Such has been the nature and scale of the IL&FS meltdown and its ripple effects on the overall economy that the future events would be referred to as ‘before and after IL&FS crisis’. The current PMC bank crisis is a continuation of the same. It has redefined the debt market in India and some have also mentioned it as the “Lehman moment for India”.
The four most expensive words in the English language are, ‘This time it’s different.’
: John Templeton
IL & FS saga
In June 2018, a default by IL&FS Transportation Networks Ltd (ITNL)was the first instance of trouble in the Infrastructure Leasing and Financial Services (IL&FS)group, an erstwhile blue-chip lender when it delayed repayment of INR 450 crore.
By the end of September 2018, it had defaulted on five of its outstanding obligations.
This led to a credit crisis due to the series of defaults- as many Mutual Funds, corporate entities and Insurance companies had invested in IL&FS. The group, at that time, had a debt of close to INR 100,000 crores.
What baffled many was that the gatekeepers- the regulators, auditors and rating agencies had been unable to identify the issues. The group had a complex structure and at that time it had 347 group companies out of which almost 50%were registered overseas. The board of IL&FS was sacked and a committee headed by Uday Kotakwas constituted which has been working towards a resolution process. Some assets have been sold and around INR 50,000 crores worth of assets have been put on the block. The term of Uday Kotakas non-executive director on the board of IL&FS has been extended till October 2, 2020.
The big culprits
After the IL&FS debacle, the situation worsened when DSP Mutual Fund sold off INR 300 crore worth of NCDs of Housing Finance Company Dewan Housing Finance Limited (DHFL) amidst news of severe liquidity issues. The share price of DHFL crashed 42% on September 21, 2018, causing panic in other Housing Finance Companies (HFCs) and NBFC stocks.
A series of downgrades followed in the coming months for several of its papers. In May 2019, it informed the stock exchanges of a possible delay in the declaration of annual results. It has defaulted on several debt payments during the last few months. It has sold a majority stake in some of the group companies (Aadhar Housing Finance, Avanse Financial Services Ltd)and office buildings in the process to reduce its massive debt, which runs into thousands of crores. It has shared a draft resolution plan with the lenders which still needs their and investors’ approval. The proposal seeks to convert debt to equity while selling assets and raising additional funds.
In early 2019, another blow to Debt Funds came from the Essel group, owner of ZEE Network businesses. Some Fund Houseswhich had exposure to the Essel group, were forced to withhold (stop maturity proceeds) or rollover (extend maturity date) certain FMPs. After failing to meet their debt obligations, the group entered into an agreement with lenders for rolling over the payments to September 30, 2019.
The Essel groups part of its expansion plan had invested in various road, port, power and infrastructure projects. All these projects went downhill post the liquidity crisis and the group piled on a debt of around INR 9500 crores, which it found difficult to pay. The group has since sold a stake in its flagship ZEE to Invesco Oppenheimer Fund. It has also restructured other non-media related businesses.
As per news reports, by last week of September 2019, they have received another extension of six months by fund houses like Aditya Birla AMC, Franklin Templeton AMC and HDFC AMC, including others.
The group still has close to INR 5000 Crores as outstanding dues.
The significant others
The others in this list which have defaulted and/or delayed payments during this one year period and have contributed to the overall malaise are:
- Anil Dhirubhai Ambani (ADAG) Group
- Altico Capital India Ltd
- Cox and Kings Pvt Ltd
The latest troublemaker in the financial markets Indiabulls Housing Finance, which had, in April 2019 announced a merger plan with the south based Lakshmi Vilas Bank in an all-share deal. However, RBI had not approved of the deal and now the bank has been put under Prompt Corrective Action (PCA) for a high level of NPAs, lack of required capital and negative returns on assets consecutively for two years.
PCA- RBI places banks under PCA if it has concerns regarding the bank’s performance and financial standing. Under PCA, banks can be restricted from opening new branches and also from paying any dividends to shareholders. It may place strict restrictions on corporate lending and state measures to reduce the concentration of loans to certain sectors. Although, the day to day functioning of the bank is not altered.
The (missing) role of Rating agencies
The role of rating agencies regarding the quality and criteria of assigning the ratings during the entire episode has been questionable. These agencies have managed to bring down ratings for most of these companies “after” the default. The manner in which ‘AAA’ rated instruments were changed overnight to ‘Default’ is a reflection of the magnitude of problems in the rating system. The rating agency, ICRA has terminated the services of its CEO. CARE ratings had sent its MD on leave and recently Brickworks Ratings’ founder Director has also gone on leave.
Certain highlights related to rating system & agencies
- Rating agencies are paid for the ratings by the same entity or company for which the ratings are being assessed – thus the system in itself is flawed.
- The rating framework is not robust and is based more on solvency ratio, historical data, past payment performance, promoter group’s standing and reputation of management.
- Multiple rating agencies have the same set of clients and are vying for more of the same business. In most of the cases, the ratings assigned have been similar and no agency has been able to detect any anomaly in the now failed or defaulting companies.
- The rating framework, guidelines, and structure need to change. These agencies ideally should be independent entities. Payments can be made to them by non-related third parties.
- Rating assessment should be objective apart from being subjective– material facts like change in management, promotor shareholding and impact on cash flow should be accounted for.
- There should be some system of penalizing the agency which gives the wrong rating.
(Un) Real Estate
A major source of funding for real estate has been the NBFC sector. After demonetization, there was a liquidity rush with huge inflows into banks, stock markets, mutual funds, and deposit accepting NBFCs. With this newfound liquidity, many institutions started lending it to HFCs, NBFCsand other entities which led the NBFCs to extend long term funds to the real estate sector. They were hoping to make a substantial profit by borrowing short term and lending long term to the real estate sector and to small and medium businesses. However, post the IL & FS failure, these short term lenders became sceptical to issue new loans or even to roll over the existing loans. The demand for redemption soared and liquidity further dried up.
Steps initiated by the Government & Reserve Bank of India
- Relaxation in securitization norms for enhancing liquidity
- Easing of priority sector lending norms
- Implementation of a partial credit guarantee scheme
- Rate reduction – the repo rate was reduced for the fifth consecutive time on October 4, 2019
- Bank recapitalization
PMC Bank debacle
The operations of Punjab and Maharashtra Co-operative Bank (PMC), a large co-operative bank based in Mumbai were frozen by the Reserve Bank of India in the last week of September 2019.
- Many small co-operative banks have placed their deposits with PMC Bankapart from individuals, housing societies, small traders & enterprises.
- With the RBIrestrictions in place, the future has become uncertain and for some small businesses, capital for running even the daily operations has vanished.
- For year ending March 2019, the bank had deposits to the tune of INR 11617 crores and an asset book of INR 8383.33 crores, out of which an exposure of INR 6500 crores (which was never reported and was fraudulently hidden) was towards the troubled real estate player HDIL, which is facing insolvency proceedings in the National Company Law Tribunal (NCLT).
- The promoters of HDIL group and the suspended former MD of PMC Bank have now been arrested.
- The RBI had initially placed a cap on withdrawals allowing only INR 1000 per person for six months, which was later increased to INR 10,000 and has now been raised to INR 25,000. Edit1: Limit has been increased to Rs 40,000 on October 14th.
- However, a number of depositors have their entire savings with the bank and are now totally at the mercy of RBI and any resolution process that it might offer.
Lessons for investors and depositors:
- Whether it is investment or banking service- quality always matters
- Quality comes with a price- it is your money, choose carefully so that there are no regrets later
- Conduct your research and due diligence ‘before’ getting into any financial agreement with the service/benefits providers. There is no point in blaming the financial institutions or other entities after a setback
- Risk management is the core of asset allocation and diversification-understanding and managing risk at an individual level is as important as making an investment
Further reading for Debt Fund investors: Assessing Debt Funds
Customers of banks should note that :
1/ In India, Deposit Insurance and Credit Guarantee Corporation of India (DICGC) covers deposits of up to INR 100000 (Principal + Interest) only, per customer per bank (Not branches of the same bank). Co-operative banks are covered by DICGC but co-operative societies are not.
2/ Not all your savings should go into a single bank – it would be a good idea to spread your money across banks and into products like AAA-rated bonds, liquid Funds, Post Office and Gold. Invest in Gold.
3/ Keep a track of what’s happening with your bank/financial services provider. In case there are signs of trouble, take remedial action.
Benjamin Graham said “The best way to measure your investing success is not by whether you’re beating the market but by whether you’ve put in place a financial plan and a behavioural discipline that are likely to get you where you want to go”
It always pays to be an “Educated and Informed investor”.