Liquidity crisis to drag
‘No respite for bulls’ screamed the headlines of the dailies last week. The stock market is yet to recover fully from the crisis witnessed on Friday, 21 September 2018, which engulfed all NBFCs and Dewan Housing Finance Corporation Ltd (DHFL) and Indiabulls Housing Finance Ltd (IBHFL) in particular. The market has not yet recovered from the sharp fall of 1,150 points on the Sensex witnessed that day. As the Infrastructure Leasing & Financial Services (IL&FS) default story continued, a renewed liquidity crisis was witnessed on Monday, 24 September 2018, and the free falling knife injured several non-finance counters like Eicher Motors (-7%), Mahindra & Mahindra (-6.45%) also. The ‘declines’ outnumbered the ‘advances’ and some mid-caps and small-caps even made new 52-week lows destroying the little confidence that was brewing from the previous session’s fall.
It is, therefore, pertinent for readers to understand the massive crisis that has surfaced in Indian financial markets. A tight bear hug engulfed the markets in which ~Rs.6.5 lakh crore ($116.3 billion) of investor wealth was wiped off in the last ten trading sessions. All this was due to the IL&FS crisis. IL&FS is an over 30 year old infrastructure lending giant that helped develop and finance projects worth $25 billion in Asia’s fastest-growing economy. The company of late has defaulted on a few payments, which means it has its liquidity has dried up. This spells trouble not only for itself but also for its investors, which include banks, insurance companies and mutual funds. Some analysts compare this crisis to the 2008 Lehman Brothers crisis in USA that triggered a global financial meltdown. Investors and traders are worried about the cascading effects of IL&FS’ defaults. Its impact can be gauged from the Sensex, which has already lost 2,000 points in September 2018 so far. Before we jump to any conclusion, let’s learn a little more about IL&FS. Apart from envisioning and building infrastructure projects, IL&FS is also a ‘shadow bank.’ The term is used to refer to the non-bank financial intermediaries that provide services similar to traditional commercial banks. Since these are not deposit-taking companies, they are not as stringently regulated.
IL&FS sits atop a web of 169 subsidiaries, associates and joint venture companies that makes the default even more worrisome. State-owned Life Insurance Corporation of India (LIC) is its largest shareholder with 25.34% stake followed by Japan’s Orix Corporation (23.54%), Abu Dhabi Investment Authority (12.56%), Housing Development Finance Corporation (9.02%), Central Bank of India (7.67%), and State Bank of India (6.42%).
In simple words, IL&FS has run out of money and is, therefore, unable to service its repayment obligations. Since 27 August 2018, it has defaulted on around Rs.450 crore of inter-corporate deposits (ICDs) to the Small Industries Development Bank of India (SIDBI). Earlier this month, IL&FS and its subsidiary, IL&FS Financial Services, also delayed payments on ICDs and commercial papers, instruments that mature in less than a year.
As per the latest update, IL&FS has a total consolidated debt of Rs.90000 crore. The recent slowdown in infrastructure projects has only worsened the situation. Additionally, IL&FS Financial Services has about $500 million in repayments that are due in the second half of this fiscal while it has only about $27 million available. Rating agencies ICRA and CARE have downgraded the parent and its subsidiaries significantly from investment grade to junk earlier this month. Such a downgrade pushes the prices of bonds lower, which affects debt funds. What makes the situation worse is that most of the assets of IL&FS and its subsidiaries include financial claims on infrastructure projects such as roads, tunnels, water treatment plants, power stations, etc. which cannot be liquidated to escape the mess. IL&FS’ default will have a significant multiplier domino impact on India’s credit markets. According to Moody’s Investor Services, the firm’s outstanding debentures and commercial papers as at 31 March 2018 accounted for 1% and 2% of India’s domestic corporate debt market respectively.
On the other hand, its borrowings from banks i.e. around Rs.57000 crore accounted for about 0.5% and 0.7% of the total banking loans! Defaults will, therefore, spell more trouble for Indian lenders, who are already battling a huge toxic loan pile.
To extinguish the default fire, IL&FS plans to put its corporate headquarter (worth ~Rs.1300 crore) on the block. It has also identified around 25 projects for sale. By selling these assets, it may reduce its debt by around Rs.30000 crore, which is just one-third of the total and this process may take a year to realize.
The RBI, SEBI, Government of India (GoI) and LIC will come to IL&FS’ rescue to salvage the entire finance sector and relieve it from the domino impact. The rescue plan and its degree of success, if at all, will unfold in the near future. “Once bitten twice shy” is the old adage but investors are experiencing the second bite this time. “Twice bitten always shy or never shy,” only time will tell. Till then, analysts may advise buying select NBFC stocks that have fallen sharply. It may not be prudent to flow against the current. You’d rather be at the banks of the high tide and keep an eye on the developments that are taking place. The after-effects of this domino impact may take some more time to ease out or cool off. Till then, let this be a glaring example of the market’s irrationality and a great lesson for us.