IL&FS exposes the rot in the rating agency system

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Published: July 24, 2019 1:18:50 AM

Grant Thornton report clearly shows just how ratings were manipulated; some serious action must be taken.

If no major action is taken against the rating firms who have been indicted by Grant Thornton, it would reflect very poorly on India’s regulatory system.

While some rating agencies mentioned in Grant Thornton’s draft audit report—on how rating agencies favoured IL&FS and various group companies—have put out press statements pointing to inaccuracies in the report, there is enough in the report for the authorities to take some serious action against these raters. The charges range from consciously delaying giving the correct ratings on group firms for years to giving them favourable ratings, as a result of which the investor public had no idea of just how precarious the group’s finances were; given this, it was easy for the group to amass a whopping Rs 106,000 crore of loans.

Just how big the hole in IL&FS’s balance sheet is can be judged from the fact that the government estimates state-owned banks will recover just half their loans. It didn’t help that, despite IL&FS’s impressive parentage—LIC owns over 25% of its equity and Orix of Japan owns 23%—and its illustrious board, no one seemed particularly interested in letting anyone know the true state of the group’s finances either. So between IL&FS’s management, the auditors that failed to notice anything and some rating agencies who fudged ratings, a rosy picture of the finances was put out. The IL&FS annual report for 2018, for instance, gives the company’s net profits of Rs 584 crore within the first few pages, but it takes till the 210th page to know that group incurred a net loss of Rs 1,869 crore that year; while the company’s borrowings are Rs 15,935 crore, it is only in the consolidated balance sheet—also in the annual report—that you get to know the group debt is Rs 106,483 crore.

While Moody’s has said that, contrary to what Grant Thornton alleges, it never asked for an additional fee for keeping its rating private—it says the fee for a private or a public rating was the same—the fact that a rating could be kept private allows the management to hide the truth from the investor public and the authorities. Indeed, Grant Thornton gives an instance of how an official of India Ratings also suggested that a rating it was giving could be kept private. The fact that the heads of both Care and Icra have been sent on leave makes it clear the boards of these firms are aware that the evidence against them is damning.

Just three firms of IL&FS—ITNL, IFIN and IL&FS itself—got 429 ratings done since 2011, so it is obvious that the group generated a lot of business; IL&FS had 347 group entities held through four levels of subsidiaries and the auditor fees paid rose from Rs 4.5 crore in FY15 to Rs 15.9 crore in FY17, before falling to Rs 13.7 crore in FY18. While the group had good ratings till around the middle of last year, the Grant Thornton report indicates that rating agencies were worried about the group’s exposure way back in 2011, but still didn’t change their ratings; hardly surprising since, as the report shows, among other favours, the group helped a senior Fitch manager get a Rs 44 lakh discount on a flat and donated another Rs 25 lakh to a trust run by the chairman of ICRA.

In December 2016, email records of IL&FS officials showed that Care was downgrading a group firm to BB+ with a stable outlook; after a round of discussions, this was bumped up to BBB- with a stable outlook! There are several such transactions that are spelled out in detail, but the real shocker is that in November 2011, Fitch had assigned a rating of AAA with a negative outlook for IL&FS; some discussions later, this became AAA with a stable outlook.

Indeed, it wasn’t just Fitch, internal IL&FS correspondence showed that Care and Icra had similar concerns pertaining to IL&FS’s profitability, divestment, weak exposure in group companies, etc. Despite this, however, not a single rating agency indicated this; in one case, an IL&FS staffer edited the rating rationale given by ICRA. If no major action is taken against the rating firms who have been indicted by Grant Thornton, it would reflect very poorly on India’s regulatory system.

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