IL&FS, DHFL and Essel were three names which rocked the debt markets in recent times. In the sixth edition of Cafemutual IFA (CIFA) event, Kirtan Shah, COO, StreetsAhead explained what went wrong in the case of these companies.
He began the session with IL&FS, which is a major infrastructure company. Kirtan attributed its inability to repay debt to asset liability mis-match (ALM).
What is ALM?
ALM is when companies borrow money for a short-term to fund long-term projects. This can happen when an infrastructure project overshoots its estimated building time. While there is still some time before it can generate money, it has to pay-off its maturing bonds immediately. As the infrastructure company is unlikely to get another long-term loan for the project from the market, it borrows money for a short term to repay its maturing long-term bonds.
IL&FS came under fire when one of its biggest entities IL&FS Transportation Networks, which has around Rs. 38,000 crore of outstanding loans missed a payment on April 2018. Worried lenders stopped rollovers. As IL&FS could no longer borrow from the market to repay its maturing loans, it defaulted.
He also talked about DHFL, which is the third largest housing finance company in India managing Rs. 1 lakh crore in assets. In the immediate fallout of the IL&FS crisis, markets became wary of lending to NBFCs even highly rated ones. In addition, DSP MF’s sale of Rs. 300 crore of DHFL debt at 10.5% - 11% yield sent panic signals regarding the company’s health. Subsequently, liquidity for the company froze. This is especially crucial as the company’s core business was borrowing money from the market and lending it.
The third company Essel suffered as it borrowed money pledging its shares. This is called loan against shares. Zee Media and Entertainment, the core company is essentially a zero debt company. However, the promoters were excited to enter new businesses such as D2H (direct to home) and infrastructure and funded them by taking loan against shares.
In the case of loan against shares, lenders give out only a percentage of share price as loan. Assuming a share price of Rs. 100, Zee could borrow Rs. 50 of loan (50% of share price) from market. However, as Zee announced newer ventures, its share price rose on expectation of earnings growth, giving the promoters more room for borrowing (assuming it rose from Rs. 100 to Rs. 500, now the company could borrow Rs. 250 instead of Rs. 50). However, as its newer businesses did not perform, its share price started sliding again, to say Rs. 200. Now though the company could only borrow Rs. 100 (50%), it had outstanding loans of Rs. 250. So, lenders approached Essel to meet the shortfall by pledging additional shares or giving cash of Rs. 150 to the borrowers. When Essel refused, lenders offloaded 1.3% of Zee shares in markets and its stock price tanked. Lenders in total hold 20% of Zee’s shares, said Kirtan putting things in perspective.
After shedding light on what went wrong, Kirtan analyzed measures taken by these companies to resolve the liquidity issue.
IL&FS divided all its entities in three buckets based on their repayment ability. The red bucket, which constitutes the most stressed companies hold Rs. 15,000 crore of loans. To generate liquidity, IL&FS has offloaded its assets worth Rs. 20,000 crore.
DHFL, meanwhile, has stopped issuing new loans, they are selling their stake in other businesses and securitizing their existing debt to generate liquidity. They plan to use the cash received from monthly income and its liquidity measures to repay its loans.
Essel is trying to raise liquidity by selling its stake to companies in digital media space.
He urged everyone that since DHFL and Essel had not defaulted yet so, they should not be clubbed with IL&FS.
He also addressed the skepticism investors had about credit ratings after IL&FS’s default. Sharing Crisil data, Kirtan highlighted that between 2007 to 2017 AAA rated paper reported a 0% default, AA rated paper reported a 0.02% default and A rated paper reported a 0.22% default for a 1 year period. Using this data, he inferred that the IL&FS may have been a one off case rather than market risk.
He also busted the myth that a debt default means all the capital is lost. While a mutual fund has to mark down the debt immediately after default, in reality fund houses may be able to recover a significant portion of the capital in the following years. Giving examples of Amtek Auto, BILT and JSPL, he shared that despite the default actually majority of the capital is recovered. Taking cue from this data, he recommended IFAs to advice their clients to hold their investments for 2 to 3 years.
He concluded his session by encouraging advisors to recommend debt products by highlighting the various opportunities of selling debt.