Company Background

IL&FS is an infrastructure and finance company headquartered in Mumbai, that has 169 subsidiaries, associates and joint ventures. Its subsidiaries, IL & FS financial services, and IL & FS Transportation networks India Limited reported loan defaults in September and July this year, respectively. IL&FS group's major stakeholders, as of March 2018, were LIC (25%), ORIX Corporation from Japan (23%), IL & FS Employees welfare trust (12%), Abu Dhabi investment authority (12%), HDFC Ltd (9%), Central Bank of India (7%) and State Bank of India (6%).

The company was started in 1987 to fund major infrastructure projects in the country. Its projects include Chennai-Nashri Tunnel, the country's longest highway tunnel. The stakeholding was opened to international holders gradually, to help provide better financing.

How did the mess unfold?

On 22 July, IL&FS Transportation Networks Limited (ITNL), that is the road development arm of the IL& FS Group, informed stock exchanges of its defaults in road and metro projects as a clarification on a series of debt down-gradations from credit agencies faced by it. The two SPVs (special purpose vehicles) of ITNL that were downgraded by ICRA that month were: Rapid Metrorail Gurgaon South Limited and Rapid Metrorail Gurgaon Limited.

In the same week, the IL&FS' founder, Ravi Parthasarathy said that he would be resigning from the position of chairman due to medical reasons, after heading the company for 30 years.

Subsequently, between July and September, the company and its subsidiaries reported multiple defaults on repayment obligations to its lenders. In the last week of September, it was informed that, IL & FS Financial Services Ltd (the non-banking finance arm of the group)  failed to pay short-term deposits amounting to Rs 52.43 crore due 27 September, a Rs 103.53 crore term deposit that was due on 25 September, and five bank loans worth Rs 284.5 crore including interest. This was made known to the stock exchanges a week after the firm's CEO and MD, Ramesh Bawa stepped down. It had also defaulted its credit obligation to IDBI Bank. Its standalone debt stood at Rs 17,000 crore.

ICRA had moved the IL&FS Financial Services' commercial papers worth Rs 4,000 crore earlier that month. It pushed the ratings of the group's debt instruments to as low as it can go.

For the period ended March 2018, the group's annual report shows losses before tax of Rs 2,110 crore. According to a Bloomberg report, the IL&FS group along with its associates has a total debt of $12.5 billion of which $500 million is due in the next 6 months.

How did the IL&FS crisis escalate?

The IL&FS commercial papers used to be rated A+ and promised high returns to its lenders, which in turn helped it accumulate $12.5 billion in debt. These loans funded long-term projects like roads, water-treatment plants, townships, all owned by companies operated by the IL&FS. All of this masked the liquidity crisis that would arise in the group.

It is also important to note that the IL&FS parent group is not listed on the stock exchange, but is only categorized as a "systemically important" non-banking financial firm by the Reserve Bank of India. Its subsidiaries are listed, however, an operator with 169 subsidiaries, associates and joint ventures with state governments is very complex for a credit-rating firm to keep any real oversight of.

Though the company is partially public and partially private, the risk exposure became majorly public. The $12.5 billion default may seem small in front of bad loans accumulated by state-run banks worth more than $200 billion, but these banks get a giant portion of funding from household deposits and have a strong interbank and central bank emergency liquidity control in place. A non-banking financial company like IL&FS, though partially public, does not have that kind of a bedding to fall on.

While the Indian authorities waited for the liquidity crisis to go out of hand, the markets reacted to the defaults. As mutual funds come with liquidity options to make them more attractive over bank deposits, these actively managed funds wanted to remove any exposure that they might have on non-banking finance companies (NBFCs) with low creditworthiness like IL&FS.

Further, credit rating companies, that were now hurt by their inability to sense the IL&FS' defaults, made hasty downgrades to avoid further investor criticism. This was followed by fund managers of MF's need to overcompensate and make things worse for healthy lenders in the non-banking finance sector. While DHFL was convincing the market that its condition was nothing like that of IL&FS and had surplus liquidity, panic in the market had already set its tone.

This is why the IL&FS default crisis is compared to being a mini-Lehman situation. With money-markets' risks spilled over into equities, the watchdogs, including the RBI and SEBI had to step in, to bail it out before it could do any further damage.

In order to seize any potential systemic disruption or a financial meltdown, the government has taken control over IL&FS and its units. It is the second time in 10 years, (first was Satyam Computers in 2009) that the government had to take such a step. It has superseded the IL&FS board (chaired by Kotak Mahindra Bank's MD Uday Kotak) under section 241(2) of the New Companies Act, 2013, to prevent it from further mismanagement in order to protect the public interest. It is working on plans to raise capital for the company.

In the 2008 financial crisis when the Lehman Brothers collapsed, the US government started an emergency bailout programme called the Troubled Asset Relief Program (TARP).