It never ceases to amaze me as to why everyone looks to the Life Insurance Corporation (LIC) for a handout when the chips are down. The recent saga of Infrastructure Leasing & Financial Services Limited (IL&FS) defaulting on a short-term loan of Rs.1000 crores ($138 million) from Small Industries Development Bank of India (SIDBI) and a subsidiary missing a Rs.500 crores ($69 million) payment has set tongues wagging[1].
Why is LIC stepping in?
IL&FS was incorporated in 1987, initially promoted by the Central Bank of India (CBI), Housing Development Finance Corporation Limited (HDFC) and Unit Trust of India (UTI). Over the years, others such as the State Bank of India, LIC, ORIX Corporation Japan, and Abu Dhabi Investment Authority (ADIA) have invested. Figure 1 below shows the percentage holdings of the various entities:
Let us get one thing straight – this is a private body and as such should not be looking only to the LIC, a public sector undertaking, for a handout. It has been around for 30+ years, and a Rs.91,000 crores ($12.5 billion) debt could not have gone unnoticed. What was the Management thinking? More importantly what were the foreign investors such as ORIX and ADIA doing? Did they not see something amiss? Why should it be the responsibility of LIC alone?
What about the AAA rating given by rating agencies?
Till July, ICRA, CARE and India Ratings — rating agencies who have been monitoring the activities of IL&FS and its subsidiaries swore that IL&FS merited an AAA and suddenly they are now junk[2]! An entity cannot run up such debts instantly – either the ratings did not look do their job or they were “persuaded”. Either way that does not bode well. That the ratings were so far off the mark (that too three of them!) warrants an inquiry by investigative agencies. Why this is important is because now IL&FS intends to make up the shortfall by raising approximately Rs.45,000 crores from the public and about Rs.20,000 crores from institutions like the LIC.
Investigate IL&FS
If you look at the history of IL&FS, it has been managed by people like Deepak Parekh of HDFC, who is labeled as a person who calls a spade a spade. He was around for a long time, almost 20 years and should know a thing or two about how IL&FS has deteriorated to this level now[3]. Likewise, Ravi Parthasarathy, another veteran of IL&FS having been there for over twenty years may be able to answer how IL&FS is now staring at a 91,000 crores debt.
Where will IL&FS get the funding?
IL&FS hopes to raise Rs.45,000 crores from the share markets and a further Rs.20,000 crores from public institutions such as the LIC. This will still leave a deficit of Rs.26,000 crores. Before going to the market, they need to look at their business model. How leveraged are they?
Is IL&FS over-leveraged?
One look at Lehman Brother’s collapse will show that their leverage ratio (a measure of the ratio of assets to owners equity), increased from approximately 24:1 in 2003 to 31:1 by 2007. This means even a 3-4% decline in the value of the assets would have entirely eliminated its book value. And that is exactly what happened. In August 2007, Lehman closed its subprime lender, BNC Mortgage, and took a $25-million after-tax charge and a $27-million reduction in goodwill. This started a domino effect that ended on September 2008, when they declared bankruptcy[4].
Reliable sources are indicating that IL&FS too is currently over-leveraged (On paper it says 16:1 but it is typically twice that in a closed economy such as India). If this is true, the warning signs are all there.
The way forward
There are close to 40 subsidiaries in IL&FS. Before allowing any cash infusion, RBI should appoint an overseer to separate the grain from the chaff (meaning separate the profitable from the lossy units). Investment should come from every stakeholder (see Figure 1 above) instead of just LIC[5]. Don’t throw good money after bad. First deleverage the assets, bring in a more realistic valuation and then start a cash infusion. Knee-jerk reaction is a no-no.
Note:
1. The conversion rate used in this article is 1 USD = 72.74 Rupees.
References:
[1] IL&FS: Rs.91,000 crore debt that might well be a ticking bomb – Sep 25, 2018, Times of India
[2] Heat on rating agencies for failing to spot IL&FS’ liquidity crisis – Sep 20, 2018, Business Standard
[3] Infrastructure merger – May 11, 2003, suchetadalal.com
[4] Bankruptcy of Lehman Brothers – Wikipedia.org
[5] IL&FS will not be allowed to collapse, all options open: LIC chief – Sep 25, 2018, Economic Times of India
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