IL&FS Default Highlights Indian ABS Servicer Continuity Risk: Fitch Ratings
The risk of a counterparty's failure causing jump-to-default in Indian asset-backed security (ABS) transactions has been highlighted by the recent default of Infrastructure Leasing and Financial Services (IL&FS), a large Indian non-bank financial institution (NBFI), says a ratings agency. 
 
In a release, Fitch Ratings, says, "IL&FS was not itself a counterparty to any internationally rated ABS notes, but NBFIs act as the originators and servicers for most Indian ABS transactions, including those rated by us."
 
The failure of IL&FS has significantly undermined market sentiment towards the Indian NBFI sector and their ABS issuance, the ratings agency says, adding, transaction flow has stalled and we have observed a rise in yields on the securitisation notes of NBFIs.
 
The underlying asset performance of Indian ABS pools rated by Fitch remains sound. Overall, it says, delinquencies for Fitch-rated ABS transactions have remained stable at below 1.5% on average (see chart below), but performance varies according to the originator and the underlying asset class.
 
 
Fitch has to date capped ratings on Indian ABS transactions at 'BBB-(sf)' in line with the account bank replacement rating triggers of 'BBB-'. 
 
Fitch says it typically does not assign an Indian ABS transaction a 'BBB-(sf)' rating unless its account bank has a rating of at least 'BBB-'. 
 
"The rating of the ABS is linked to that of the account bank as credit enhancement for ABS transactions in India typically comes in the form of a cash deposit with one or more financial institutions. This means that the failure of the deposit bank would wipe out the vast majority of credit enhancement available to note holders and therefore could significantly undermine a transaction's CE and its rating," Fitch added.
 
According to the ratings agency, prolonged and severe stress of a transaction's servicer can disrupt collections on the underlying assets, undermining liquidity. In such an event, a transaction's liquidity coverage is usually relied upon to avoid a direct negative impact on transaction performance, it added. 
 
Fitch says it considers mitigation of servicer continuity risk to be a critical element of structured finance ratings. It says, "All Fitch rated Indian ABS transactions have liquidity coverage of at least three months, which reflects our expectation that this length of time could be needed to replace a servicer in a stress scenario. This liquidity requirement increases in cases where we believe servicer continuity risk is particularly high or that the servicer replacement time is likely to be longer." 
 
The ratings agency feels that inadequate mitigation of servicer continuity risk might lead to a cap on the ratings of notes. 
 
Recently, Fitch says it declined to rate transactions that did not have sufficient liquidity coverage, which could have led to excessive dependence on the unrated servicer and potentially exposed senior notes to jump-to-default or severe downgrade risk upon jump-to-default of the servicer.
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GIFT-City Gujarat Needs SFIO Probe Like IL&FS, says Petitioner in Fresh Application
Dr DC Anjaria, independent director and former audit committee chairman of Gujarat International Finance Tec-City—GIFT City, had filed a fresh civil application demanding investigation of GIFT-City by Serious Fraud Investigation Office (SFIO), as has been ordered by the NCLT (National Consumer Law Tribunal) with respect to the beleaguered parent—Infrastructure Leasing & Financial Services (IL&FS). 
 
Dr Anjaria's original petition had alleged that this Rs70,000-crore GIFT-City project had virtually been gifted away to the private sector partner, IL&FS, leading to massive losses to the government and the people. He also alleged falsification in accounts, and incorrect recording of audit committee meeting at GIFT-City. The new application has also added names of fresh respondents, including a former Whole Time Member of SEBI (Securities & Exchange Board of India). 
 
In his civil application to the 2016 Writ petition No 260 of 2015 (PIL) filed last week, Dr Anjaria says, "...in view of findings of regional director, ministry of corporate affairs (MCA), Mumbai, that affairs of IL&FS and its group companies are carried out prejudicial to public interest, the affairs of GIFT-City are also required to be investigated by SFIO for two reasons. 
 
"Firstly, IL&FS has a 50% stake in GIFT-City and there it is part of the one of the group companies of IL&FS. Secondly, three senior directors on the board of GIFT-City are also part of board of directors removed by the National Company Law Tribunal (NCLT) at Mumbai. They are Hari Sankaran, K Ramchand and Arun Saha. The presence of these three persons on the board of GIFT-City is apparently inimical to the public interest,” Dr Anjaria added.
 
He has also alleged that there was falsification of accounts by not recognising income against the guidance note issued by Institute of Chartered Accounts of India (ICAI) and falsification and incorrect recording of minutes of the audit committee meeting presided by him. 
 
Dr Anjaria, who originally designed the concept of GIFT City, alleges that Prof JR Varma of IIM-Ahmedabad (former whole-time member of SEBI) was appointed as independent director and as chairman of the audit committee after he was relived of his position as chairman of the audit committee. Dr Anjaria ceased to be independent director on the GIFT-City board six months later. Prof Varma is accused of having approved of the minutes of the meeting, held six months earlier and presided over by Dr Anjaria, that too when he was not even a member of the Gift-City board at that time and had not attended the meeting. He further says that the minutes were approved, despite his notice to Prof Varma, making him party to what is alleged to be “falsification and incorrect recording of the minutes book.”
 
"Ramakant Jha, the then chief executive of GIFT-City connived with Dipesh Shah, Head (IFSC & Strategy), GIFT-City and compliance officer for falsification and incorrect minutes," Dr Anjaria alleges. 
 
He says Haribhakti and Co, chartered accountant, did not recognise income from sale of development rights in spite of a guidance note issued by ICAI. Dr Anjaria says in the application, that it was incumbent upon Haribhakti and Co., as a member of ICAI to report non-compliance with guidance note by GIFT-City. The chartered accountant firm failed to discharge its duty and thus needs to be added as party respondent in the petition, he says. 
 
Taking cognizance of the massive financial debacle at IL&FS, Dr Anjaria, in a separate petition says these developments will "affect goodwill of GIFT-City project, which, in turn, will discourage international finance players and bring a great disgrace to the entire country where an IFSC of would class standards is envisaged."
 
According the petition, out of four erstwhile directors of IL&FS, who are facing a lookout notice, two of them, Hari Sankaran and K Ramchand, are presently serving on the board of GIFT-City. "Apart from this, Ramesh C Bawa, who is also facing lookout notice, was also on the board of GIFT-City as representative of IL&FS. In view of this, there is palpable apprehension that these three persons would have also mismanaged affairs of GIFT-City and there is it is necessary to issue notice to IL&FS and it should answer charge against it," the petition says.
 
Earlier, GIFT-City has failed to respond to our queries regarding Dr Anjaria’s petition and instead published an advertorial in the form of an interview in the Business Standard. The paper later published a rebuttal by Dr Anjaria.  
 
Moneylife has written to Prof JR Varma and the Gift-City management for their comments. This article will be updated with their response as and when we receive it. 
 
You may also want to read…
 
 
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COMMENTS

arun k Dasgupta

2 months ago

ILFS mess was created over a period with the support and connivance of so called eminent board members and the auditors/CA firms. Let there be a forensic audit and the role of both internal/ nominee/ independent directors and the audit firms be critically examined because it is very much possible that these people wanted to look aside and their silence/ approvals were purchased at a cost. The truth should come before the nation as these tainted directors are spreading their tentacles in many other companies and are playing with the public trust.

Liju Oommen

2 months ago

Khaunga aur apne doston ko bhi khilaunga. Legalising corruption.

Jayendhran Santhanam

2 months ago

May i know why "Weekly Moneylife Indices & Sector Trends" missing in this week? Hope there're no plans to get rid of this column

Sunil Rebello

2 months ago

THIS IS WHAT I SAID 5 DAYS AGO
.............
Sunil Rebello 5 days ago The base problem of IL&FS is the GIFT city.

We may say that IL&FS is not a PSU but it always acted as a quasi PSU.

your article: 'Former bureaucrats and executives who quit the group and attempted to expose the group have been hounded, humiliated and even arrested'

This tactic is the clear example of our present government - shoot the messenger.

This is also exemplified in their name changing spree all over the country.

Now the whole weight of government authorities - RBI NCLT SIFO CBI ED etc etc are on IL&FS head.

But do they have expert advise or are they depending on the crap advise of the present Financial & Law team.

To change some major scam - you have to first accept that there is a scam.

IL&FS was not paid by the GOI for their work, Therefore the GOI takes it over.

who will take the haircut of 80,000 Cores+. for sure it will be us tax payers

IL&FS Mess: Can SFIO do Justice to the Probe with its Dwindling Staff?
The government has got the Serious Frauds Investigation Office (SFIO) to take charge of IL&FS’s servers in Mumbai and has started an audit. Unfortunately, the SFIO is a lame duck, with most of its investigations and findings unceremoniously buried by the Ministry of Corporate Affairs (MCA). Moreover, SFIO simply does not have the manpower to takeover any new investigation due to pendency of cases. Out of 186 cases assigned to SFIO during FY2018-19, it had completed investigation only in one case as on 20 July 2018 due to a 55% shortfall in staff strength, data from the Lok Sabha questions shows. 
 
Earlier, in August 2017, in response to a question in the Lok Sabha, the Union Minister of State Arjun Ram Meghwal provided summary of 233 fraudulent finance companies and chit funds that the SFIO had investigated over the previous five years. He also admitted, “No money in these cases has been restored back to the investors”. 
 
PR Senthilnathan, a member of Parliament (MP) had asked about action taken by SFIO against fraudulent companies and refund of money to victims by fraudulent companies and chits funds. As per the list, maximum number of fraudulent companies (132) were from West Bengal followed by Orissa at 31. 
 
With many insiders starting to allege that top executives of IL&FS were gold-plating projects to create their own pot of gold, an investigation is clearly warranted. But unless the SFIO is asked to work in a time-bound manner and report directly to the Prime Minister’s Office (PMO), the outcome will be no different this time.
 
What is more shocking is as against a sanctioned strength of 133 posts, SFIO has only 45% or 59 officials working on various cases and use services of external consultants. Due to this, over the past three years, SFIO was even unable to spend budget sanctioned. 
 
While during FY2018-19, its budget was increased four times to Rs62.22 crore from Rs17.37 crore past year, as on 30 June 2018, it could spend only Rs4.71 crore. This was informed by PP Chaudhary, Minister of State for Corporate Affairs while responding to a question in the Lok Sabha on 20 July 2018.
 
 
Mr Chaudhary also told the Parliament that during the past three years, 94 complaints and prosecutions were disposed of by the various courts by levying a total fine of Rs5.9 lakh or Rs6,276 per case.
 
Since its inception in 2003, SFIO had investigated 312 cases till 2016-17. According to information provided by Ministry of corporate affairs (MCA) to a Parliamentary Panel, only six convictions, including those in the Satyam and Reebok case, had fructified out of 162 investigations completed till March 2015. 
 
In short, over the past 12 years, the conviction rate of SFIO is just 3.7%. In contrast, the conviction rate of UK’s SFO on whose lines the former is modelled, was as high as 85% as per its progress report submitted on 23 June 2014.
 
Coming back to the IL&FS mess, the reconstituted board has to submit a resolution plan to the NCLT (National Company Law Tribunal) by 31 October 2018. Many Indian and international experts, point out that IL&FS has been largely and infrastructure play in the private sector and cannot be given special treatment just because it masqueraded as a quasi-government body. If the rating agencies or banks treated it as one, they ought to be hauled up. 
 
Strangely, the regulator of rating agencies, Securities and Exchange Board of India (SEBI) is silent so far. How difficult is the new board’s job? It has to first understand the modus operandi of Ravi Parthasarthy, who ran the show with his cronies for over two decades. (Read: How IL&FS Was Enriching Itself at Public Cost)
 
It holds assets of around Rs1,65,000 crore of which a whopping Rs30,000 crore are at risk, according to data analysed by REDD Intelligence.
 
Banking analyst Hemindra Hazari has written about how the complete erosion of IL&FS’s networth has been disclosed in the consolidated balance sheet for several years. 
 
In an article in The Wire he writes: “A cursory analysis of the consolidated accounts however reveals a horrifying saga: IL&FS has been an insolvent company since at least FY’2014 (no disclosure of consolidated accounts prior to FY’2014).”
 
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