WHY KEEN TO SAVE IL&FS?

When the world marked the 10th anniversary of the collapse of Lehman Brothers which triggered the global financial crisis in September 2008, India's leading infrastructure finance company IL&FS defaulted on payments to lenders triggering panic in the markets. Below is all about IL&FS and what went wrong with it:

WHAT IS IL&FS?

IL&FS Ltd, or Infrastructure Leasing & Finance Services, is a core investment company and serves as the holding company of the IL&FS Group, with most business operations domiciled in separate companies which form an ecosystem of expertise across infrastructure, finance and social and environmental services. A brain child of the late MJ Pherwani, IL&FS was founded in 1987 with equity from Central Bank of India, Unit Trust of India and Housing Development Finance Co to fund infrastructure projects when peers IDBI and ICICI were focused more on corporate projects.

WHO OWNS IL&FS?

State-owned Life Insurance Corporation of India (LIC), which owns a 25.34% stake in IL&FS, is its largest shareholder, followed by Japan’s Orix Corporation (23.54%). Other key shareholders are the 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%).

WHAT AILS THIS COMPANY

As infrastructure became the central theme in the past two decades, IL&FS used its first mover advantage to lap up projects. In the process, it has built up a debt-to-equity ratio of 18.7. The group with at least 24 direct subsidiaries, 135 indirect subsidiaries, six joint ventures and four associate companies is sitting on a debt of about Rs 91,000 crore. Of this, nearly Rs 60,000 crore of debt is at project level, including road, power and water projects. A major reason behind troubles of IL&FS is complications in land acquisition. The 2013 land acquisition law made many of its projects unviable. Cost escalation also led to many incomplete projects. Lack of timely action exacerbated the problems.

WHAT HAS HIT IL&FS?

A credit crunch facing major Indian infrastructure financing and building company, Infrastructure Financing and Leasing Services Ltd (IL&FS), has roiled the nation's financial markets in recent days, triggering concerns about risk in the rest of the country's shadow banking sector. As Prime Minister in 2014-15 announced a major program to build highways, roads, tunnels, affordable housing and renewable power generation across the country, IL&FS's ambitions grew and it was one of the biggest beneficiaries of the drive. It has won several of these projects, either through direct bidding or joint ventures, but has taken on heavy debt as a result. Until early August, it had an AAA rating from credit rating agencies largely thanks to its place at the center of government infrastructure plans and its robust list of top shareholders.

WHAT WENT WRONG?

In summary - the company piled up too much debt to be paid back in the short-term while revenues from its assets are skewed towards the longer term. IL&FS first shocked markets when it postponed a $350 million bonds issuance in March due to demand for a higher yield from investors. Under increasing pressure from the Reserve Bank of India to identify and deal with bad loans quickly, the country's banks were wary of extending and rolling over loans if the credit risks were high. This made it more difficult for IL&FS to refinance its debt as it came due. IL&FS' net debt to earnings before interest, tax, depreciation and amortization, a measure of a company's ability to pay debt through its operating income, was hovering around a ratio of 11 at the end of March 2018, based on data from the company's latest annual report. Analysts consider anything above 5 a red flag. Then came a string of rating downgrades, beginning in June. In more troubles for the crippled IL&FS group, India Ratings on Tuesday downgraded the long-term issuer rating of a group company, IL&FS Environmental Infrastructure and Services (IEISL), and placed its ratings under watch. The agency has also downgraded the ratings of various debt instruments to ‘BB’.Rival rating agency Icra had last month junked the ratings of most of the group companies. The downgrade by India Ratings reflects a similar rating action on its parent, IL&FS, following the default on repayment of commercial papers. The board of IL&FS then rushed to approve a rights issue of 45 billion rupees to be completed by October. The board also sought to recapitalize IL&FS Financial Services, ITNL and three smaller subsidiaries. The Company said in its annual report that because many of company's claims and other payments involved government contracts it might take two-three years to get these resolved. By the middle of September, IL&FS and IL&FS Financial Services had a combined 270 billion rupees of debt rated as junk by CARE Ratings and a further six group companies had suffered downgrades with a negative outlook on another 120 billion rupees of borrowings.

SERIOUS LAPSES ON PART OF GOVERNMENT

This brings us to the IL&FS episode where the mayhem began in the first place. A look at the financials of ILFS Financial Services (IFIN) — whose commercial paper was swiftly downgraded from A1+ (having a very strong degree of safety and lowest risk) to A4 (very high credit risk to default) and then to default status in a matter of two weeks — suggests that there were enough warning bells in the company’s books for lenders or ratings agencies. As per the FY18 financial results of the company, its gearing (debt/equity) was a high 8 times and the rise in provisioning and interest costs was already adding pressure on the company’s profitability. The company’s exposure to infrastructure sector, only increases the risk. While rating agencies have been taking note of the company’s high concentration in loan book, deterioration in asset quality and subdued profitability, they assigned top notch rating to the company’s CPs, drawing comfort from the strong parentage of the IL&FS group. But the swift downgrading of the parent company’s ratings has once again highlighted that placing undue importance on promoter backing and parentage can cost dearly— ratings of instruments issued by many PSU banks suffer from a similar myopic view. In ICRA’s September 3 release, the rating agency had taken stock of a delay by IFIN in meeting its commercial paper (CP) repayments due on August 28, 2018. But since the delay in CP redemption was on account of technical issues and the facilities were repaid through surplus available with IFIN along with funding support from the group, the rating was left unchanged.

In its September 17 release when it finally downgraded the company’s CPs to D rating, citing recent irregularities in debt servicing, it also interestingly mentioned the change in definition of ‘companies in the same group’.It has stated that as per IFIN’s board policy, each business vertical of IL&FS and its respective SPVs were considered as an individual group; thus the various verticals were not treated as companies of the same group.

LACK OF REGULATOR’S OR GOVERNMENT’S ROLE

The Reserve Bank of India (RBI) is reportedly conducting a forensic audit into IL&FS’s books. The banking regulator, along with market watchdog Securities and Exchange Board of India (SEBI), released statements on Sept. 23 to allay investor concerns.The company, however, has been directed by the RBI now to follow guidelines set out in the Companies Act, for determining ‘companies in the same group’, wherein entire loans to IL&FS group companies would be classified as exposures to companies in the same group, impacting capital adequacy calculations. Such reporting lapses coming to fore only after a crisis unfolds once again raises questions over the murky role of auditors in the entire episode, much like in the PNB scam. For the IL&FS group as a whole that has a consolidated debt of about ₹91,000 crore, the high debt level itself should have raised red-flags with lenders and the regulator. Given that the group has about 135 subsidiaries — 27 direct and 105 indirect — and loans have been extended to group companies, the regulator, as a pre-emptive measure, should have ensured proper inspection of the books of accounts.

DIGGING DEEPER

Road construction is undertaken by IL&FS mainly through special purpose vehicles floated by its subsidiary IL&FS Transportation Networks (ITNL). Crippled infrastructure development and finance company IL&FS has claimed that if funds worth Rs 16,000 crore stuck with concession authorities were released on time, it wouldn't have landed in the mess it is currently in.

EFFECT ON INDIVIDUAL’S INVESTOR

Since the defaults have been on commercial papers, it will affect individual investors, too. This is because mutual funds invest in them and these CPs are supposed to be relatively secure investments. Even the value of unit-linked insurance plans, endowment plans, the National Pension Scheme, etc. will be hit. There may also be some indirect effects. For instance, several projects, including the Bengaluru Metro construction plans, are likely to be delayed, which will affect individuals, too, besides the firms involved.

WHY GOVERNMENT IS KEEN IT SAVE IL&FS

There are certain issues which I am very curious to understand but not getting any answer and they are as below-

(1) If IL&FS could be saved then why not Vijya Mallya?

(2) Is it not an attempt to save foreign investors