Why in news?
Infrastructure Leasing & Financial Services (IL&FS) and its subsidiary received credit downgrade from rating agencies ICRA, India Ratings and CARE recently.
What led to the downgrade?
- IL&FS, including its subsidiaries, has under its belt around 90 entities and Special Purpose Vehicles (SPVs).
- IL&FS and its subsidiary IL&FS Financial Services enjoyed high credit ratings in the recent period.
- But concentrated exposure to infrastructure and real estate projects led to an overstretched balance sheet and deteriorating asset quality scenario.
- Also, fragile financial condition of state distribution companies buying power from IL&FS Wind Energy Limited led to the deteriorating credit profile.
- This, along with other such causes, made IL&FS along with its subsidiaries to have around Rs 1 lakh crore worth public debt on its books.
- It recently sought immediate loan assistance of Rs 3,000 crore from two of its shareholders, the SBI and LIC.
- Recently, reports started leaking that the subsidiary had missed due dates on commercial paper, while the parent had defaulted on deposit dues to SIDBI.
- Several credit rating agencies thus abruptly downgraded its credit rating, from high investment grade (AA+ and A1+) to junk status (BB and A4).
- In the Indian context, any bond rated ‘BB’ and below is classified as speculative grade category.
- This has a significantly higher risk of default of interest and principal.
What does it imply?
- Rating agencies - The stretched liquidity position of the group was known before.
- But it took an actual default for the rating agencies to revisit their investment grade ratings.
- The rating agencies repeatedly flagged loan book concentration, high debt levels and the dire financial straits of the group’s firms in their reviews.
- But they seem to have pinned their hopes on IL&FS’ big-name promoters to bail it out of its troubles.
- This exposes the fragility of the ‘structured obligation’ in the ratings, to actually weak entities but hailing from large industrial groups, on the faith of a possible rebound in future.
- Mutual Funds - The mutual funds failed to restrict their exposures to the high-risk paper to their ‘credit risk’ funds.
- Fund managers instead parked it with their liquid and low duration funds.
- They also marketed them as low-risk alternatives to savings bank accounts.
- Banks - The episode again shows the risks of banks in funding long-gestation projects with short-term money.
What is the way forward?
- The episode has underlined the need for institutional investors to build their own capabilities.
- They have to strengthen the independent credit appraisal instead of over-relying on rating agencies for their investment calls.
- Also, SEBI should revisit its recent fund categorisation rules to ring-fence certain categories of debt funds from credit risks and address the shortcomings of fund mangers.
- Also, rating agencies need to be proactive rather than reactive with their rating actions.
Source: Business Line
Quick Facts
Credit-risk Funds
- Credit-risk funds are debt funds which have at least 65% of their investments in less than AA-rated paper.
- They generate high returns by taking higher credit risk and by investing in lower-rated papers.
- Such companies offer higher interest rates, and as and when their ratings move up, they offer a benefit of capital gains.