DAMAGE CONTROL
Can the government’s intervention to save ‘systemically important’ IL&FS shore up its prospects—and prevent a larger NBFC meltdown?
Can the new board constituted by the government save IL&FS and a cascading crisis in the NBFC sector?
IN
In his nearly three-decade stint with Infrastructure Leasing & Financial Services (IL&FS) what distinguished Ravi Parthasarathy from other CEOs was his ability to take a decision and stick to it. What he built in the process was an institution with annual revenues of close to Rs 19,000 crore. It was acknowledged as a pioneer in public-private partnerships (PPP) in India, with expertise in execution of projects in sectors as diverse as roads, water, power, ports, area development and environmental infrastructure. That financial edifice looked impenetrable, till cracks appeared in the form of long-term liabilities, threatening the firm’s survival and rattling the stock markets.
In a surprise move, on October 1, the Centre replaced all board members by moving the National Company Law Tribunal (NCLT), as it attempted to calm the financial markets after the beleaguered infrastructure funding firm defaulted on its loans and threatened to shake up the entire NBFC (nonbanking financial companies) segment. A new six-member board led by Uday Kotak, vice-chairman and MD of Kotak Mahindra Bank, has taken over as a new phase begins for the firm.
THE GOLDEN YEARS
Parthasarathy, 66, a post-graduate in business administration from the Indian Institute of Management (IIM), Ahmedabad, joined IL&FS in 1987 as president & CEO and was appointed managing director in 1989. Merchant bankers who have worked with him closely on various projects say Parthasarathy’s aggression as a CEO suited a fledgling IL&FS in the early 1990s, both in raising funds as well as finding infrastructure projects. “But he was far too optimistic,” says Ashvin Parekh, a former EY partner and now an independent consultant. It was to Parthasarathy’s credit that IL&FS gained control of Maytas Infrastructure in 2011, a Ramalinga Rajupromoted company that was in the eye of the storm just ahead of the Satyam scam; turned IL&FS Transportation Network (ITNL) into a prominent player in the roads segment, and expanded the group into a host of sectors with subsidiaries in each of them. The company was, in fact, a conglomerate of some 200 firms, with IL&FS being the holding firm for over a dozen companies, 23 direct subsidiaries, 141 indirect subsidiaries, six joint ventures and four associate companies. Parthasarathy’s stature grew with the firm he nurtured. In 1994, he was elevated as vice-chairman and MD and became chairman and MD in November 2004.
What assisted a fleet-footed Parthasarathy in the early years was the hunger for infrastructure funding, a new appetite for projects in the PPP arena after the government opened the floodgates of liberalisation in 1991. That three state-owned institutions should come together to form IL&FS— the Central Bank of India, the then Housing Development Finance Corporation (HDFC) and Unit Trust of India (UTI)—was proof enough of the need of the day. Gradually, as the organisation needed better financing, it additionally opened itself to two large international players—Mitsubishi (through Orix Corporation, Japan) and the Abu Dhabi Investment Authority. As on March 31, Life Insurance Corporation of India held 25.3 per cent in IL&FS, while Orix Corporation held 23.5 per cent. Other prominent shareholders include Abu Dhabi Investment Authority (12.6 per cent), Housing Development Finance Corporation Ltd. (9.02 per cent), Central Bank (7.7 per cent) and State Bank of India (6.4 per cent). But as he went on an expansion-spree, with a finger in every infrastructure pie, Parthasarathy was losing sight of the long-term picture. In the process, IL&FS amassed close to Rs 91,000 crore in debt and began defaulting on loan repayments. Parthasarathy’s sudden resignation in July this year, citing health reasons, only added to the confusion.
Meanwhile, the Serious Fraud Investigation Office (SFIO) has started a probe into the alleged financial irregularities, the erstwhile top IL&FS management is being questioned, and searches are on at the group’s offices, say reports.
SIGNS OF TROUBLE
“I felt something was structurally wrong because there was no long liability,” says Parekh. IL&FS funds long-term projects of over 10 years, but its borrowings are of shorter durations, which widens the asset-liability gap. Parthasarathy was hoping the government would do two things—create some kind of buyout mechanism the minute a project became operational, and second, create a credit enhancement bureau so that if/ when an infrastructure funding unit found a project unviable, the bureau would step in and offer some sort of buffer or liquid-
Those who worked with him closely on projects say Parthasarathy’s aggression as a CEO suited a fledgling IL&FS in the early 1990s, both in raising funds as well as in finding infra projects
ity. “Neither of these happened. Against that backdrop, IL&FS should have realised that they were running with their legs tied,” says Parekh. The pressure kept building up. The group’s consolidated debt increased by Rs 11,211 crore in financial year 2017-18, and to Rs 91,091.3 crore as of March 2018. Much of it (82 per cent, or Rs 74,591 crore) was contributed by its subsidiaries.
Close on the heels of the Lehman Brothers bankruptcy filing in the US in 2008, a number of large infrastructure projects in India, especially those in power generation, started getting into trouble, several running afoul of environment policy guidelines. IL&FS got stuck with those, but Parthasarathy was still hopeful and kept on building more and more assets. The first warnings of ill health came in the RBI’s annual inspection report in 2014-15. It said that IL&FS Financial Services’ net owned funds had been wiped out and that it was overleveraged. But the IL&FS management refuted the RBI’s views and refused to take corrective measures. This was the time when Parthasarathy’s health was also failing, and he was in exit mode. Nothing seemed to go right thereafter. IL&FS closed FY 201718 with revenues of Rs 18,798.78 crore on a consolidated basis and a loss of Rs 1,886.85 crore.
DEEP IN A QUAGMIRE
The firm began to repeatedly miss debt repayments in the past few months. On September 24, for the third time that month, IL&FS defaulted on interest payments on commercial papers. Commercial papers are unsecured, short-term debt instruments issued by a corporation, typically for the financing of accounts receivable and inventories, and meeting short-term liabilities. It defaulted on a short term loan of Rs 1,000 crore from Small Industries Development Bank of India (Sidbi). So far this year, it has not been able to pay Rs 490 crore and is due to pay an additional Rs 220 crore by end-October. In the next six months, it needs to pay up as much as Rs 3,600 crore.
When a financier categorised by the RBI as ‘systemically important’ has such a huge debt, it is in trouble, say experts. The danger is that almost 60 per cent of IL&FS’s borrowings are in non-convertible debentures that are not secured by physical assets or securities. The subscribers of a major chunk of the debentures are insurance companies, pension funds and provident funds—savings the country’s middle class banks on. A collapse will have grave consequences for all the NBFCs in the country.
Sources say more infrastructure lending firms could come under the scanner. Firms such as IDFC will be looked at more closely, as it has to retire long liability in the next three years of a very high order, they say. The stock markets too faced the IL&FS heat. The BSE sensex fell over 1,000 points on September 21 in a highly volatile market. “Fear psychosis in the market has a ripple effect. More than fundamentals, it is sentiments that matter,” says J.N. Gupta, a former Sebi executive director.
WAKE-UP CALL
There are many who say the troubles at IL&FS are unlikely to spill over and create a national financial crisis, especially with the government putting its weight behind the firm. The rescue plan is in place and shareholders like LIC and SBI are willing to invest to meet the firm’s repayment obligations. At the same time, the present crisis should act as a wake-up call, especially since neither the major shareholders nor the regulator (RBI) were able to sense the trouble early enough.
In its petition before the NCLT, the government reportedly cited mismanagement by the firm’s
“A board under the chairmanship of a respected financial sector professional like
Uday Kotak will have the legitimacy to gauge the extent of trouble at IL&FS,” says a Mumbai-based banker
board and expressed deep concern over the cascading effect the IL&FS collapse may have on mutual funds. One allegation against the earlier board was that the company continued to pay dividends and huge managerial payouts in the face of a looming crisis. The average percentage increase in managerial remuneration was 66 per cent in 2017-18. Parthasarathy drew a salary of Rs 26.3 crore in 2017-18, a 144 per cent jump in his remunerations. “Some mismatches were thrown up. The new board will examine what is a quick way out of this. A resolution plan has to be put in place,” says Arijit Basu, MD, SBI. Apart from Kotak, other members of the new IL&FS board are retired IAS officer Vineet Nayyar, former Sebi chairman G.N. Bajpai, ICICI Bank non-executive chairman G.C. Chaturvedi, IAS officer and Director General of Shipping Malini Shankar and senior bureaucrat Nand Kishore.
Sandeep Parekh, founder, Finsec Law Advisors, says the government move will instil confidence and contain the financial contagion. It will also help bring fresh equity infusion into the company. The new board will look into all the allegations against the earlier management as well as the company’s fragile financials. This, according to experts, will calm the markets, as the real magnitude of the problem will now be ascertained.
At the annual general meeting of IL&FS on September 29, shareholders approved its Rs 4,500 crore rights issue, which reports say three shareholders—LIC, Orix Corp. and SBI—will subscribe to. Shareholders passed an enabling resolution for a Rs 15,000 crore non-convertible debenture (NCD) issue and also approved an increase in its borrowing limit by Rs 10,000 crore to Rs 35,000 crore. Short-term fund infusion, coupled with a new management should help the firm stabilise for now. But only a deeper probe will bring into the open its hidden weaknesses, helping the government and regulator fix the malaise at the firm Parthasarathy had mentored for so long.