IL&FS mess highlights failure of key stakeholders, corporate governance

A line of defence by IL&FS is that the mounting dues from various agencies were the prime reason for its liquidity woes

If you are all things to all comers, you end up being a big nothing to almost everybody. The Infrastructure Leasing & Financial Services (IL&FS) affair tell us the distance between the two can be short: going from being a triple-A rated entity to default grade in a matter of weeks. 

Now that the mess is coming out in public view, inspiration comes in the form of the cop in the movie Casablanca who says: “Round up the usual suspects”.

This includes shareholders who took a cat-nap at the wheel and have been woken up to infuse Rs 45 billion by way of a rights issue to keep IL&FS afloat and which is to be closed out by October 30, 2018. It will be of interest to watch out for the response of two key shareholders in IL&FS to the offer: ORIX Corporation, Japan with a stake of 23.54 per cent and Abu Dhabi Investment Authority (12.56 per cent), a sovereign fund which is in untested waters in the unfolding narrative. 

State Bank of India and Life Insurance Corporation (LIC) were called on to throw in a life-line of Rs 30 billion in loans but are having second thoughts given that they will, in effect, as equity holders be hiking their exposures. The IL&FS Group is to more than halve its debt to Rs 300 billion from the Rs 910 billion at end-March 2018. Nearly 25 projects are to feature in a fire sale over the next 12-18 months for which offers are on hand for 14 of them. It’s a no-brainer that these will be at basement-discount prices.

Shareholders, the board, regulators, internal compliance systems, auditors (S R Batliboi & Co signed off on the 2017-18 accounts; it was Deloitte Haskins & Sells in the preceding year) - you name them, just about everybody slipped up. 

The 2017-18 annual report says the risk management committee of the board never met (it last met in 2014-2015). Its chairman was S Bandopadhyay and the other members were R C Bhargava, Michael Pinto and Arun Saha. 

Bandopadhyay resigned as director on April 3, 2017 and his place was taken by Hemant Bhargava, the LIC nominee, after a board meeting on August 24, 2017. Amazingly, the stakeholder relationship committee did not receive any complaints, so shareholders can’t crib now.  And all of this happened right under the nose of the Reserve Bank of India (RBI). 

If you can, wish it away 

Ravi Parthasarathy, as the then chairman of IL&FS, said in his note in the 2016-17 annual report that “asset-liability management has been an area of focus in the context of the preponderance of investments on the company’s balance sheet as a CIC (Core Investment Company) and the need to maintain a consistent liability profile. Resource mobilisation has accordingly been concentrated on the issuance of securities on longer term and mismatches maintained well within regulatory limits.” The same statement finds place in the 2017-18 annual report was signed by the new chairman Hemant Bhargava. No alarm bells in either case. 

What was more worrisome was the company’s stance when the RBI—late as it was—went in for a special audit of its books after the delay in the repayment of inter-corporate deposits raised from the small Industries Development Bank of India. IL&FS came across as contesting the audit’s “special” status and, in a communication to employees, stated the regulator’s move was routine in nature.

 A line of defence by IL&FS is that the mounting dues (Rs 160 billion) from various agencies were the prime reason for its liquidity woes—a burden which many others also shoulder in the infrastructure financing space. But the company could have been more forthcoming when the refinancing to elongate the debt maturity profile and reduce the cost of funds got hit when interest rates began rising during the October-December 2017 period. 

There is a sense of deja vu. On October 23, 1997 (a week ahead of Diwali), the fire crackers went off when Crisil, in one fell swoop, downgraded the debt of 14 non-banking finance companies (NBFCs) in the aftermath of the CRB Capital fiasco. Sure, IL&FS is not a deposit-taking NBFC, but it is a ‘systemically important’ entity; it can more than scratch institutions—banks and mutual funds—with the twist in its fortunes. Incidentally, IL&FS never went in for a Crisil rating though it had from others such as CARE, ICRA and India Ratings.

What now?  

Nomura, in a note said a good part of IL&FS group’s exposure would be standard assets for most banks, except for dud-loan recognition of its power loans: “The slippage risk remains high after the recent rating downgrades.” It added an analysis of bank-wise exposure to the group shows Punjab National Bank, Bank of Baroda and Union Bank of India with a relatively higher one, equivalent to 50-100 basis points of their March 2018 loan book. 

 A complete rehaul of IL&FS may be on the cards. This needs to be seen in the light of the fact that the RBI in its inspection report wanted IL&FS Financial Services (IFIN) to consider exposures to group firms as per the Companies Act for determining ‘companies in the same group’. It had impacted on the computation of net-owned funds and the capital adequacy ratio of IFIN. The RBI had given time up to end-March 2019 to comply with these norms. 

The bigger picture: IDFC turned into a bank. So did erstwhile term-financing institutions like ICICI and IDBI even though none of them had a like model when compared to IL&FS. Perhaps a fresh look at the Nachiket Mor Committee Report (2016) may be worthwhile as it made a case for strong NBFCs to enter as “differentiated banks or national banks, without abandoning their core capabilities”. 

But then again, it might be a bit late in the day. For now, it’s time to round up the usual suspects.

In a Majority of One

The reason why IL&FS fell through the regulatory cracks may be in the way it was imagined: It was neither an IDFC nor a Macquarie. It was a CIC with IL&FS Financial Services in its belly. The RBI’s focus was largely on these two but, given the non-deposit-taking nature of these businesses, a tad less intense. Units in transportation or power were not strictly in its domain. Debt and related issues fell both within the company’s and Securities and Exchange Board of India’s remit. 

It presented senior executives with a good life, which included first class international travel, dedicated rooms at guest houses to themselves, and golf kits kept readily available for each person. The emirs’ oasis is in trouble now.