ILFS Takeover by Government

Background of IL&FS
Infrastructure Leasing & Financial Services Limited (IL&FS) is an Indian infrastructure
development and finance company. It operates through more than 250 subsidiaries including
IL&FS Investment managers, IL&FS financial services and IL&FS Transportation networks
India Limited (ITNL). Its projects include some of the largest infrastructure projects in India
including India's longest tunnel, Chenani-Nashri Tunnel, which was opened for traffic in April
2017.

IL&FS has 256 group companies, including subsidiaries, joint venture companies and associate
entities. Though on the surface, the company appears to have 23 direct subsidiaries, 141 indirect
subsidiaries (including special purpose vehicles for different projects), 6 joint ventures and 4
associate companies, each of them is further subdivided into additional legal entities, with much
cross ownership as well as ownership by investment vehicles of various governments.

IL&FS has several projects in different sectors including Transportation, Area Development,
e-Governance, Health Initiatives, Cluster Development, Finance, Power, Ports, Water and Waste
Water, Urban Infrastructure, Environment, Education, and Tourism. In 2009, it became the new
promoter of the Maytas Infra Ltd. and in January 2011, Maytas Infra was taken over by IL&FS
and renamed to IL&FS Engineering and Construction Company Limited In September 2009, it
picked up a significant minority stake in the Reliance Industries' special economic zone project
in Haryana.

As of March 2018, the largest shareholders of IL&FS Investment services were as follows:

LIC: 25%
ORIX Corporation, Japan (a part of Mitsubishi Keiritsu): 23%
IL&FS Employees welfare trust: 12%
Abu Dhabi investment authority: 12%
HDFC Ltd: 9%
Central bank of India: 7%
State Bank of India: 6%
NBFCs and Risk of Default
The Non Banking Financial Companies (or NBFCs) are the institutions that offer many banking
services. However, they are different from banks as they do not have any banking license. The
further differentiating points from banks stand as under:

- They have no right to accept demand deposits whereas regular banks may accept these
deposits.
- NBFCs cannot issue cheques drawn on themselves as they are not a part of payment and
settlement system
- For depositors of NBFC, the deposit insurance facility of Deposit Insurance and Credit
Guarantee Corporation will not be available

As compared to banks, NBFCs are at a greater risk of default due to the following reasons:

1. Mounting Debt: The borrowing in these firms takes place through CPs and bonds.
According to RBI data, the CP borrowing went from Rs 46,200 crore (March’ 2014) to
Rs 1,26,700 crore (March’ 2017). As the share of Commercial Papers and bonds
constitutes over 40% of the capital mix of NBFCs, these pose a high risk.
 2. High Interest rates: When NBFCs stuck into crisis, interest rates rose globally (as well
as domestically). The reason for the push was a weak rupee and inflationary pressure.
Thus, when Infrastructure, Leasing and Financial Services company stuck into a
precarious situation, the the rupee was week and inflation was high. This lead to more
and more debt accumulation (which also happened with other NBFCs). This skewed the
balance sheet of these companies more towards the liability side, making the companies
risky in their respective operations.

3. Consumer Durable Loans: Market share has expanded in retail loans, credit cards and
affordable housing in the past two years. There is yet another segment cropping up in the
NBFC market loans: THE UNSECURED LOANS.
NBFCs have been going aggressively with accumulating assets. This has been narrowing
their liquidity to a drastic level. If the borrowers default at this point in time, the
companies may face a big blow, which will lead to a chain effect with unmatched
consequences.
It is expected by many industry experts that Indian Regulators will cancel licenses of
around 1500 small NBFC companies due to the fact that they do not have appropriate
capital. As some of the bigger companies have deep pockets, they may traverse the storm.
However, the new entrants will have a tough time to make their ends meet.

Why did ILFS default?

IL&FS had a total consolidated debt of Rs 91,000 crore and it started to miss deadlines on its
debt obligations. The first signs of trouble emerged in June 2018, when IL&FS started facing a
liquidity crunch, defaulted on inter-corporate deposits and failed to service its commercial papers
(borrowings) on due date worth about Rs 450 crore. After the first default, ICRA rating agency
issued a note reporting irregularities in debt servicing by four of its subsidiary IL&FS
Transportation Networks’ (ILTN) project special-purpose vehicles. A fifth project paid good on
its dues by utlising its debt service reserve.

In July, the board announced the resignation of Ravi Parthasarathy, the chairman and founder of
IL&FS. In August, ICRA downgraded the long-term rating on Rs 4,475 crore worth of debt
securities from AAA to AA+ due to the company’s elevated debt levels rising from funding
commitments towards Group ventures. Over the next few weeks, rating agencies like India
Ratings and CARE also abruptly downgraded IL&FS and its subsidiary’s long term ratings from
high investment grade (AA plus and A1 plus) to junk status, implying actual or imminent
default. As a result, the infrastructure giant no longer carried an investment grade rating which
made it difficult for the company to raise money in future.
The downgrades brought IL&FS under the radar of Reserve Bank of India. The company had
assets, and after its first default they had outlined plans which seemed credible, to bring things
back on track. However they couldn’t liquidate the assets on time to meet their debt obligations.
IL&FS yet again defaulted on a short-term loan from SIDBI (Small Industries Development
Bank of India), in September 2018.

Infrastructural development had become a key aspect in the past couple of decades and IL&FS
had the first mover advantage in lapping up projects. Gradually it built up a debt-to-equity ratio
of 18.7 and eventually ran short of cash when the time came to service those debts.

A major reason behind troubles of IL&FS was complications in land acquisition after the 2013
land acquisition law which made many of its projects unviable. The resulting dry up of new
infrastructural projects along with disputes over contracts locked in about Rs 90 billion of
payments due to the organisation by the government. It also suffered from soaring interest rates
for short-term borrowings. Cost escalation also led to many incomplete projects.

Some of IL&FS’s own construction projects, including roads and ports, faced cost overruns amid
delays in land acquisition and approvals. Out of the total debt of about Rs 91,000 crore, nearly
Rs 60,000 crore of debt was at project level, including road, power and water projects. In the
meantime, Ravi Parthasarathy, who had built the IL&FS Empire over the last three decades,
stepped down for health reasons in July.

IL&FS fell so spectacularly because it had lent to too many projects that went sour, one way or
another. Even though IL&FS had the required assets, the lack of timely action exacerbated the
problems. IL&FS also made plans to start selling assets. However, the sales couldn’t be
completed in time to avert a default. It was finding it difficult to raise funds after it started
defaulting and its credit ratings dropped. The company piled up too much debt to be paid back in
the short-term while revenues from its assets were skewed towards the longer term.

A key reason for this was the way IL&FS was structured. The gigantic debt of Rs 91,000 crore
by the IL&FS group had been accumulated through just Rs 9.83 crore of equity capital in the
unlisted parent company. Even though the other listed subsidiaries —IL&FS Engineering and
Construction Co., IL&FS Transportation Networks and IL&FS Financial Services — had their
own equity capital, short term debt was mostly raised by the parent company and infused as
equity in each subsidiary. The subsidiary would then use that equity (which was debt on the
parent IL&FS’s books) to raise more debt.

At IL&FS this created a mismatch between its assets and liabilities. Short-term money was being
used for infrastructure financing which is long term in nature and IL&FS started facing cash flow
issues and losses due to various projects being stuck at different stages of completion with claims
pending with the government. Almost 80 percent of its assets were long duration infrastructure
assets with receivable claims on them. At the same time, short-term debt and interest had to be
paid when it became due. Given the rising cost of capital and the fact that IL&FS projects were
taking longer than anticipated, the asset-liability mismatch accentuated.

Impact of the default and why the government took

over
The systemic disruption and a financial sector meltdown beginning forced the government to
take control of Infrastructure Leasing and Financial Services and its units by superseding the
current board. The move sends multiple signals. One, with government in control, it was a clear
reassurance to lenders that their outstanding loans to ILFS will be repaid. Two, it will stop the
spread of instability the interconnected financial system, especially when the panic had started
spreading across the financial markets. Finally, finalization of a restructuring plan and repayment
of outstanding loans.

The government committed itself to arrange adequate liquidity for ILFS to eliminate future
defaults which will ensure smooth implementation of infrastructure projects.

Some of the possible reasons or necessities for government takeover are:

1. Nearly two-thirds of the firm & accumulated debt of 910 billion rupees was from public sector
banks and therefore it was critical to save ILFS. Apart from this, “ILFS accounts
for 16 percent of the total exposure of banks to India’s non-banking financial companies
(NBFCs)”, the government said in the petition.

2. Big part of ilfs was owned by public companies, that’s why it was necessary for the govt
to take charge and stop further financial defaults and also take measures to resolve
defaulted dues to the claimants

3. ILFS has infrastructure and financial assets worth more than 1.15 trillion rupees but its
debts are the result of mismanaged borrowings in the past as per government.
That’s why government fears that ILFS’s inability to finance and support the projects
could damage the infrastructure sector.

4. The ministry warned that “Mutual funds had an exposure of 28 billion rupees to ILFS bonds
and were likely to face redemption pressure from their corporate clients following the ILFS
episode,” according to the petition. Because of this the government feared that it could trigger an
Indian debt market sell-off if mutual funds resorted to selling government securities because of
an illiquid corporate debt market.

6. The defaults in payments by certain group entities of ILFS have triggered fears of
liquidity crisis in the financial markets. Government takeover was necessary to protect
the public trust on NBFCs in India.

The Process of Takeover by Government

The govt stepped in to take control of ILFS by moving the National Company Law Tribunal
(NCLT) to replace and reconstitute the board of the firm which has defaulted on a series of its
debt payments. They invoked the Article 241(2) of the Companies Act, 2013 for superseding the
board. This was an attempt to restore the confidence of financial markets in the trustworthiness
and solvency of the ILFS group. Government also unveiled an investigation into IL&FS’s
management by the Serious Fraud Investigation Office (SFIO). This makes it only the second
time in history of corporate law in India (i.e., since the enactment of the first Companies Act,
1913), that the government of India has taken over a non-government company using provisions
of the Companies Act (all other actions have been through nationalisation, the era for which
ended with liberalization in the 1990s).

The tribunal approved the government’s proposal to bring in a new six-member board to run the
affairs at IL&FS. Its members are: Uday Kotak, Vice Chairman and MD of Kotak Mahindra
Bank; retired IAS officer Vineet Nayyar; former Sebi and LIC Chairman G N Bajpai;
former IAS officer and ICICI’s non-executive chairperson G C Chaturvedi; Director
General of Shipping and Maharashtra cadre IAS officer Malini Shankar and former
Deputy Comptroller and Auditor General (CAG) Nand Kishore. The control of the company
was given to the six-member board headed by leading Indian banker Uday Kotak.
The new board members unanimously elected Vineet Nayyar as the Vice-chairman and MD of
the Infrastructure Leasing & Financial Services (IL&FS).

The new board reviewed the operations and funding plan of the IL&FS group and worked out a
restructuring proposal. It was also likely to revamp the boards of subsidiaries and associate
companies. The total liabilities of the IL&FS group stand at Rs 91,000 crore with most of its
operating assets owned by its 169 direct and indirect subsidiaries.
The revelation of serious corporate related deficiencies made it necessary for the govt to change
the management and the governance in the ILFS group in order to save it from a financial
collapse.

The finance ministry issued a secret note stating that it was concerned that merely 2800 crore of
ILFS securities owned by mutual funds could trigger a chain reaction amongst the investors. This
might derail the government’s borrowing plan.

Consequences of the Govt takeover

The move sends multiple signals.
1) With the government now in control, it is a clear reassurance to lenders that their
outstanding loans to IL&FS will be repaid.
2) It will help in ending rumours that debt mutual funds had started facing redemption
pressures from nervous investors.
3) It will effectively stop the spread of systemic instability in an interconnected financial
system, especially as panic had started pervading across the financial, money and capital
markets.
4) There is clarity on the way forward: finalization of a restructuring plan, identification and
valuation of assets, sale of the assets and repayment of outstanding loans.
The Future path
The company proposed to raise funds from shareholders and offload assets to reach solvency
after series of defaults. Following are the plans that was decided by the company-

● Plan to raise INR 4500 crores through rights issue to recapitalize the company
● The second is to sell assets accumulated to repay creditors and maintain liquidity

Further, in the meeting three key decisions were made as follows:

● The board will persist in their application under section 230 to ensure the firm’s
moratorium to issue debt and securities to satisfy the investors
● The board is to prepare a restructuring plan to regain the investor’s confidence
● IL&FS has appointed Alvarez and Marsal to implement the above-mentioned plan

The crux of all the steps taken by the board was to bailout the company from current debt burden
and save it from going down

References and Citations

1. https://www.investopedia.com/terms/n/nbfcs.asp
2. http://www.mondaq.com/india/x/743970/Corporate+Commercial+Law/The+government
+takeover+of+ILFS+is+unlike+Satyams+Here+is+why
3. https://timesofindia.indiatimes.com
4. https://www.moneycontrol.com/news/business/companies/debt-and-defaults-what-happe
ned-to-ilfs-2952381.html
5. //economictimes.indiatimes.com/articleshow/66026024.cms?utm_source=contentofintere
st&utm_medium=text&utm_campaign=cppst
6. https://www.bloombergquint.com/business/the-indian-debt-default-that-s-got-everyone-w
orried-quicktake#gs.SaXLYlpA
7. https://scroll.in/article/896729/why-il-fs-went-bust-and-what-it-means-for-the-health-of-i
ndias-financial-system
8. https://indianexpress.com/article/explained/ilfs-defaults-nbfc-whiplash-understanding-the
-debt-market-crisis-5374379/