Uday Kotak will have to move with skill and speed 

In its petition to the National Company Law Tribunal seeking the sacking of the board of IL&FS, the government accused the management of “negligence and incompetence.” Those adjectives do not mesh with its other observations that the top managers of non-banking finance company (NBCC) presented a ‘rosy picture” by “camouflaging its financial statements’ to hide the “severe mismatch between its cash flows and payment obligations.” But it is right in holding them in contempt of their fiduciary duties to the various stakeholders.

Ravi Parthasarathy, who founded the group in 1987, is considered a financial wizard. An ex-Citibanker, he resigned from IL&FS on July 21 after 30 years as non-executive chairman on health grounds. He is a pioneer in leasing and in structuring deals which is a reason why he was reportedly picked by Deepak Parekh, the chairman of HDFC to head IL&FS. HDFC, a founder of IL&FS along with Central Bank of India and Unit Trust of India (now Axis Bank), currently has a 9% stake in the company. LIC of India, ORIX Corporation of Japan and Abu Dhabi Investment Authority came in later and are bigger shareholders.

The 9.2-km Delhi-Noida Delhi tollway shows the best and worst of IL&FS. Completed in 2001, it provided a much-needed link between Noida and south Delhi. It was among the first few infrastructures to be developed in public private partnership (PPP) and was presented as a showcase project where private capital could be tapped to provide public goods. It was financed with $30 million in equity and $70 million in long-term debt, which were successfully raised.

But the contract was one-sided. It is not clear whether this was due to the connivance of officials or their ignorance of matters financial. IL&FS was to get a return of 20% on investment (not just equity). This included the cost of construction and major maintenance costs. The shortfall in returns in any year would be added to the project cost. The rate of return was applicable to the debt component was well. In 2002, the lenders took a haircut and brought down the interest rate from 14.7% to an average 8.5%. But the company continued to earn 20% of return on borrowed capital. In 2016, the Allahabad High Court found the deal so egregious that it cancelled the concession of Noida Toll Bridge Company, a subsidiary of IL&FS, in response to a public interest suit. It noted that the project cost of ₹325 crore at the time of completion in 2001 had swelled to more than ₹5,000 crore because of the formula IL&FS had employed. The company had collected ₹810 crore in tolls by 2014, yet wanted the initial concession period of 30 years to be extended to 100 years so it could recover its investment.

Gajendra Haldea, a retired IAS officer, who was adviser to Montek Singh Ahluwalia, the former Deputy Chairman of the erstwhile Planning Commission, calls IL&FS an unholy alliance of bankers and retired IAS officers. Many of its projects, he says, are negotiated deals. Some of them were first of their kind to be attempted by the private sector, like the RauPithampur bypass road project in Madhya Pradesh, or the 65-km-long pipeline to bring drinking and industrial water from the Cauvery to the hosiery town of Tirupur. There were no bidders for them, so they were awarded on nomination basis.

When this writer met Parthasarathy in the early 1990s, he asked not to be quoted. Indeed Parthasarathy was wary of publicity and kept a low profile. But he was good at building relationships and IL&FS was the preferred partner whether for the development of Gujarat International Finance Tec City, which was Narendra Modi’s dream project as Chief Minister to relocate the Gujarati-dominated financial services industry from Mumbai to Ahmedabad or to take over the assets of Maytas (Satyam in reverse), a property development firm, after its promoter Ramalinga Raju confessed to defrauding Satyam Computer Services in January 2009.

Over the years, IL&FS became a sprawl of 169 companies of which 24 are direct subsidiaries, 135 indirect ones, six joint ventures and four associates. Apart from financial services, the group was engaged in township development, waste management, wind, solar and thermal power production, port, airport and highway development. In short, it grabbed every opportunity in the infrastructure field.

In 2008, IL&FS restructured and converted itself into a holding company after spinning off its lending and advisory business into a subsidiary called IL&FS Financial Services. The holding company is as a systemically-important NBFC - which means its financial stability has a bearing on the overall economy – and a core investment company as per RBI norms. Six of the companies account for 60% of the assets of the group. Of these, IL&FS Transport Network and IL&FS Financial Services made profit after tax of ₹124 crore and nearly ₹100 crore respectively in the last financial year. The other four companies – IL&FS Energy Development, IL&FS Tamil Nadu Power, Noida Toll Bridge Company and IL&FS Engineering and Construction made losses of ₹560 crore.

Among the group’s other big losers last year were two companies running Gurgaon’s Rapid Metro (loss of ₹386 crore), IL&FS Maritime Infrastructure Company (₹317 crore), Charminar RoboPark (₹206 crore), MP Border Checkposts Development Company (₹171 crore), IL&FS Township & Urban Assets (₹114 crore), IL&FS Wind Energy (₹83 crore), ITNL Road Infrastructure Development Company (₹81 crore), IL&FS Renewable Energy (₹75 crore), Sabarmati Capital Two (₹73 crore) and Baleshwar Kharagpur Expressway (₹59 crore).

Some of the losses were due to events beyond the group’s control, like government delay in awarding projects, providing environmental clearances or making land available. Disputes over concession agreements also told on the group’s toll collection. These “intangible assets” increased from ₹18,540 crore in 2016-17 to ₹20,004 crore in the last financial year. The government, in its petition to the company law tribunal, suspects these are exaggerated. These ‘assets” might have to be substantially written off.

Infrastructure financing in India is fraught in the absence of a well-developed corporate debt market. Developers borrow short-tenor loans from banks, but their projects take long to yield revenue. This mismatch between assets and liabilities has to be carefully managed.

IL&FS’ total borrowing rose from ₹11,073 crore during the last financial year to ₹91,091 crore of which short-term borrowing was ₹13,559 crore, a rise of ₹3,050 crore over the previous year. The bulk of the company’s borrowing was long-term. Banks, companies, mutual funds, pension funds and insurance companies will take a hit now that the company’s debt has been downgraded and if there are further defaults.

The auditors’ report dated May 30 did not raise any red flags. It said the repayment of the principal amount is as stipulated and payment of interest has been regular, “except for 119 instances of delays in receipt of principal and interest,” and “there is no amount overdue for more than 90 days as of March 31, 2018.” The company was also not in default to banks, financial institutions, the government or debenture holders, the report said.

But in August, credit rating agencies called into question the ability of the group’s Gurgaon Metro Rail subsidiaries to service their debt. In September, Moneylife, a magazine reported that IL&FS and another subsidiary had defaulted on repayments to the Small Industries Development Bank of India to the extent of ₹1,500 crore.

The Reserve Bank of India’s inspection team seemed to have noticed that things were amiss. The 2014-15 annual report of IL&FS Financial Services, a subsidiary, states that a contingency provision of ₹117 crore was created in addition to the regulatory provision required by RBI. But the RBI did not deem enhanced vigil necessary.

The group also presented a picture of normalcy. Its revenue from operations increased by nearly 10% to ₹18,799 crore in the last financial year and it reported a net loss of ₹1,887 crore against a profit of ₹142 crore in the previous year. Yet it declared a dividend of ₹1 per equity share of ₹10, lower than the payout of ₹4.20 the previous year but not warranted by its financial performance.

Despite losses, Parthasarathy’s remuneration was hiked by 144% to ₹20.45 crore which was 141 times the median income of the employees.Hari Sankaran, the vice-chairman and managing director, took home ₹7.76 crore. In all, the remuneration of the top management was ₹49.82 crore.

The government has now done a Satyam on IL&FS. On October 1, it sacked the board, which comprised eminent persons like RC Bhargava, Chairman of Maruti Suzuki, Michael Pinto, the former shipping secretary, and Jaithirth Rao, the founder of Mphasis Ltd. A committee of wise men led by Uday Kotak, Managing Director of Kotak Mahindra Bank, has been set up to nurse the group back to health.

In the case of Satyam, a team headed by Kiran Karnik, a former President of the software industry lobby, Nasscom, swiftly restored confidence and put it on the auction block within a few months. It is now known as Tech Mahindra.

But containing the fallout of IL&FS will require skill and speed. Further defaults will have a snowballing effect on the economy. It is possible that most of the assets of IL&FS are not of poor quality; it is just that the group is facing a temporary liquidity crunch. Kotak commands respect as a banker. If he can persuade the shareholders to infuse funds, he would have obtained a reprieve.

(The writer is a senior business journalist)