Shishir Asthana
Infrastructure Leasing & Financial Services (IL&FS) is a case study of all that is wrong with infrastructure financing in India. The company that was at the forefront of infrastructure funding has been crushed under its weight. Poor management, a slowing economy and red tape have all played a role in its downfall.
IL&FS defaulted on inter-corporate deposits and commercial papers earlier this month. On September 4, it came to light that IL&FS had defaulted on a short-term loan of Rs 1,000 crore from SIDBI, while a subsidiary also defaulted on Rs 500 crore due to the development financial institution. While no action taken by IL&FS has come to light, SIDBI asked its chief general manager in charge of the risk management department to resign.
The stress on IL&FS' books was visible much before the institution defaulted. Unfortunately, not many risk managers, or for that matter, debt fund managers and rating agencies could see the writing on the wall. The commercial papers and bonds of IL&FS were downgraded only when the default took place.
Having said that, IL&FS is a difficult company to track. It does not have the most transparent annual report and few analysts track the company closely. Under the umbrella of the parent, there are 24 direct subsidiaries, 135 in-direct subsidiaries, six joint ventures, and four associate companies.
Over the years IL&FS’ shift in business model added to the complexity of the structure. The company shifted its focus from project sponsorship to that of project advisory and project facilitator for development and implementation of projects. From a financier of projects, it moved to own projects and building them.
What this complex model does to a company that was built as a finance company is create an asset-liability mismatch. Building and owning a big infrastructure project has a much different risk profile than financing a portion of a project. As an owner of the project, any delay would result in cost overruns which need to be funded either by the parent company or through borrowing from the market.
In the IL&FS case, most projects resided in special purpose vehicles (SPVs). These entities depended on the parent for funding. The source of funds for IL&FS was cash flows from its operations, borrowing from the market and concessions that the government gave for projects. While IL&FS stretched itself on generating funds and raising money from the market to feed its numerous subsidiaries, it claims it was let down by the government when it came to releasing funds as part of the concessions.
In its 2017-18 annual report, IL&FS puts the blame on the government in as many words: “Another hurdle has been the delay in decision making/passing of the buck at the relevant Authorities, especially with regards to compensating the Concessionaire / Contractor for delays and defaults on part of Authority.”
The report goes on to blame these delays as the reason for the huge cost overrun incurred by its unit IL&FS Transportation Network (ITNL). It also said ITNL did not receive funds owed to it from arbitration and settlement awards.
As per the 2018 annual report, receivables against service concession arrangements stood at over Rs 8,500 crore on a consolidated basis. Under concession contract, a private partner gets exclusive rights from the government to operate, maintain and sometimes even carry out investment in a public utility for a given period of time. Revenue to the private party comes from the user fee charged to users of the facility while the government gets a fixed sum or a percentage of revenue.
IL&FS management has said the figure is now as high as Rs 16,000 crore. Under ideal conditions, if IL&FS had received these amounts on time, it could have avoided the crisis.
That argument doesn’t cut much ice since any company that has a long history of operating in India knows the rules and pitfalls of the game. Where IL&FS faltered further was in adding projects despite the stress in its balance sheet. With projects getting delayed, the parent company borrowed from the market and passed on the money to the companies under its umbrella. With assets of these companies not yet being operational and some being low-yielding, stress was visible at many points in the balance sheet.
The consolidated debt of the company increased to Rs 91,091.3 crore in 2018 from Rs 48,671.3 crore in 2014. Interest outgo rose to Rs 7,922.8 crore from Rs 3,970.7 crore during the same period. However, operating profit increased at only half the pace to Rs 7,267.3 crore from Rs 5,087.4 crore. By 2018, the company was not even making enough profits to take care of its interest expense leading to the default.
A question worth asking is how did a company in the business of financial advisory in the infrastructure space not heed its own advice. Probably, the company did not want to let go of the growth opportunity that presented itself over the last four years.
Thankfully, IL&FS has enough assets in its books, including a posh office, to reduce debt levels and continue with its business. Experts have called for heads to roll and rightly so.
If a risk manager from a lender (SIDBI in this case) can lose his job for not raising the red flag, why should the board of IL&FS, that comprises of industry stalwarts, be allowed to continue managing a company which was run to the ground.
IL&FS not only needs a new office but a new team and a robust business model in order to stay relevant.
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