Last June, IL&FS group’s transport subsidiary IL&FS Transportation Networks (ITNL) delayed repayment of Rs 450 crore of inter-corporate deposits from Small Industries Development Bank of India (SIDBI), triggering a series of repayment defaults resulting in liquidity crisis in the financial services market & the situation has not been resolved till date. IL&FS and its subsidiaries owe Rs.99,354 crore i.e a massive exposure of Rs.1 lakh crores.
Let's discuss about IL&FS & its business model first.
Infrastructure Leasing & Financial Services Limited is or in fact was, one of India's leading infrastructure development and finance companies. It was registered with RBI as a "Core Investment Company" to provide finance and loans for major infrastructure projects.
IL&FS operates through a highly complex structure of subsidiaries with multiple business verticals & 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 short, IL&FS is a shadow bank, an NBFC which is not subject to complete & stringent regulatory oversight like banks are, hence the concept "Shadow Bank".
The initial reasons for series of repayment defaults that were cited by the market analysts & pundits were-
1) Asset Liability mismatch
This scenario is somewhat the primary flaw of the NBFC business model. NBFC's raise money through Bank borrowings, Bonds, NCD's (Non convertible debentures) & Commercial Paper & further lend this money for business or personal needs. What IL&FS did was that, It raised short-term funds & lent these funds out on long-term basis. So, ST funds repayment creates a bottleneck as company still hasn't been able to earn a return on it's LT lending. Simply put, salary credit hui nhi, but kharche shuru hogye!
2) IL&FS's over-dependence on PPP model (Public Private Partnership) didn't prove to be fruitful due to red tape involved. So projects were delayed till the point they became infeasible.
3) Post the enactment of LARR (Land acquisition, Rehabilitation & Resettlement Act), additional compensation to the tune of Rs.17,000 Crores had to be paid to the land owners which put extra burden over the company's already mounting repayment obligations.
But soon, MCA in consultation with RBI realized there's more to this than meets the eye.
The ministry soon launched a probe with it's investigation wing SFIO, to look into the same. NFRA too came into action to oversee the work of company's statutory auditors.
Shocking revelations were made during the investigation which is still ongoing.
1) There were inherent weaknesses in the financial statements of the group which was window dressed by the Management & not highlighted by Statutory Auditors.
2) Auditors never mentioned in their audit report about the material facts given in RBI's inspection report like negative cash flows, over-leveraged capital structure, adverse financial ratios etc.
3) No. of subsidiaries which were reported, in fact misreported were 169, against the actual no. of 348 which resulted in non-detection of circular rotation of funds among the group entities.
4) Inaccurate valuation of assets alongwith poor recognition of NPA's made it worse.
The new management that took over the co. on NCLT's order claimed that 90% of the advances were NPA's. The fact to be acknowledged here is that rating agencies like CARE & ICRA were already aware of the inherent weaknesses but never downgraded their ratings due to coercive tactics used by IL&FS's top guns. These agencies instead maintained their top ratings for the company & ratings were only downgraded after the first default. The same has been revealed in the exhaustive 787 page SFIO report.
5) At first instance, it seemed to be a liquidity issue due to Asset-Liability mismatch but soon became a solvency problem due to the fact that value of assets was way lower than the liabilities.
6) Forensic Audit carried out by Grant Thornton, one of the audit majors of the country, revealed another set of details-
(a) There were instances of advances without any collateral security which only indicates towards the possibility of personal favors & fraud.
(b) 107 cases of loan ever-greening were reported in report. To oversimplify it, new loans were granted to repay the old ones so that NPA's never find a place in the books.
The shocking & interesting part is that the engagement team and engagement partners of Deloitte, the then statutory auditors, had the awareness of the company's modus operandi of funding the defaulting borrowers for payment of interest and principal in a fraudulent manner by the management again and again to window dress the asset book of the company for several years. The auditor was thereby complicit in nature with the management.
The investigation team found a document in the email server of IL&FS prepared by the Deloitte's engagement team identifying the wrongful funding of borrowers.
(c) There were direct links between IL&FS & the borrower companies.
The promoters & directors of these borrower companies were part of the IL&FS management at that time or in the past.
In one such case, loans were advanced to former IL&FS senior manager & Siva group chairman, C Sivasankaran. His loans were ever-greened & repayments delayed. There 15 transactions of funds advancing but only 4 for repayments. Mr. Sivasankaran also arranged hospitality favors for 3 top executives of IL&FS which included foreign travels, private jets, resorts & even home decor for apartments in Brussels.
In a nutshell, it's really difficult for a retail investor to know what's actually going on in the company, the books aren't enough. Everyone can carry out an ex-post analysis but we can always have some useful basic takeaways from such instances. Mine are-
1) Look out for 3 P's- - Promoters - Process - Price (Cost of funds- lower the better) [Also depends upon credit rating of the NBFC]
2) Study structure of borrowings, its source & cost (i.e interest rate), its maturity (i.e analyse asset-liability mismatch).
3) Study portfolio of loans advanced i.e its asset side. You have to analyse the fact that on which particular sector(s), the NBFC is stressing upon & make decisions accordingly based upon your inferences that whether loans advanced are in safe hands or not.
4) Avoid NBFC stocks that are over-leveraged.
Leverage= AUM (Assets under management)/ Net Worth
(isse pta chlega ki debt ka level kitna hai) - 4-5x is desirable for NBFC's - 8-10x for private banks - 15-20x for public banks
5) Stress upon following ratios- - Cost of fund= Interest exp/ borrowings - Net Interest Income (NII)= Interest earned- interest expenses - Net Interest margin (NIM)= NII/AUM - Return on Asset (ROA) - Return on Equity (ROE) - Gross NPA, Net NPA & provisioning
6) Most importantly, carry out an extensive research w.r.t objectivity, integrity & competency of the top guns i.e the management.
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