This is week MFs: IL&FS rating downgrade makes industry nervous

IL&FS (Infrastructure Leasing and Financial Services) finances and develops infrastructure across the country, on its own and through a range of group companies. The group is among the largest in the infrastructure space, both on lending and on development.

On September 8, rating agency ICRA downgraded debt papers of IL&FS by several notches, across maturities. Other rating agencies such as CARE have also downgraded papers of IL&FS and its group companies.

Commercial papers (CPs) are short-term instruments of less than a year’s maturity. IL&FS and its subsidiaries IL&FS Financial Services delayed on inter-corporate deposits and commercial papers last week.

Owing to this and an increase in liquidity pressure on IL&FS, its ratings were downgraded. Further, because IL&FS is a major source of funding and expertise support for its group companies, the parent’s liquidity pressures caused a downgrade in group companies as well.

Debt downgrades are not rare, especially when companies find it hard to meet obligations. However, what’s different about the IL&FS downgrade was its steepness and swiftness.

Consider this: long-term debt facilities of IL&FS dropped from AA+ (investment grade) to BB (below investment grade). Please note that the SEBI’s new categorization consider AA+ and above as superior quality credit. Short-term debt was marked to A4, down from A1+ which is the highest credit quality.

What is the impact?

A downgrade in credit rating sends the bond’s price down – this either reflects in market price in traded bonds or rating agencies revalue the bonds. This means there is a mark-to-market loss that debt funds take, much like equity shares.

The extent of the fall depends on the nature of the downgrade. In this case, because the downgrade was steep — from a top rating into below investment grade, the mark-to-market hit on prices was pronounced.

According to fund houses, mutual fund schemes with exposure to IL&FS and IL&FS Financial Services had to take a 25 percent markdown in the price of their holding in these instruments.

The hit to bond prices and NAVs comes for CPs and debentures with maturity dates of September 10 and later as the downgrade took place on the evening September 8.

Fourteen of these schemes, as on August 31, had two percent or more of their assets invested in the debt securities of IL&FS and its group companies.

Tata Short Term Bond Fund had a Rs 170 crore exposure to commercial papers of Infrastructure Leasing & Financial Services, amounting to 3.2 percent of its assets, while Tata Money Market Fund had exposure worth Rs 49 crore, amounting to 2.3 percent of its total assets.

BOI AXA Credit Risk Fund had Rs 100 crore investment in the company's commercial paper and it made up for 6.1 percent of its total assets. Principal Mutual Fund had collective exposure worth Rs 73.51 crore in its portfolio.

What is the outlook?

IL&FS has been cognizant of its liquidity issues. The company had the approval to conduct a rights issue of up to Rs 4,500 crore; reports peg a larger issue being considered by the company’s board. IL&FS counts LIC, SBI, Abu Dhabi Investment Authority and HDFC among its shareholders.

Cash-starved IL&FS may also get a helping hand from Life Insurance Corporation of India (LIC) in the form of a loan in the range of Rs 700-800 crore. But it comes with riders, which includes IL&FS showing a clear roadmap for reducing debt in the next three months.

The LIC loan is part of the Rs 3,000-crore fundraising proposal that the troubled company's board will be taking up to discuss in Saturday's meeting. The board will also explore options to reduce the financial stress on IL&FS.

Sources also said that Insurance Regulatory and Development Authority of India (IRDAI) is keeping a close watch on the situation, but is yet to instruct LIC on its investments in IL&FS and group companies.

LIC is the largest shareholder in IL&FS with 25.34 percent stake as on March 31, 2018. According to insurance regulatory rules, an insurance company cannot have more than 15 percent stake in a single entity but can seek IRDAI exemption for specific transactions.