INSUBCONTINENT EXCLUSIVE:
ILFS is a huge borrower, accounting for 2% of outstanding commercial paper.Indian authorities have spent the week containing the collateral
damage from a major infrastructure lender struggling to service $12.6 billion in debt
Next up: Figuring out why the nation's credit rating agencies didn't see the crisis coming.ILFS Group is a vast conglomerate with a
complex corporate structure that funds infrastructure projects across the world's fastest-growing major economy
The financier, set up in 1987, and its listed subsidiaries have powered India's infrastructure boom-- including the Chenani-Nashri road
tunnel, India's longest--and raised billions of dollars from the country's corporate debt market.In July, company founder Ravi
Parthasarathy stepped down, citing health reasons
In August a default within the group rattled India's money markets, added to pressure on corporate bond yields and sparked a sell-off in
The Reserve Bank of India has initiated a special audit, given the potential systemic risk the group poses to other non-bank lenders and
worries about $500 million of repayment obligations coming due over the next six months.The nation's credit rating industry has come under
scrutiny after the firms that assessed ILFS, including the local partners of Moody's Investors Service and Fitch Ratings, failed to see
the financial troubles brewing at the financier
The group's debt burden jumped 44 percent in the year ended March 31 from 2015.Here's why the ILFS default is worrying investors"Rating
agencies need better market intelligence and surveillance rather than depending upon historical data and some structure based on past
estimates." said Nirmal Gangwal, founder of Brescon Corporate Advisors Pvt., a distressed asset turnaround specialist
"They also need to factor changes on the ground like change of leadership, cash flow management in recent past and market environment."Great
UnravelingThe Indian credit rating companies' failure to foresee the great unraveling at ILFS has left Prime Minister Narendra Modi's top
economic policymakers, including Reserve Bank of India Governor Urjit Patel and Finance Minister Arun Jaitley, facing contagion risk to the
broader financial sector."There is definitely a case for revisiting ratings standards and the whole rating framework," Rajiv Kumar, India's
banking secretary said in an interview
"Some kind of accountability needs to be there
It has to be made more robust."ILFS is a huge borrower, accounting for 2 percent of outstanding commercial paper, 1 percent of debentures
and as much as 0.7 percent of banking system loans
The group itself in turn acts as a key source of capital to non-bank lenders
Another worry is a stampede by individual investors out of fixed-income mutual funds that will force portfolio managers to sell other
companies' debt securities to cover redemption requests, setting off a vicious cycle."We have not had this kind of a systemic event of this
magnitude in the bond market before in India, and so we don't really have a precedent as to how to deal with it," said Kunal Shah, a debt
fund manager who oversees nearly $1.7 billion at Mumbai-based Kotak Mahindra Life Insurance Co.Until July, India's credit rating companies
had investment grade ratings on billions of dollars of corporate debt raised by the ILFS Group and its subsidiaries
The first signs of trouble came in June, when the special purpose vehicles tied to ILFS Transportation Networks Ltd., a group subsidiary,
defaulted on its debt obligations
More defaults in other parts of the empire followed in August and September.In August, major credit rating companies such as ICRA, a unit of
Moody's , Fitch-owned India Ratings Research and CARE began to cut their rating for the group's parent company, Infrastructure Leasing
More rating downgrades to default status came in September
All three rating assessors declined to comment.Project SlowdownThe burning question now is whether credit analysts should have seen the
financial reckoning at the ILFS group earlier
It was no secret that funding costs for companies in India surged as the interest rates in the nation's credit markets hit multi-year
For ILFS, short-term debt increased 30 percent to 135.6 billion rupees ($1.9 billion) in the year to March 31, according the company's
annual report.The pace of new infrastructure projects has slowed down in India, and some of ILFS's own construction projects, including
roads and ports, have faced cost overruns amid delays in land acquisition and approvals
Disputes over contracts have locked about 90 billion rupees of payments due from the government.Indian credit ratings companies rely on the
same "issuer-pays" model common in the United States that allows the entity issuing a financial instrument to pay credit analysts upfront
to rate the underlying securities
SP Global, Moody's and Fitch were criticized for placing profits before investors when rating mortgage securities in the run-up to the
United States financial crisis in 2008."Where we have gone wrong in India is where regulators have written regulations that force regulated
entities, such as banks, mutual funds, to use the rating," said Professor Ajay Shah with the National Institute of Public Finance and Policy
"A rating company should be just a research company, which has to sink or swim based on the value that it contributes to the institutional
investor."ILFS group's investment grade rating was based on the strength of the investors in the parent company, according to an official
The lender's investors include Life Insurance Corp., India's largest life insurer; State Bank of India, its largest bank; and Housing
Development Finance Corp, its largest mortgage lender
is the company's second-largest shareholder.India's central bank deserves some of the blame, the person said, because it tolerated the
excessive dependence on debt used for project funding in India.Shriram Subramanian, the founder of Mumbai-based proxy advisory firm InGovern
Research Services Pvt., says Indian credit analysts aren't skeptical enough and assume wrongly that big investors will bail out companies in
a jam."In most cases, they take into account projections given by managements which tend to be rosy," said Subramanian
"Rating companies have a role to play in rating the various securities, but they need to increase their sophistication by developing models
that account for various scenarios."Regulatory measures should be on the table, according to the head of a rating assessor
"The regulators should seriously consider mandatory rotation of the rating agency of an issuer just like the rotation of auditors," Sankar
Chakraborti, chief executive officer at Acuit#233; Ratings Research Limited, a local ratings company
"This will allay the concern that a very long association between issuer and rating agency may allow scope for complacency."Credit rating
firms in India's big Asia economic rival, China are also facing increasing scrutiny as authorities look to rein in risks and foreign
investors have long cited inflated ratings offered by local firms as a key reason for not buying onshore corporate notes.While penalties had
previously been restricted to discreet warnings, regulators in August banned a rating company for a year from assessing bonds
China opened the door for foreign rating companies last year
Yet so far, no international raters have set up wholly-owned units in the country.For ILFS, rating company ICRA, flagged the group's
"elevated leverage" in March but kept its investment grade rating because of "experienced senior management team and its significant track
record of operations in the infrastructure domain."The company's shareholders are scheduled to meet on Saturday to vote on increasing its
authorized capital, which will start its plan to "restore normalcy," Vice Chairman and Managing Director Hari Sankaran said in a note to
employees this month."Certain conflicts of interest inherent in the current structure prevalent in India need to be reviewed," said Sunil
Sharma, executive director chief investment officer at Sanctum Wealth, which manages $1 billion
"Greater disclosure and access to information needs to be mandated."(Except for the headline, this story has not been edited by
TheIndianSubcontinent staff and is published from a syndicated feed.)
