The Infrastructure Leasing & Financial Services (IL&FS) debt saga has entered a decisive phase with the government dissolving the IL&FS board and appointing new directors with Kotak Mahindra Bank head Uday Kotak as the non-executive chairman.
Any move by the government or the regulators to protect the interest of a large financial institution like IL&FS and to address the contingent effects of the episode is a welcome move as it will help in regaining the market confidence.
The new management will surely provide clarity on how the liability side issues of IL&FS would be resolved. The transparent views of the new management will help the institution survive the financial turbulence. Given that scenario, let’s look what led to that situation.
Market speculations have been running thick and fast after the stocks of non-banking finance companies (NBFCs) tumbled recently, as part of the ripple effect of IL&FS defaulting on the Rs450 crore worth of inter-corporate deposits (ICDs) to the Small Industries Development Bank of India (SIDBI).
It’s the liquidity issue, the asset-liability mismatch and the contagion effect which have been broadly held responsible for the free-fall of the NBFC stocks. And, those expert inferences point to the fact it’s about time the credit ratings agencies, market regulators as well as NBFCs change their outlook and the way of functioning.
Before the IL&FS debt crisis broke out, the debt instruments of IL&FS were enjoying healthy ratings from a number of credit rating agencies. However, within a matter of few days of the news when the IL&FS default hit the headlines, those agencies promptly downgraded those ratings.
It is well-known that for everyone involved in the process, there is a high degree of weightage given to the ultimate parentage – IL&FS was considered equal to a sovereign/public sector firm given pedigree of its shareholders and the work it was doing – this perception overrides the deep evaluation of underlying business and its ability to sustain and survive.
This has always created an unfair advantage to the firms which enjoy the liability side purely because of their parentage – history has taught us that most of the crisis have been triggered by firms which have at some point of time been considered ‘fail-proof’.
A company like IL&FS can’t develop cash-flow mismatch all of a sudden and the point is that the mismatch didn’t get reflected on the ratings for such a long time. So, it’s evident that while awarding those marquee ratings, those leading credit rating agencies presumed that IL&FS wouldn’t face issues while refinancing its debt. Such a flawed presumption stems from an erroneous practice of giving too much importance to the promoters’ and shareholders’ profile while assigning ratings to various companies with so-called reputed credentials.
The latest IL&FS debt fiasco proves that linking credit ratings of a company to the support it enjoys from a bigger business group is a risky proposition. Ideally, the credit ratings should assess the standard of the corporate governance, the management team and the inherent business model of a company more than anything else.
The process of weighing the financial wherewithal of the promoters’ group of a company should not be the priority mainly because the contagion effect of the promoters’ group can have an adverse effect on the valuation of the company.
The banks usually don’t face liquidity or liability crisis mainly because they have access to RBI repo window. Similarly, the market regulators can think of extending such facility to a certain section of NBFCs which are of a certain size and institutional significance. Liquidity can be made available to those NBFCs through that process.
NBFCs themselves also need to do some course correction. As far as asset-liability aspect is concerned, NBFCs should adopt more transparency in terms of disclosure on the liability side to avoid any mismatch. There is always a refinancing risk attached to any financial institution. But, clarity has to be there.
NBFCs should also evolve a culture of moderate growth and profitability. They usually borrow from the convertible debentures market – not from the banks always – in order to improve their profitability.
However, NBFCs shouldn’t be in the game of achieving absolute gain of market cap and price multiple. They should look at implementing long-term sustainable business model.
Having said that, the market is overreacting at the moment to the recent developments. The growing perception is that the exposure of the NBFCs to mutual funds are higher than the exposure to banks. But the fact is that the majority of the NBFCs is financed by the banks. In absolute term, the mutual fund exposure has gone up three times in the last three years because most of the incremental growth of the NBFCs have been funded by MFs. There should be a systematic effort to quell those speculations.
The fundamentals of NBFCs - credit quality, disbursement, etc. - continue to be very robust. NBFCs are not facing any NPA issue at the moment. And given the fact that they are such an important part of the financial ecosystem, the market regulators and the industry as a whole should undertake initiatives to repel those flawed perceptions on NBFCs.
It’s the liability-side constraint and the contagion effect which are posing some challenges that are manageable.
Going forward, the growth rate of the NBFCs could come down a little bit. NBFCs which are very large and are fully leveraged will witness headwinds, as investors have become cautious. However, those are the near-term impacts of the prevailing market scenario.
Within six months, the situation will become normal. The NBFCs with strong fundamentals will reap the benefits in the long-term.
(The writer is Executive Chairman and Managing Director of Ugro Capital)
Updated Date: Oct 01, 2018 17:14 PM