The IL&FS Fiasco And How It Impacts Common People

What is IL&amp FS issue?

Corporate bonds and long-term loans of IL&FS were downgraded to BB from AA+, a drop of 9 notches. On consolidating the holdings of open-ended debt funds, we find 18 debt funds had a total exposure of around Rs 2,500 crore (as on August 31, 2018) to the affected instruments.

The problems at IL&FS first came to light when analysts started questioning the ability of IL&FS to service the $500 million of debt that was payable in the next few months. IL&FS only had liquidity of around $27 million leaving it with a huge shortfall of close to $473 million. That was the time the problem first came to light. The SIDBI default was the trigger that set of a series of downgrades. But IL&FS has financed assets against these loans, so what is the problem. That is exactly the problem. Most of IL&FS assets are locked up in road assets or toll assets which are illiquid and cannot be monetized easily. Also, finding ready buyers would come at a huge cost in the form of haircuts. With the recent downgrade, IL&FS is unlikely to get funding from any of the institutions. The question is whether we could see another implosion in India?
Why IL&FS really matters

The problem with IL&FS is that it is not any other company. It is deep in debt and most of the funds are deployed in deep infrastructure assets with limited short term visibility. IL&FS is not a deposit taking company but funds itself through institutional money. The ripple effect could be huge. It has issued bonds to the tune of $12.5 billion and its buyers include insurance companies, provident funds and domestic mutual funds. In addition, the LIC has a 25% stake in the company and that also makes the company systemically important. How the situation is remedied remains to be seen even as IL&FS has put its BKC headquarters on the block. But then, there are bigger questions that come up here.

Here are the events describing to what exactly the IL& FS  crisis is all about and how it could affect people like you and me:

1) Infrastructure Leasing and Financial Services (IL&FS) is a major infrastructure financing and construction company. Till end September it had defaulted on debt obligations totalling Rs. 3,800 crores.

2) What happened? IL&FS is a private firm but with over 40% of the shares held by government-owned firms which means the government needs to ensure the solvency of IL&FS to maintain financial stability in the country. IL&FS has infrastructure and financial assets worth more than Rs. 1,15,000 or $15.77 billion but its debts are the result of "mismanaged borrowings in the past," the government has said.

3) How much debt, exactly? IL&FS and its subsidiaries have a total debt pile of nearly $12 billion or Rs. 91,000 crores. So is it Satyam 2.0? Not quite - or at least, not yet. Several references have been made to the 2009 scam when Satyam promoter Ramalinga Raju admitted to defrauding his company of over a billion dollars. On IL&FS, the government says the management had "lost total credibility" given the fact that "huge managerial pay-outs were made despite a looming cash crunch." The government has ordered a fraud inquiry for IL&FS.

4) So the government has this week replaced the board of IL&FS with six selected nominees and said it would ensure IL&FS has the liquidity needed to ensure no more defaults take place and the infrastructure projects are implemented smoothly. India has rarely stepped in to take control of a private company. The government's attempt to take control of real estate major Unitech Ltd. late last year was stalled by the Supreme Court. The new six-member IL&FS board will prepare a revival plan, but it is becoming clear some of its lenders will need to suffer major losses, claims Reuters.

5) Who or what is to blame? The government blames the board and management. Interestingly, Ravi Ramaswamy Parthasarathy who is one of the longest-serving Whole Time Directors resigned in July as the group's chief. Just weeks later, in August, group companies began defaulting on loan repayments to the tune of hundreds of crores. What - a business model where short-term loans were taken to pay for long-term projects and essentially, the long-term projects weren't earning enough or fast enough to pay off the short-term loans. It has now transpired that the company had leveraged itself 13x - "the borrowing of about Rs.91,000 crores is on the base of equity capital and reserves of about Rs. 6,950 crores", as per the government. 

6) The group needs about 4,000 crores fast to pay loans. That money is likely to come from LIC and SBI, state-owned firms which together hold over 30% equity in IL&FS. This may not seem much but remember that a massive, respected firm not being able to repay its loans has shaken the confidence of investors. Nobody is sure how deep or widespread is the rot. IL&FS had compromised on corporate governance and risk management norms, the government has said.

7) How does this affect the common person? While the 4,000 crores needed urgently to pay IL&FS' debts is really not much for cash-rich giants like LIC and SBI, the concern is how often will they be called to save too-big-to-fail firms? Recently, LIC began the takeover of IDBI for an estimated 13,000 crores to save the government bank from collapsing. Of course, LIC and SBI are cash rich on the back of, to a fair extent, small investors' savings. If you have investments in stock markets and equity mutual funds, these have taken a pounding in the last few weeks. In September alone, BSE-listed companies lost Rs. 14 lakh crore in market capitalisation.

8) Debt investments - from secure to shaky? Debt investments have been a by-word for secure returns. But IL&FS, which went from the top-most 'AAA' ratings to 'D' or Junk, has spooked investors into wondering if there is enough cash or liquidity in the markets in case they want to sell their investments or bonds in other corporations. Finance gurus have noted that the Public Provident Fund, that refuge of lakhs of small investors looking for a secure return of around 8%, has 'serious exposure' to IL&FS. Fixed income funds are another worry.

9) Has the government's response been swift? This is being hotly debated. On one hand the NDA blames the UPA, on the other questions are being raised how come government regulators failed to detect any sign of trouble in the last four year. That apart, on September 24th, a finance official said the group is independent of the government and it needs to resolve it's issues on its own. By the 30th the ministry was writing a panic-stricken note to replace the (mis)management. The take over happened within 24 hours.

10) What have IL&FS' big contributions been? The Delhi-Noida Toll Bridge, IL&FS Tamil Nadu Power Company, the all-weather tunnel in Patnitop between Jammu and Srinagar; among other nation-building projects, it's constructing the ambitious and challenging tunnel at Zoji-La at over 11,000 feet to make the Srinagar-Kargil road open even in winter. Which is why the government says if it doesn't have access to funds now it would be "quite damaging to the overall infrastructure sector, financial markets and the economy". Government support now should help to restore confidence, specially as it says other economic fundamentals are strong. However, add the IL&FS crisis to the weakening Rupee, rising oil and interest rates - and it isn't a pretty picture.