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- What is IL&FS? IL&FS was floated by government-controlled entities, including the Central Bank of India, Unit Trust of India and the Housing Development Finance Corp in the 1980s. India needed huge infrastructure financing and development, and the company grew from a small road building and operating firm to an infra giant in 30 years.
- Very ambitious: The coming of NDA 2 and infra announcements made the firm very ambitious. It saw opportunities in building highways, roads, tunnels, affordable housing and renewable power generation across the country. It won many projects, either through direct bidding or joint ventures, but took on heavy debt as a result.
- Various subsidiaries: Its empire includes subsidiaries like – 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.
- Top notch shareholders: Until August 2018, it had an AAA rating from credit rating agencies largely thanks to its place at the centre of government infrastructure plans. IL&FS's major shareholders include state-backed LIC with 25.3 % stake, SBI with 6.42 %, Japan's Orix Corp holding 23 % and the Abu Dhabi Investment Authority with 12 %.
- The problems: The company piled up too much debt to be paid back in the short term while revenues from its assets are skewed towards the longer term.
- IL&FS first shocked markets when it postponed a $350 million bonds issuance in March due to demand for a higher yield from investors.
- Under increasing pressure from the RBI to identify and deal with bad loans quickly, the country's banks were wary of extending and rolling over loans if the credit risks were high. This made it difficult for IL&FS to refinance its debt as it came due.
- IL&FS' net debt to earnings before interest, tax, depreciation and amortisation, a measure of a company's ability to pay debt through its operating income, was around a ratio of 11 in March. Anything > 5 is bad!
- Then came a string of rating downgrades, beginning in June 2018. The board of IL&FS then rushed to approve a rights issue of 45 billion rupees by October 2018. The board also sought to recapitalise IL&FS Financial Services, ITNL and three more smaller subsidiaries. The rights issue will close in October 2018.
- The company said in its annual report that because many of company's claims and other payments involved government contracts it might take two-three years to get these resolved.
- GIFT city project: IL&FS is an anchor investor and co-developer of Gujarat International Finance Tec-City (GIFT), building 7.77 million square feet (msf) of commercial and residential space. Its ITNL subsidiary has the contract to build a 14.2-km tunnel to connect the northern city of Leh to Kashmir. The work is yet to start. The group is also the largest company in India constructing roads on a build-operate-transfer basis, with 26 operational and seven projects under construction. Its energy operation is developing up to 13,600 megawatts (MW) of capacity including 5000 MW from a solar park in a JVwith the Rajasthan govt.
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- Defaults and Contagion threats: IL&FS has revealed a series of delays and defaults on its debt obligations and inter-corporate deposits. Recently, IL&FS said it was unable to service its obligation towards a letter of credit to IDBI Bank Ltd. This immediately raised concerns about the possibility of further defaults hitting mutual funds with exposure to IL&FS and its group companies.
- Scale of the problem: Twelve asset management companies through 32 funds held an aggregate 22.83 billion rupees in debt securities of IL&FS and its subsidiaries at the end of August. Some of them have already marked down those investments as bond prices crashed, according to fund management sources. Investors are also worried about redemption pressure spilling over to other shadow bank lenders.
- Impact on Indian markets: The problems of IL&FS are quite real and some resolution is expected since the government, RBI and SEBI are very serious about it. Since IL&FS has defaulted on some payments, there has been a ripple effect, with DHFL when DSP sold some paper at a high yield and then rumours started and the sentiment was impacted. It will be relatively difficult for NBFCs to raise money at the right kind of pricing in the immediate future. That will trouble the market further.
- The immediate future: However, it is neither a small problem nor one with a quick fix solution and the system has to be prepared for meaningful losses from this episode. While a systemic intervention by RBI will help get emergency liquidity (to contain the contagion), the long-term problem is structural and the stakeholders will end up paying the price.
- Numbers are bad: The FY18 financials suggest the consolidated entity reported a loss. Its interest coverage ratio was just above one till FY17, indicating it was barely able to service its interest obligations. This dropped to 0.73 in FY18. In effect, the earnings are now insufficient to cover the interest the group has to pay.
- Structure of borrowings:
- Of the massive borrowings of Rs 91,000 crore close to Rs 25,784 crore of shorter term loans will have to be immediately rolled over.
- The company doesn’t earn enough to service interest and hence the repayment of principal is a tall ask. Post FY18 results, IL&FS’ short-term borrowings rose further, indicating their desperation to service long-term loans by borrowing short-term. IL&FS could borrow freely because their papers enjoyed a good credit rating before the default.
- The group’s exposure to myriad banks and financial institutions by way of term loans is close to Rs 53,816 crore. This is not a significant number (0.6 percent) in the context of the total system’s credit.
- Given the long-term unsustainable business model of IL&FS, Indian banking sector may be also staring at a hair-cut from its exposure to IL&FS. It is premature to hazard a guess on the quantum, but conservatively a figure of close to Rs 27,000 cr shouldn’t be a surprise.
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