IL&FS: India’s ‘Lehman’ moment?

Last September, roughly 10 years after the collapse of Lehman Brothers and the start of the Global Financial Crisis, Indian investors started wondering if they were experiencing their very own ‘Lehman moment’.

Infrastructure Leasing & Financial Services, one of the country’s largest infrastructure developers and financiers, announced at the end of August that up to 160 billion rupees ($2.1 billion; €1.9 billion) of the firm’s liquidity “was stuck in claims and termination payments”. Its net worth stood at 74 billion rupees, it said.

The company – which reportedly has a total debt burden of 910 billion rupees and is labelled a “systemically important” financial institution by the Reserve Bank of India – then proceeded to default on several payments. Once that happened, IL&FS’s liquidity crunch immediately raised fears about an impending crisis across the whole financial sector.

After weeks of uncertainty, the government intervened in early October to restore confidence, appointing a new board for the group, led by the renowned banker Uday Kotak, managing director of Kotak Mahindra Bank. It also ordered the Serious Fraud Investigation Office to launch an inquiry into the company and its subsidiaries.

Similarly, government-owned Life Insurance Corporation, IL&FS’s largest shareholder, came out publicly to assure that it will not allow the company to collapse, local media reported.

LIC did not reply to requests for comment from Infrastructure Investor.

“Because IL&FS is such an important institution, there was a concentrated effort in getting a new, reputable board that could reassure and convince the market that the defaults wouldn’t evolve into a collapse of the whole IL&FS [group] – and would get resolved in a timely and definitive manner,” Soumitra Majumdar, a partner at JSA, a law firm focused on India’s finance sector, explains.

Indeed, the appointment of the new board seems to have calmed markets, with the National Company Law Tribunal granting a moratorium on creditor legal action against IL&FS, to allow the new board to come up with a resolution plan for the cash-strapped company.

“The government sent a very strong signal to investors, that it would act decisively,” asserts an Indian fund manager, who asked to remain anonymous.

Despite this, the company’s liquidation is not yet off the table. And even if the firm’s creditors and the NCLT accept the recovery roadmap, it might take months of painful debt restructuring and portfolio divestments before IL&FS can stand on its own two feet again.

As it looks for a way forward, the country is trying to figure out how a company that was once described to us as a “financial behemoth” ended up becoming a ticking time bomb.

An unsustainable model

When asked what went wrong with IL&FS, most analysts point to a mismatch between the firm’s assets and its liabilities as the origin of the liquidity crunch. Put simply, IL&FS was resorting to short-term debt to finance long-term projects, an unsustainable model which echoes the behaviour of several firms pre-GFC.

But observers also point to the firm’s expansion away from its initial core business as one of the most significant underlying problems.

“IL&FS was meant to be a financial institution providing financing to the infrastructure sector, but they crossed over to become developers without having the expertise. That resulted in inflated project costs because of delays caused, potentially, by lack of experience in project development,” argues MK Sinha, GIP India’s managing partner.

IL&FS was created in 1987 to finance Indian infrastructure projects but as Sinha points out it became increasingly involved in the development of all kinds of assets. Over the years, the conglomerate created a complex network of 347 affiliated entities, according to a recent statement by the new board.

The firm credits itself with being a pioneer of the public-private partnership and build-own-operate-transfer models in India. Across the frameworks, it has been involved in the development of projects in the maritime and logistics, road, energy, renewables, and waste management sectors, among others.

Although the group argued in public statements that it could leverage its “ecosystem of competencies” and “varied skills” when developing infrastructure projects, pundits believe this model ended up becoming counterproductive.

Another Indian manager, who also asked to remain anonymous, says investors have become suspicious of platforms that develop and finance projects at the same time, due to inherent “conflicts of interest”.

“In the last five years, there has not been any sizable investment in any of the Indian contractor-backed [infrastructure] platforms like IL&FS,” the source says.

IL&FS declined to comment for this story.

Payment delays

Delays in the construction of some projects and payments due have also eroded IL&FS’s financial position. In August, the company said the government “had taken several measures to expedite settlements and streamline the process”, but warned that it would take “two to three years more” to have access to that capital.

“The government has been very lazy in releasing the money, creating mismatches in the cashflow [of the company],” Anuj Puri, chairman at AnaRock, an Indian real estate services firm, says.

Sources from the Ministry of Road Transports and Highways tell us that “some claims and counterclaims” emerged from road project payments, claims that, in some cases “have gone to arbitration”.

The source did not provide an estimate on the amount of money owed but says most of the disputes arose from unfinished projects awarded before 2014. In some cases, those projects had been approved before land had been made available, or all the necessary permits had been issued. In 2014, India’s Land Acquisition Act came into force, increasing land acquisition costs steeply for infrastructure developers and authorities.

Financial lenders, auditors and credit-rating agencies have also been criticised for not being careful enough when assessing the group’s leverage level. “IL&FS had a very credible name, and, on the back of that name, leverage was provided by banks without looking at the fundamentals behind the loans,” says Sinha.

The credit ratings of the group and its subsidiaries fell sharply in September. In a telling case, credit rating agency ICRA downgraded the rating for IL&FS Financial Services’ commercial paper twice in less than 10 days. The instrument plummeted from A1+ – the highest possible level – to D, meaning those instruments are expected to default on maturity.

CRISIL, India Ratings & Research and ICRA – three of the rating companies that graded IL&FS and its subsidiaries – declined to comment or did not reply to questions from Infrastructure Investor.

A bumpy road ahead

IL&FS’s new board has appointed Alvarez & Marsal, JM Financial Consultants and Arpwood Capital – which declined to comment for this story – as its new financial advisors, to help draft a resolution plan for the company.

In early November, the new board announced that resolution options could “broadly involve”, either individually or in combination, a “significant” capital infusion, divestments and debt restructuring at an asset, business or group level.

In August, the previous board announced it was hoping to raise up to 45 billion rupees through a new share issue. At the same time, the firm announced plans to sell 25 projects in a move that could “reduce overall debt by 30,000 rupees crore [300 billion rupees]”.

However, those plans were scrapped once the government-appointed board took over, with investors now waiting to see what the new resolution plan will look like. At the beginning of November, the new board said the resolution plan would be completed in six to nine months.

Managers contacted by Infrastructure Investor predict lenders will have to accept a haircut. All sources agree that an individual sale of company assets or some of its business-wide portfolios would generate strong interest among the current players in the Indian infrastructure space.

“It cannot be ruled out that a financially robust company takes over IL&FS as a whole, but what’s also possible is to sell the various assets on a piecemeal basis to different buyers,” Majumdar says.

The company holds a massive portfolio of assets that include more than 10,800 kilometres of operational roads, a portfolio of maritime and logistics assets valued at more than $2 billion, 2,870MW of operational energy assets and 840 kilometres of transmission lines, according to IL&FS’s 2016-17 annual report.

“The excitement with IL&FS is that you get almost free-risk assets, with no construction or development risk,” AnaRock’s Puri says.

Macquarie, Brookfield, Edelweiss, Lone Star and I Squared Capital were among the major companies named as possible bidders for an eventual sale of company assets. All the firms declined to comment for this story.

Towards a cleaner sector

Will IL&FS’s default hinder India’s ambitious infrastructure plans?

Although the company has played a crucial role in the market’s development, the fund managers we contacted believe IL&FS’s downfall indicates a move towards a healthier model, in which the Indian government undertakes some of the risks attached to greenfield assets.

“We are migrating to a model in which the government funds the construction and development of infrastructure projects […] and, once they are operational, they package them and transfer ownership to large investors,” Sinha says.

Another GP similarly points out that, during the past five years, private investors have transitioned from developing greenfield assets – usually alongside contractors – to more professionally driven platforms focused on operational assets.

“The majority of transactions in the past four or five years have been with independent asset-owning platforms, backed by funds with professional management, instead of contracting companies,” the source explains.

A 2016 reform to India’s bankruptcy guidelines has also helped to expose the non-performing players in the market, with many assets changing hands from distressed companies to international operators.

“A lot of genuine, good players are vying to get good, distressed assets, and this has become a good market for these activities,” JSA’s Majumdar says.

Sinha, for his part, believes that, far from a crisis, this is an opportunity that can boost the development of India’s infrastructure market: “Companies that relied on obfuscation in the past are being exposed and you see some large corporates taken into the bankruptcy court. I see this as the green shoots of a cleaner and more robust framework under which to operate,” he says.