What is the way ahead for Infrastructure Leasing & Financial Services Ltd (IL&FS)? One approach is to treat it as a private matter that the company and its creditors will resolve. The bankruptcy courts are there if it comes to that. But that way will lead to disaster.
IL&FS: Somebody has to catch this falling knife soon
The company’s investments are chiefly in public assets—infrastructure projects. Banks and financial institutions have lent money not just to IL&FS, but also to these projects. Financial firms hold not just equity in its various arms, but also its debt papers. Moody’s Investors Service estimated that IL&FS’s bank loan exposure was 0.5-0.7% of banking system loans, while its outstanding debentures and commercial paper accounted for 1% and 2%, respectively of the domestic corporate debt market. Allowing the firm to head to the bankruptcy court will be an unmitigated folly.
Last Friday brought a glimpse of how capital markets could seize up if panic spreads. While nobody knows what spooked the markets, one fear was funds holding IL&FS in their debt/equity portfolio could sell other investments to maintain sufficient liquidity.
The immediate need is to restore confidence. IL&FS has a strong set of institutional shareholders, and so far there are no allegations of any frauds committed. But the current situation is certainly a case of mismanagement. That shareholders recognized this, belatedly though, explains why a spate of management exits has happened.
But it is not enough to replace them with candidates from within. The situation calls for an external appointment at the helm, a respected name in the financial markets, especially among regulators, lenders and the government. This person should get a free hand to appoint a new team and clean up the mess. This will be a key step in restoring confidence.
The next near-term priority is providing liquidity. IL&FS will seek shareholder approval to raise money through a rights issue and also hike its borrowing limit at its annual general meeting on 29 September. While the rights issue may get approved, it has to be subscribed to. If the main shareholders publicly commit to investing in IL&FS (something they have not done, so far) that can be a strong vote of confidence. This money can ease the group’s liquidity crisis. A new management, equity infusion and repayment of defaulted loans could reopen the liquidity taps.
Then, IL&FS also intends to liquidate operational assets such as stakes in infrastructure projects. But this may not be easy. Recently, a lender got an interim stay on a disposal of investment in two infrastructure projects. More lenders may move to protect their interests in individual projects. IL&FS itself has given a commitment to lenders and equity partners to not sell its stake in several projects. It will need to negotiate permissions from these parties to sell its stake in such assets. Again, a strong management will be able to do a good job here.
A comprehensive debt restructuring scheme can also give it more time to repay liabilities maturing in the next year or two. This will address problems caused by delays in its infrastructure projects and therefore, cash flows needed to service maturing debt.
While the government and regulators need not get directly involved in the rescue, they can play an indirect role. The firm claims that it has not been paid for several infrastructure projects, which is one of the main reasons for its defaults. The government could ensure that genuine problems are looked into and money due is paid quickly. Regulatory approvals for divestments could be expedited, so that these proceeds can be used to repay debt.
Lastly, there is a need to revisit IL&FS’s model of taking exposure to both project execution and financing. While a more robust risk management system could help, exiting one of the two or splitting them into delinked firms could be another solution. It can’t afford a repeat of this situation.