One week after we reported that India’s NPL crisis finally erupted after IL&FS, a major shadow bank at the heart of India’s economy defaulted in one day on three debt payments, India’s government announced on Monday that it would immediately seize control of a shadow lender whose defaults have caused widespread upheaval at mutual funds.
The nationalization is virtually unprecedented: the nation’s corporate affairs ministry has sought to take control of a company on just two prior occasions, and only followed through once, with Satyam Computer Services in 2009. A bid by the government to take control of debt-laden realty firm Unitech in late 2017 was stalled by the Supreme Court after the move was challenged.
According to Bloomberg, officials ousted Infrastructure Leasing & Financial Services Ltd.’s entire board and a new six-member board will meet before Oct. 8, the National Company Law Tribunal said on Monday. India’s richest banker Uday Kotak and ICICI Bank Chairman G.C. Chaturvedi will be part of the proposed board, which will elect a chairperson themselves.
An AAA-rated entity for decades, over the last few years IL&FS, saw an increase in its debt levels. The situation worsened in the last two months with both the parent company and its subsidiaries defaulting on a number of repayment obligations. Banks and insurance companies have the largest exposure to IL&FS.
For India to resort to such a dramatic move, the panic must have been palpable: the nationalization, which unfolded within the span of a hectic day in Mumbai, underscores the government’s concern about IL&FS’s defaults spreading to other lenders in the world’s fastest-growing major economy.
Considered systemically important, the group has total debt of $12.6 billion, 61 percent in the form of loans from financial institutions. The ripple effects of its defaults have already seen mutual funds post mark-to-market losses, a slump in corporate bond issuance and a brief but sharp sell-off in equities.
As we noted previously, IL&FS’s outstanding debentures and commercial paper account for 1% and 2% respectively, of India’s domestic corporate debt market as of March 31, according to Moody, while its bank loans made up about 0.5% to 0.7% of the entire banking system loans. It is, in a word, systemic.
And while bad loans in the Italian banking system have received a ton of attention from investors, India is not far behind and India’s economic recovery is built on an even shakier foundation.
It took IL&FS insolvency to bring these to the forefront.
In addition to its direct debt exposure, there was also concern that the group’s troubles could spread to other shadow banks and crimp Prime Minister Narendra Modi’s infrastructure plans before elections next year.
“The solution would need to address how to prevent massive write downs by the banks, not merely by regulatory engineering — as that would simply defer the real problem by a few years,” said Krishnava Dutt, a managing partner at law firm Argus Partners. “As I see it, someone now needs to bite the bullet.”
The National Company Law Tribunal will next hear the matter on Oct. 31.
In response to the news, shares of the group’s listed subsidiaries climbed in Mumbai. IL&FS Transportation Networks Ltd., which develops and maintains toll highways, surged nearly 19 percent to close at 26.80 rupees, paring the year’s slump to 68 percent. Fund manager IL&FS Investment Managers Ltd. advanced about 10 percent.
The nationalized company, and the new board, will inherit a restructuring process that just saw IL&FS shareholders sign off on a non-convertible debt sale, a higher borrowing limit and a rights offering.
Some bankers to IL&FS have been hesitant to provide fresh cash injections without more details on asset sales, people familiar with the matter have said.
Other investors in IL&FS include Japan’s Orix Corp., the second-largest shareholder in the company with , Abu Dhabi Investment Authority and Housing Development Finance Corp., India’s biggest mortgage lender.
“Dismissal of the IL&FS board will raise uncertainty on the firm’s plans to sell off assets and pay off debtors,” Sunil Pachisia, vice president at brokerage Pratibhuti Viniyog, said by phone. “There is a fear that the lenders may have to take deeper hair cuts once the government steps in.”
LIC, IL&FS’ biggest shareholder with a more than 25% stake, had said last week that it would participate in the rights issue. Other investors in IL&FS include Japan’s Orix Corp., the second-largest shareholder in the company with a 23.54% stake, Abu Dhabi Investment Authority, with 12.56% and Housing Development Finance Corp., India’s biggest mortgage lender.
“Dismissal of the IL&FS board will raise uncertainty on the firm’s plans to sell off assets and pay off debtors,” Sunil Pachisia, vice president at brokerage Pratibhuti Viniyog, said by phone. “There is a fear that the lenders may have to take deeper hair cuts once the government steps in.”
IL&FS funds infrastructure projects across Asia’s third-largest economy. Its defaults on commercial paper, once considered rock-solid, from August sparked concern among households holding mutual funds invested in such debt, and forced banks, mutual and pension fund managers to brace for further losses.
In retrospect, the only solution to restore confidence and stabilize the financial system was for the government to step in. Whether this will be sufficient, or merely boost fears about what else is hiding below the surface of India’s financial system remains to be seen.
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