Rating agencies had red-flagged excessive leverage of IL&FS and its arms

A number of rating agencies had been flagging the excessive leverage of Infrastructure Leasing & Financial Services (IL&FS) and its arms for over a year before the crisis finally hit home.

A look at rating notes issued before the defaults show leverage and liquidity emerging as key risks for the company and its arms. Getting strategic partners, and selling off its assets were seen as important to meet future obligations. However, the plans either did not materialise or took too long to benefit the company.

The IL&FS Group has undergone multiple defaults following liquidity issues in recent times. This has led to a crisis in fixed income markets and severe reactions in equities on account of fears of contagion to other lenders.

Major rating agencies had seen the worries at IL&FS and its subsidiaries though sharp downgrades only happened recently.

“Going forward, considering the high leverage levels; IL&FS’ rating will remain sensitive to its ability to monetise its assets in a timely manner, achieve commensurate returns on investments while also preventing any breach in limits (as mandated by regulations) on leverage levels,” said Icra’s March 27, 2018 rating report on the parent company.

“…going  forward, the induction of strategic partners/sale of investments would be critical for IL&FS to manage its leverage levels within regulatory limits and also support its group companies,” said the May 10, 2017 press note from Credit Analysis & Research on IL&FS.

This in turn was seen to have an impact on the finances of a subsidiary such as IL&FS Financial Services (IFIN).

“IFIN’s ratings are linked with those of IL&FS. Any downward movement in IL&FS’s ratings will lead to a similar movement in IFIN’s ratings… In addition, high delinquencies or continued elevated leverage of IFIN, which, in the agency’s view, requires a quantum of support that is considered onerous for IL&FS, can lead to a rating downgrade,” said the India Ratings and Research press release on IFIN and its debt instruments on October 5, 2017.

A senior official with one of the rating agencies said the company was expected to get liquidity through additional equity and a credit line from shareholders. “Since this didn’t materialise, everyone was caught on the wrong foot,” the official said.

The fact remains that the agencies did not flag the issues in time for investors to avoid losses on account of the default.

J N Gupta, co-founder and managing director at corporate governance firm Stakeholders Empowerment Services, pointed to similar events in 2008, when ratings agencies were blamed for not identifying problems with sub-prime derivative instruments which later went on to cause the global financial crisis. The current issues would suggest that there has been no change in a decade. “We are back to square one,” he said.

It cannot be considered normal course of business for ratings agencies to cut ratings so quickly from the highest to the lowest grade so quickly, he added.

Shriram Subramanian, founder and managing director of domestic proxy advisor InGovern Research Services, blamed the business model where the company pays to get itself rated. “If investors were paying, they would be much more watchful,” he said.

Emails sent to the ratings agencies remained unanswered.