is in at present. Over the years, IL&FS has transformed into a full-fledged infrastructure development company from a pure-play infrastructure finance company. As one of the pioneers of the pubic-private partnership (PPP) model of development, IL&FS has played a vital role in rebuilding India with world-class infrastructure. But the new business model that it adopted made IL&FS grow into a huge giant with numerous arms or subsidiaries. From a financier of projects, it moved to own them. The shift resulted in a huge build-up of debt. Cost overruns further added more loans into the books of IL&FS, and as earnings slowed down, the company's asset-liability mismatch only widened further.
It is indeed an interesting coincidence that the IL&FS crisis should precipitate exactly a decade after the collapse of Lehman Brothers that led to the global financial crisis of 2008. In fact, the situations leading to the turmoil at the two giant institutions are eerily similar.
Like Lehman, the IL&FS Group is also too big to fail, with the risk of a contagion effect threatening to disrupt markets in case of a disorderly collapse. The Indian company, like its American counterpart, has escaped stringent scrutiny of regulators. The run-up to both the crises has been similar too, with rating agencies caught napping up until the last moment.
The timing of the IL&FS crisis and the disturbing similarities leading up to the turmoil at Lehman and IL&FS make it tempting to label the IL&FS crisis as India's Lehman moment. The comparison is at best only superficial. But unlike a private entity like Lehman Brothers, IL&FS is very much a government-owned enterprise, with LIC, SBI and Central Bank of India holding significant stakes. Moreover, its shareholders bailing out IL&FS - albeit the delay - was imminent.
The bailout of IL&FS will now help in calming down tense markets and investors. However, the bailout will be meaningless if it is not accompanied by some crucial, long-term solutions. To begin with, IL&FS has to dismantle its complex and unwieldy corporate structure. This will go a long in bringing about much-needed accountability and transparency in the infrastructure behemoth.
Apart from a course correction at IL&FS, the capital market and the ecosystem too have to go in for some major changes. The entire framework of rating agencies needs a thorough overhaul. A lack of rigorous scrutiny has led to credit rating agencies being less than efficient with their analysis and rating. In essence, they failed to spot the liquidity crisis brewing at IL&FS. It is curious that all these agencies downgraded IL&FS' debt instruments by multiple notches in a matter of few weeks after the company began defaulting.
The debt market, especially the corporate bond market, is crying out for some far-reaching reforms. There is an over-reliance on the banking system - which is battered by the NPA menace - to cater to the credit needs of a fast-growing economy. This can be corrected by deepening the corporate bond market. A good beginning has been made by the SEBI permitting tri-party corporate bond repos - a third party, especially a stock exchange, acting as an intermediary between a seller and a buyer of corporate bonds - and both NSE and BSE
A prolonged crisis at IL&FS could spread negative sentiments and have a contagion effect across markets.
Chenani-Nashri tunnel in Jammu & Kashmir Chenani-Nashri tunnel in Jammu and Kashmir& Jal Mahal palace in Rajasthan A pioneer of PPP, IL&FS has left its imprints of some of India's iconic projects.
Unlisted and non-deposit-taking IL&FS was able to avoid scrutiny of both RBI and SEBI.