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Event update: Financials; IL&FS –A positive step, but haircuts likely

The government has taken a big, positive initial step on the ILFS problem. On the government’s plea, NCLT has allowed it to supersede the board of IL&FS under Section 241 of the Companies Act. The government has replaced the earlier IL&FS Board with six new directors, each of whom is very well-regarded.

As background, the IL&FS group is engaged in infrastructure and financial services with as many as 169 group companies. The consolidated debt is huge at Rs911bn. The company was rated AAA till August when it started defaulting on repayments. As a result, the parent and many group companies have been downgraded by several notches by rating agencies. The IL&FS downgrades have had repercussions on India’s debt market where a breakdown of investor confidence has led to a severe liquidity crunch for NBFCs.

Here’s our take on the IL&FS situation following a new board being appointed:

A credible Board will help justify capital infusion by existing shareholders: If the government would not have superseded the Board, it would be very difficult for existing shareholders to infuse more funds into the company. Already the Congress had started criticising the central government for planning to use public funds to fund a private company. There was also a possibility of a PIL being filed which would have made it impossible for LIC and SBI to put in more equity or debt into the company as it would be akin to putting more good money after bad. There is a proposal that three existing shareholders - LIC, SBI and Orix will infuse Rs45bn of equity through a rights issue into IL&FS. There were also media reports that IL&FS is seeking fresh credit lines of Rs30bn from LIC and SBI to tide over its liquidity issue. This would not have been possible if the earlier Board was not suspended. With a new and credible Board, there can be a justification for existing shareholders to infuse more equity capital and debt.

But banks may still have to take haircuts and classify their exposures as NPLs: We believe there is no magic fix to the huge leverage that IL&FS has built on its books. The change in Board will ensure an immediate fund infusion of 75bn (Rs45bn of rights and Rs30bn of debt). Based on the annual report of FY18, we understand that IL&FS needs funds of Rs335bn for the fiscal year 2019. While IL&FS has already identified assets worth Rs160bn for monetization, these sales will take at least 18 months. So we do not see the funding crunch being resolved easily though the government has taken a big, positive initial step. Banks can restructure / grant moratorium on debt maturing in FY19 as a resolution, but for that the exposure may have to be classified as NPL first. Also, lenders will likely have to take a haircut on their debt.

Total debt of IL&FS is Rs910bn of which banks and FIs have lent Rs575bn. Of the total bank debt, 90% is secured and 10% is unsecured. Exposure to the IL&FS group is standard and performing for banks. Also, it is not part of the watch list for any bank. As such, if this account slips it will be part of undisclosed stress.

New board members: The board was replaced with a new six-member panel headed by Managing Director of Kotak Mahindra Bank Uday Kotak. He will be joined by ICICI chairman GC Chaturvedi, former vice-chairman of Tech Mahindra Vineet Nayyar, former Sebi chairman GN Bajpai and bureaucrats Malini Shankar and Nand Kishore.

Timeline of action: The NCLT has asked the new Board to hold its meeting by October 8 and come up with a road map before the next hearing on Oct-31. 

Bloomberg Quint article: The government used the example of Satyam Computers as one of its arguments in favour of superseding the ILFS Board. In 2009, the UPA government stepped in to take  over the affairs of Satyam Computers after its promoter confessed to fudging accounts. The government appointed a 3 member team headed by Deepak Parekh to take charge and sell the company.  Here’s an article of Bloomberg Quint which carries an interview with one of the new Board members of IL&FS. The interview highlights some distinctions between the Satyam case and the IL&FS problem.