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Waiting for a miracle.
DEBT DEBACLE

Appointing a new board was easy—but fixing IL&FS won’t be

By Kamalika Ghosh

Watching the debt crisis unfold at Infrastructure Leasing & Financial Services (IL&FS), one can’t escape a sense of déjà vu.

It’s been less than a decade since the Indian government intervened to pull IT major Satyam Computer Services from the brink of collapse, and now, in a similar vein, it has stepped in to take control of IL&FS—the Mumbai-based infrastructure financing firm, whose debt defaults have spooked the financial markets.

On Oct. 01, the government announced that it is taking control of the management of IL&FS, whose loans and debentures have been downgraded to default status by rating agency ICRA. The Mumbai National Company Law Tribunal—a quasi-judicial body that decides on issues relating to Indian companies—allowed India’s ministry of corporate affairs to replace the company’s board with a new one.

“The financial mismanagement of IL&FS is apparent from its rapid debt build up and misrepresentation of the true state of financial fragility, which is being reflected in an unprecedented rating downgrade from highly rated to a default category,” the government said in a press release.

What makes the situation extraordinary is that, even though the liquidity problems of the company were known, no one was expecting a full-blown crisis, partly because of the stakes of government-owned entities in IL&FS. State-owned Life Insurance Corporation (LIC) is the biggest stakeholder with a 25.34 percent stake. Other stakeholders include lenders Central Bank of India (7.67%), and State Bank of India (6.42%).

“The liquidity problems were known, but people were not thinking about it because of the government names (backing IL&FS),” Nitin Bhasin, head of research at Ambit Institutional Equities, told the Financial Times.

The existing management of IL&FS has been replaced with a new six-member board, which will be helmed by Uday Kotak, managing director of Kotak Mahindra Bank.

Other members include Vineet Nayyar, executive vice chairman of the IT services company Tech Mahindra; GN Bajpai, former chief of India’s market regulator Securities and Exchange Board of India (SEBI); former ICICI Bank chairman GC Chaturvedi, and former IAS officers Malini Shankar and Nanda Kishore.

“This step (putting in place a new management) will give some comfort to creditors and lenders. There maybe a freeze on actions like payout of management salaries and payout of dividends that were declared at IL&FS’s annual general meeting (AGM) on Sept. 29. These are some things that they could consider immediately,” Shriram Subramanian, managing director at proxy advisory firm InGovern told Quartz.

In 2009, after Satyam Computers founder Ramalinga Raju had admitted to fraud, the government had appointed a new board of directors to take control of the firm. This subsequently led to a strategic stake sale in the company to Tech Mahindra, the IT arm of Mahindra and Mahindra (M&M). Today Tech Mahindra, which merged Satyam into its fold in 2013, is a thriving software services business.

But can the government do an encore at IL&FS with the new board led by Kotak? There are challenges.

A different beast

Despite the similarities with Satyam, IL&FS is a different beast.

What makes the situation particularly worrisome is the company’s complex structure—it has 169 subsidiaries, associates, and joint-venture companies. The 30-year-old IL&FS has reportedly helped develop and finance projects worth $25 billion in Asia’s fastest-growing economy. The shadow bank is a financial behemoth with assets in excess of Rs1.15 lakh crore ($16 billion) and debt of Rs91,000 crore.

The task for the new board, then, is cut out—to raise long-term equity to pull the company out of the woods.

That the government chose Kotak to lead the rescue team comes as no surprise. A veteran banker, Kotak has experience in shepherding a company through crises. He was in the thick of things when he led Kotak Mahindra bank through the tumultuous years post the collapse of Lehman Brothers in 2008. Under his leadership, Kotak Mahindra Bank is considerably insulated from the bad loans mess that peers in the public and private sectors are grappling with.

But even for Kotak, IL&FS might be a tough nut to crack.

The new board will have to figure a way to unravel the numerous subsidiaries and associate companies, which have over the years burgeoned under the parent IL&FS’s blessings. The firm and its subsidiaries will have to raise funds to settle current liabilities and meet future fund requirements.

The immediate task for the board would be to come up with a roadmap to arrange for the funds and to also re-examine the IL&FS business model of being both a financier and a developer of infrastructure projects.

To accomplish this, the new board is reportedly considering monetisation IL&FS’s assets to pay back investors and lenders. It also plans to sell as much as 24 projects to raise around Rs30,000 crore.

There might be legal tangles as well. The government has begun its probe to ascertain the nature of the financial transactions that lead to the defaults. The ministry of corporate affairs has asked the Serious Fraud Investigation Office to look into all the financial dealings of IL&FS to determine whether any malpractice was involved at any level.

So besides raising funds, the board may also have to order an audit to identify what went wrong and take action against those found responsible.

The new board at IL&FS, then, marks only the end of the first phase of the crises.