Cri­sis at IL&FS once again ex­poses fis­sures in the fi­nan­cial sec­tor, which needs long-term so­lu­tions rather than short-term res­cue pack­ages.

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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.

Tough times

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."



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.

Deeper im­pact

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.

Lehman lessons

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.

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