The government on Monday decided to takeover the management of IL&FS. The reason was a series of payment defaults by IL&FS and its subsidiaries to lenders. In other words the entire board of IL&FS was suspended and six new directors – including Uday Kotak and ICICI Bank’s G.C. Chaturvedi – were appointed to restore confidence in the financial markets
IL&FS has Rs 91,000 crore of debt and has been unable to repay loans in the last one month.
What is IL&FS?
Infrastructure Financing and Leasing Services Ltd (IL&FS) was set-up by government-controlled entities in 1980s as a small road building and operating firm. Its shareholders included Central Bank of India, Unit Trust of India and the Housing Development Finance Corp in the 1980s.
The government’s thrust on infrastructure like highways, roads, tunnels, affordable housing and renewable power generation grew over the years leading to a huge financing and development requirement. As a result IL&FS grew from a small road building and operating firm to an infrastructure giant in three decades.
IL&FS’s major shareholders include Life Insurance Corp of India (25.3%), State Bank of India (6.42%), Japan’s Orix Corp (23%) and the Abu Dhabi Investment Authority (12%) , according to the company’s website up to the end of the financial year to March 2018.
The problem
IL&FS won several of projects, either through direct bidding or joint ventures, but took on heavy debt to execute them. It set up subsidiaries including transportation network building subsidiary IL&FS Transportation Networks Ltd (ITNL), engineering and procurement company IL&FS Engineering and Construction Co Ltd and financier IL&FS Financial Services Ltd.
Until early August, it had a AAA rating from credit rating agencies largely thanks to its place at the centre of government infrastructure plans and its robust list of top shareholders, a fact that also helped IL&FS to secure funding from investors.
But the company ended up borrowing money that had to be paid back in the short term while revenues from its assets are skewed towards the longer term.
The first jolt came when IL&FS postponed a $350 million bonds issue in March due to demand for a higher yield from investors. Then, In June, came a string of rating downgrades. Though the board of IL&FS rushed to approve a rights issue of Rs 4500 crore to be completed by October, the company and its subsidiaries in August and September defaulted on term-deposits, short-term deposits, inter-corporate deposits, commercial paper and non-convertible debentures.
The defaults are alarming as they point to the possibility of a collapse. This will not only halt or at best delay the projects which IL&FS is developing, but also lead to a possibility of further defaults hitting mutual funds with exposure to IL&FS and its group companies. Moreover, it will lead to a redemption pressure spilling over to other shadow bank lenders.
This could create issues for the financial sector with a spill over effect on the economy.
Government control and its implications
So, the government’s control of IL&FS is a welcome step. The law ministry took the company to the Mumbai bench of National Company Law Tribunal (NCLT) on Monday, which suspended the entire IL&FS board. The government said in a release that the financial mismanagement of IL&FS was apparent from the rapid debt build-up and misrepresentation of the state of financial fragility, which is being reflected in the ratings downgrade from highly rated to a default category.
“Fresh funds will be infused when the new board comes up with a revival plan,” said Sanjay Shorey, joint legal director in the ministry of corporate affairs, who was representing the government before the tribunal.
The move sends multiple signals.
- The government now in control lenders are reassured that their outstanding loans to IL&FS will be repaid.
- Quell rumours due to which debt mutual funds had started facing redemption pressures from jittery investors.
- Stops the spread of systemic instability in – financial, money and capital markets.
- Clarity on the way forward – finalization of a restructuring plan, identification and valuation of assets, sale of the assets and repayment of outstanding loans.
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