The following is an excerpt from noted journalist Tamal Bandyopadhyay’s latest book 'Pandemonium: The Great Indian Banking Tragedy. The book is a definitive insider story on the rot in India’s banking system – how many promoters easily swapped equity with debt as bank managements looked the other way to protect their balance sheets, until the RBI began waging a war against ballooning bad loans. It will be released on November 9.
If the rise of Infrastructure Leasing & Financial Services (IL&FS) defied all logic and the creation of this ‘business model’ broke all sorts of laws and regulations, there was a lot of mystery shrouding its fall as well.
On 24 July 2018, Ravi Parthasarathy, chairman and managing director of IL&FS, who had run the group with the authority and flamboyance of a promoter, stepped down like a professional manager, citing ill health.
A last-ditch attempt was made to raise funds that could have alleviated the liquidity crisis. This was through a rights issue. It is an even bigger mystery how and why this rights issue was aborted. The rights issue was approved at the company’s annual general meeting on 29 September 2018.
A resolution was passed to raise capital through a rights issue, to approach the National Company Law Tribunal (NCLT) for permission to sell assets, and generate liquidity to repay debtors. Hari Sankaran, the vice-chairman and managing director of IL&FS, unveiled this three-pronged strategy at its annual general meeting.
The Rs 4,500 crore rights issue was launched; a small amount from one shareholder did flow into an escrow account, kept with one of the lenders, which had given a short term-loan to IL&FS to tide over a temporary liquidity crisis. And yet, the rights issue was aborted. The lender was IndusInd Bank Ltd.
It had exposure to a few operating companies of the group, the largest account being a Rs750 crore loan to Chenani Nashri Tunnelway Ltd – this was classified as a standard asset. Who pulled the plug on the issue? And, why? Had it gone through, IL&FS could have continued to function as a ‘going concern’, giving it time to sell off assets at reasonable prices.
Apart from the rights issue, IL&FS also had plans to tap some lenders and equity holders for liquidity support of about Rs3,500 crore. Pending the rights issue and liquidity support, IL&FS approached IndusInd Bank for a short-term loan of Rs2,000 crore as it needed to meet running expenses and service debt. Several meetings were held at different levels.
The assets of the holding company were offered as security and the proceeds of the rights issue were earmarked as one of the repayment sources. IL&FS also offered to open the rights issue’s escrow account with IndusInd Bank.
Before disbursing the money, IndusInd Bank brass met the senior management of LIC, the largest shareholder of IL&FS, to revalidate its claim about the rights issue and collected no-objection certificates from the security trustee for taking the assets as security.
There was a catch, though. Even though the security document was signed, it was not registered due to the sudden turn of events and the board was superseded. In the absence of registration, it may not be easy for IndusInd Bank to recover the money it gave. But that’s a different story.
Valuation Collapse IL&FS was set up in 1987 by Central Bank of India, HDFC and Unit Trust of India. As of 31 March 2019, LIC was the largest shareholder in IL&FS with a stake of 25.34 per cent, followed by Orix Corporation of Japan (23.54 per cent), Abu Dhabi Investment Authority (12.56 per cent) and IL&FS Employees Welfare Trust (12 per cent).
Among others, HDFC held 9.02 per cent, Central Bank of India 7.67 per cent and State Bank of India 6.42 per cent. Three years before the default, the Piramal Group, a diversified group with a big presence in healthcare, life sciences, drug discovery, financial services and real estate, was looking to buy a big stake in IL&FS. But LIC put its foot down.
Piramal wanted to acquire a 35 per cent stake in IL&FS in a deal that could have offered a lifeline to the cash-strapped infrastructure lender. But LIC was not happy about the valuation. Piramal’s offer was at Rs740–750 per share but LIC was not willing to accept anything below Rs1,200.
Three years down the line, LIC chose not to subscribe to a rights issue priced at just Rs150 a share! A 34-page affidavit, filed with NCLT by Sankaran, said LIC’s decision in 2015 not to back the proposed merger with Piramal group worsened the crisis at IL&FS. The group was already facing a cash crunch due to delayed projects and problems with refinancing. Piramal’s entry would have generated Rs8,500 crore of investible funds in the entity.
The bulk of IL&FS’s debts increased from Rs48,671 crore in 2014 to Rs94,216 crore by October 2018 when the edifice crumbled. LIC which apparently had reservations about welcoming the Piramal Group on board watched the unsustainable growth of the infrastructure funding juggernaut. The state-owned insurer was busy ‘privatising’ IDBI Bank Ltd during that period.
Up to March 2019, the state-owned insurer had invested Rs24,078 crore to raise its stake in the bank to 51 per cent by infusing fresh capital. At the time of writing, in May 2020, the new board of IL&FS was able to complete the sale of only its wind energy assets. That sale helped lighten the outstanding debt of Rs94,000 crore by Rs4,300 crore. A Family of 347! India’s NBFC sector is a ‘shadow banking’ industry.
Similar ‘shadow banks’ exist in many Third World countries, notably China, Indonesia and Bangladesh, among others. These are financial institutions that borrow and lend funds for all sorts of projects. But as they are not banks, they are subject to light touch supervision and regulation. That has advantages since such firms can be nimble and take smart commercial decisions to create and exploit new markets.
But less regulation may also open the door to more creative accounting and fraud. IL&FS was registered as a ‘core investment company’ and grew into a group with businesses straddling infrastructure and financial services. It had 14 whollyowned subsidiaries (called intermediate holding companies) – ten for infrastructure and four for finance.
The group had its finger in every pie. It had exposures in airports, education, information technology, maritime, power, ports, roads, technology, turnkey contracts, water and waste management… You name it. Even within the power sector for example, it was present in every segment – solar, wind and thermal. Subsidiaries, joint ventures and associate companies in India and abroad ran these businesses. The group structure consisted of a maze of inter-connected companies.
Overall, IL&FS group consisted of 347 companies – 203 for transportation, the maximum number of companies for one sector, and one each for real estate and EPC, the minimum. There were 44 joint-venture companies, 19 associate companies and 110 entities to manage the activities of the group along with socalled third parties and government agencies. Of these, 113 entities were housed around the world – in China, Dubai, Mexico, Portugal, Spain, the US, etc. Some of these overseas entities have very intriguing profiles.
For instance, Se7en Factor Corporation, based in Seychelles, had Rs21 crore of assets and no turnover in 2018; Grusamar Albania SHPK in Albania was under liquidation in the financial year 2018; and Nigeria-based ITNL Africa Projects has had no operational revenues in all years since its inception in 2012. The Spanish subsidiary, Elsamex S.A., itself had 11 subsidiaries and 56 joint venture companies as per the 2017 annual report.
First Progress Report The ‘First Progress Report’ prepared by its new board, dated 30 October 2018, estimated the fund-based facilities (as of 8 October, 2018) at Rs94,215.6 crore. Of this, the parent held Rs18,052.5 crore, the intermediate holding companies Rs23,301.1 crore and the operating companies Rs52,862 crore. IL&FS and IFIN together had lent Rs31,247.3 crore to the subsidiaries, joint ventures and associates. The non-fund-based facilities such as letters of credit and bank guarantees (as of 30 September 2018) were pegged at Rs5,138 crore.
Overall, IL&FS’ exposure to group companies was Rs24,866 crore. It borrowed money to invest in equity in its group companies and gave intra-group loans to its subsidiaries and associates. This was a recipe for disaster as there was no return, in the absence of any cash flow in many subsidiaries. Going by the RBI norms, a core investment company can borrow up to 2.5 times its networth but IL&FS stretched it to many times more. It tapped every available source in its borrowings.
Lenders included public sector banks, private banks, foreign banks, financial institutions, NBFCs. It also raised money through market instruments such as NCDs and CPs. The public sector banks held more than one-third of the IL&FS debt…. The Serious Fraud Investigation Office (SFIO) looked into the activities of the group for the ten years until 2018. But there was muck even before 2008. Like Alexander the Great, Parthasarathy was trying to build a global financial empire.
In the process, he strayed a long way from the original mandate. Instead of being a catalyst for infrastructure creation, the group ended up owning scores of outfits working in completely unrelated fields. Why did IL&FS do this? The projects had problems at every level – the structure, funding pattern, leverage, and cost and delays. While the span of supervision got lost in the mesh of over 300 companies, board meetings hardly lasted beyond an hour, illustrating how casually this was ‘managed’.
The directors just danced to Parthasarathy’s tune. Who is to be blamed for the collapse of IL&FS? The responsibility must be shared between CEO, management, the board, auditors, rating agencies as well as equity holders, who had representatives on the board but allowed it to be run the way the ‘gang of nine’ wanted. The gang of nine – the group of directors – at the helm had ‘amassed multiple immovable properties’ and huge financial assets.
Nine directors and senior management persons, including Ravi Parthasarathy, chairman and managing director of IL&FS (non-executive chairman from October 2017); Hari Sankaran, vice chairman and managing director; Arun Kumar Saha, joint managing director and chief executive officer; and Vibhav Kapur, chief investment officer; exercised ‘control over the group’. All of them had been at the helm of affairs for over 20 years.
DHFL’s Date with Destiny Sixteen days after the IL&FS default, India’s fourth-largest mortgage financier among the NBFCs (some of the banks have bigger home loan portfolios), Dewan Housing Finance Corporation Ltd (DHFL), another triple-A rated company, had its date with destiny. On 21 September 2018, DSP Mutual Fund, a joint venture between Indiabased DSP Group and BlackRock Inc, an American investment management company, sold Rs300 crore worth of DHFL commercial paper at a discount.
This created panic in the debt market and sparked speculation that DHFL could be facing a liquidity crunch and headed for a default. The news of the sale triggered a 60 per cent fall in the DHFL share price intraday, prompting a probe by SEBI. The stock closed 43 per cent lower, dragging down other NBFC stocks as well. ‘The asset manager sold DHFL bonds at a net yield of 11 per cent compared with a coupon rate of 9.1 per cent at the time of issue.
The bond was sold at a steep discount in third week of September of 2018 (Rs100 bond was sold at Rs82),’ according to a finance ministry note to the corporate affairs ministry. The CP was maturing in June 2019. DSP MF sold the paper at a steep discount as it was facing redemption pressure. As on 31 August 2018, the DSP MF’s asset under management was Rs1.12 lakh crore. By 19 September, it had shrunk to Rs1.06 lakh crore – which was largely in line with redemption pressures across the debt mutual fund industry.
DSP Mutual Fund President Kalpen Parekh was quoted in the media as saying that the sale of the paper at higher rates was an interest rate call rather than a credit call. ‘With regards to the sale of NCD of DHFL, the last deal in the security happened at yield of 10.25–10.5 per cent. Since our volume was Rs300 crore, the yields went to 11 per cent. Even after this sale, we continue to hold Dewan Housing Finance paper worth around Rs800 crore in our debt portfolio.”
The Origin That was the beginning of the end for DHFL but what was behind this panic? DHFL’s maiden bond issue of secured non-convertible debentures (NCDs) for Rs1,000 crore, with an option to retain over-subscription up to Rs4,000 crore, saw demand of Rs18,586 crore when it closed on 4 August 2016. Kapil Wadhawan, its promoter and chairman of the board of directors, smelt an opportunity. Around the same time, another mortgage lender was looking for funds. Wadhawan wanted to queer the pitch for this rival.
DHFL immediately floated another public issue with a base size of Rs2,000 crore and an option to retain oversubscription up to Rs8,000 crore, to soak up all the available money. Opening on 29 August 2016, this issue mopped up Rs12,678 crore. Two years later in April 2018, an even bolder DHFL raised Rs1,000 crore by selling rupee-denominated bonds overseas – these were so-called masala bonds. Going by the Euro Medium Term Note (EMTN) programme filed by the company, it planned to raise up to Rs13,000 crore at the prevailing exchange rate through many tranches in that year. By any yardstick, these were all record collections.
Even before floating the masala bond, DHFL had started giving big loans to real estate developers and slum rehabilitation projects. It had sanctioned around Rs8,000 crore in loans towards slum rehabilitation and Rs20,000 crore to the developers. In the three years, between March 2015 and March 2018, DHFL’s assets almost doubled – from Rs54,638 crore to Rs1,07,572 core. Typically, the NCD issues earmarked 20 per cent each for qualified institutions and corporations and 30 per cent each for retail investors and high networth individuals.
Did these investors have a safety net? No. These were fully secured issues in theory but the ‘security’ was flawed. There was general and not specific collateral, beside a floating charge on the company’s assets. Unlike a fixed charge, which is created on a specific asset, a floating charge is created over receivables and stocks in general. The money raised through these debentures was used to fund both retail and wholesale assets. An end-use clause could have prevented the diversion of funds, as was discovered later. DHFL was one of the contenders vying to buy PNB Housing Finance Ltd, another mortgage lender.
An Economic Times report dated 12 September 2018 says seven bidders, including DHFL, submitted non-binding offers to acquire PNB Housing Finance in a deal estimated at around $2.3 billion. Was the timing of the sale of DHFL debt paper at a discount and the company’s bid for PNB Housing Finance purely a coincidence? … Staying Alive On 16 March 2019, the DHFL board approved the divestment of the company's entire 30 per cent shareholding in Avanse Financial Services Ltd to Olive Vine Investment, an affiliate of the Warburg Pincus Group.
Avanse Financial Services, an education-focused NBFC, is an associate enterprise of DHFL in which International Finance Corporation held 20 per cent equity stake. The RBI approved the sale on 4 June 2019. DHFL and its parent Wadhawan Global Capital also exited Aadhar Housing Finance Ltd, a specialised lender for low-income earners, on 10 June 2019 for about Rs2,200 crore. DHFL got Rs500 crore by selling its entire 9.15 per cent stake in Aadhar Housing.
The stake was sold to BCP Topco VII Pte Ltd, which is controlled by private equity funds managed by Blackstone. DHFL also exited the mutual fund industry by selling its 50 per cent stake in DHFL Pramerica Asset Managers to its joint venture partner Premerica. Apart from these deals, DHFL sold Rs2,000 crore worth of its loan portfolio to offshore investors in a transaction led by SC Lowy, a banking group based in Hong Kong. It also sold Rs1,375 crore of wholesale loans to foreign alternative investment management fund, Oaktree Capital, which buys distressed loan portfolios at a discount.
Between September 2018 and June 2019, DHFL shrunk its balance sheet from Rs1.15 lakh crore to Rs85,000 crore and it lived to tell the tale. In a regulatory filing on 25 June 2019, DHFL claimed that since September 2018, it had met liability obligations of over Rs41,000 crore. But it could not come back from the hole it had dug for itself. On 4 June, DHFL missed interest payment on NCDs. It did pay up after a week but the rating agencies did not wait.
On 5 June, DHFL was downgraded to default category. At least Rs750 crore worth of CPs was due for redemption that month and it was in talks with banks to arrange money for that. The default sounded the death knell for DHFL. By the time, India’s general elections got over and a new government (NDA-2) was in place.Pandemonium: The Great Indian Banking Tragedy by Tamal Bandyopadhyay, courtesy Roli Books. Releasing on November 9, 2020. Price Rs 695.