IL&FS brief
In 1987, Infrastructure Leasing & Financial Services (IL&FS) was incorporated as an initiative to form “RBI registered Core Investment Company”. It is a non-banking finance company (NBFC) which was initially promoted by Central Bank of India, HDFC and Unit Trust of India (UTI). Over the past 30 years, IL&FS has aided in developing some major infra projects around the nation.
Few projects to name are Gujarat International Finance Tech-City (GIFT), Delhi-Noida Toll Bridge, Tripura Power Project and Chennai-Nashri tunnel (India’s longest road tunnel). Currently, Life Insurance Corporation of India, ORIX Corporation and Abu Dhabi Investment Authority (AIDA) are the largest shareholders for the company.
What is the crisis?
IL&FS ran out of cash due to a severe liquidity crunch. This resulted in the company to default on a few payments. They also failed to service its commercial papers (CP). The first hint of downfall in the public domain came in March 2018 when the company postponed a $350 million bonds issuance. During the same month, their consolidated total debt stood at whopping Rs 91,091 crore. IL&FS defaulted on inter-corporate deposits and commercial papers of about Rs 450 crore.
Later that year, IL&FS Financial Services cleared their dues related to Commercial Paper on 31st August, three days after the due date. IL&FS and it’s Financial Services subsidiary had a combined Rs 270 billion of debt rated as junk by CARE Ratings. Soon are the defaults came into the knowledge of the public, rating agency ICRA downgraded their borrowing ratings which came as a huge dent on the lendor’s business image.
The Asset-Liability Mismatch
This was one of the biggest reasons why IL&FS hit rock bottom. The company was borrowing loans in the form of commercial papers. You would be thinking, what are Commercial Papers? CPs are short-term unsecured debt-market instruments. These debt instruments have a maturity period varying from 7 days to one year.
The company was taking short-term debt and using it for financing long-term projects which would give returns only after 5-10 years. With the company’s rapidly depleting cash, they were unable to meet the demand and defaulted on several of its obligations. IL&FS’ leverage ratio jumped from 10.6x in September 2017 to 16.8x as of March 2018. That means, 6.2x jump inside a mere 6 months!
PPP Model Inefficiency and LARR
The Government of India introduced the Public-private partnership (PPP) model to aid companies for better efficiency and thus better output. With the launch of this model, the company was assured that the government will help them in financing big projects. With this assumption, they invested heavily in infrastructure projects. The company started acquiring lands on a very big scale, took numerous infrastructure projects and financed them.
But the government did not cooperate with the company to the level they expected and launched LARR (land acquisition rehabilitation and resettlement act) in 2013 instead. When LARR was passed, landowners claimed their compensation for the lands which were theirs. With the rules of LARR and no help from the government in this regard, IL&FS has to pay Rs 17 crore plus worth of compensation to the landowners. This resulted in the overshooting of the cost of the projects and future defaults. This gave birth to the huge difference between the estimated cost of the project and the executed cost.
Other Reasons
IL&FS was incorporated as a finance company. Their purview of work was to fund the infra projects. But from 2015 onwards, they started taking ownership of several risky projects. To meet this, they took short-term loans and diverted the funds for long-term applications. This was done to take loans at a cheaper rate as short-term loans incur less rate of interest when compared to long-term loans.
The company was incurring losses and having very poor cash stability from the past 5 years. Yet the remunerations to the top management was not reduced.
IL&FS operates in a very risky business. No return could be derived from the infra projects until it is successfully completed. Yet, the top risk management team did not hold any meeting for over two years.
Going Forward
More than 30 funds across all categories, such as liquid funds, short-term funds, etc. had IL&FS in their portfolio. Inside two weeks short-term scrips of IL&FS were downrated ‘D’ from ‘A4’. This severely affected the fund houses and forced to mark down the value of the schemes. This led to a steep fall in the NAV (Net Asset Value) of these funds. Recently, Franklin Templeton announced the shut down of its six Debt Mutual Funds with Rs.26000 Crore Asset Under Management. IL&FS crisis played a huge role in the liquidity crunch here as well.
IL&FS defaulting was a very big blow for the Indian economy. Even after two years, the country is still feeling the effects of its downfall. The government should aim to make strict laws to be made so that transparency is restored. The auditors also did a terrible job as they failed to detect the fraud numbers behind the company’s financial. They even failed to flag some of the blatant errors. As big the IL&FS mess is, everything cannot be explained in one article. Marketfeed will come up with more pieces on this topic so that the readers can understand the aftermaths of IL&FS blowout in detail. Until next time.