A series of defaults by the IL&FS holding company and group outfits beginning in August have set off a market-wide contagion. Here is a low-down on how the issue snowballed.
Infrastructure Leasing & Financial Services Ltd. (IL&FS) was set up in 1987 by the legendary M.J. Pherwani (former chairman of Unit Trust of India, National Housing Bank, etc.) to finance and promote infrastructure projects in the country.
It is now a financial behemoth with assets of over ₹1,15,000 crore — and debt of ₹91,000 crore.
IL&FS is a holding company that operates through 169 other companies that are either subsidiaries, group companies or joint ventures with others. It is/has been associated with landmark projects such as the tunnel under the Zoji La Pass, Delhi-Noida toll bridge, Gujarat International Finance Tec-City (GIFT) and a host of road, power, water and port projects.
Three of its group companies are listed on the stock markets. They are IL&FS Investment Managers Ltd., IL&FS Engineering and Construction Company Ltd. and IL&FS Transportation Networks Ltd. IL&FS was originally promoted by the Central Bank of India, Unit Trust of India and HDFC. Orix Corporation of Japan, Abu Dhabi Investment Authority, LIC and SBI joined in as co-promoters later.
What’s the controversy now?
IL&FS Finance, a group company, defaulted in late August on a commercial paper repayment. This was followed by a default by IL&FS on repayment of a ₹1,000 crore deposit to Small Industries Development Bank of India (SIDBI). A series of defaults by the holding company and group outfits followed in the ensuing weeks running up to the annual general meeting of IL&FS on September 29.
That the group was over-leveraged and facing liquidity issues was well known in the market over the last few months leading to ratings downgrades by CARE and ICRA of IL&FS paper to junk status. Yet, the series of defaults in September shocked the markets. When a mutual fund sold the debt paper of a housing finance company at a steep discount to meet its fund redemption obligations in mid-September, the markets pressed the panic button and resorted to wholesale selling of all NBFC shares. The fear set in that defaults by IL&FS, a company rated as important to the system by the RBI, was spreading across the financial system.
How did IL&FS land in this mess?
Simply put, the company borrowed many times its equity (rumoured to be between 10-18 times its equity) to fund its infrastructure projects, most of which bring in returns over 20-25 years. Making things worse, IL&FS’s borrowings were all repayable in the short to medium-term of roughly 8-10 years. Usually, these would be rolled over at the end of the term. Where IL&FS ran into trouble was in its projects stalling and not being completed due to various reasons ranging from statutory approvals not coming in, problems of land acquisition and projects simply becoming unviable as it happened in the case of power plants. With returns from these projects not coming in, IL&FS was forced to borrow more. Lenders pulled the plug leading to trouble for IL&FS.
Was there a cover-up by the company?
According to the government, a report from the Ministry of Corporate Affairs regional office in Mumbai revealed “serious corporate related deficiencies in the IL&FS holding company and its subsidiaries”. Assets and receivables were exaggerated in the financial statements and the top managers took home large pay-outs and continued to pay dividends to shareholders despite the financial situation. An investigation has been ordered by the Serious Fraud Investigation Office.
What are the unanswered questions?
If IL&FS was a systemically important company, how did its over-leveraging escape the notice of the Reserve Bank of India? What did the periodic inspections of the company by RBI reveal? How did the developing situation pass the attention of shareholders? Did they look the other way since their dividends were serviced?