Mumbai: Rating firms decided against assigning a default rating on a 100 crore commercial paper of IL&FS Transportation Networks Ltd (ITNL) despite a delay in repayment in June, relying on the management’s pedigree and key shareholders of its parent Infrastructure Leasing and Financial Services Ltd (IL&FS). The agencies were, therefore, caught on the wrong foot when IL&FS itself defaulted on a 1,000 crore loan in early September.

Mint spoke to senior executives of at least three credit rating agencies, which have a rating on ITNL and IL&FS. All except one agreed to be named. They, however, conceded that none of them anticipated a liquidity crunch at IL&FS, given the backing by leading financial institutions such as Housing Development Finance Corp. Ltd and State Bank of India.

On 22 June, ITNL informed BSE of a delay in funding investor account pertaining to redemption of commercial paper (CP) due on 21 June. At the time, it said unsecured CPs worth 100 crore issued for tenure of 90 days at a coupon of 9.75% were in default. It attributed crediting of money after NEFT cut-off time as the reason for the delay.

To be sure, the three rating agencies—ICRA Ltd, India Ratings and Brickwork Ratings—which rate the company’s CPs, downgraded the instrument between May and July, without assigning a default status. India Ratings downgraded the CPs to A4+ from A1 on 25 July; Brickwork downgraded the CPs to BWR A2+ from BWR A1 on 22 June and ICRA downgraded the paper to A2+ from A1 on 26 May.

M.S.R. Manjunatha, head for ratings administration at Brickwork said the chinks in the armour were visible when ITNL defaulted in short-term paper. “CP defaults are always serious due to two reasons. First, mostly A1 and A1+ rated instruments only are traded in the CP market and so the expectation of default are very low. Second, it restricts the firm’s ability to raise short-term funding for the next six months due to penalties that kick-in on account of default," he said. He further added that most rating agencies saw the CP default as a “liquidity issue and not a solvency issue."

Brickwork on 22 June downgraded the CPs but said it factored in the strong parent support from IL&FS by way of infusion of capital, “established track record of executing large infrastructure projects, strong order book position, operating portfolio of road networks and focus on reduction of overall debt levels".

“It was expected that shareholders will bring in funds to tide over the problem but that did not happen. That’s when steep downgrades started," said Manjunatha.

ITNL is promoted by IL&FS and IL&FS Financial Services Ltd which own stakes of 71.92% and 1.3%, respectively.

According to a senior rating agency executive, some amount of leeway is given to companies with a sound management and strong investor credentials.

“Wherever there are refinancing gaps or asset-liability mismatches or where the company is trying to sell some assets to reduce leverage, there are degrees of leeway we give on the basis of credibility of their plans and of its management," said the executive.

He said in the case of ITNL, the parent was sharing its plans of divestment and refinancing of debt.

“Second, this is an entity where we have a long track record of a credible board, management, independent directors and credible key shareholders. “Moreover, when the board, which includes two large shareholders, approves a credit line, then it is difficult to anticipate that these shareholders will not stick to the plan," he said.

Another senior executive at a rating agency said in a market where liquidity is a concern and secondary trades of these instruments are few, it is not easy to track defaults.

The rating agencies now plan to deploy some controls to better anticipate an impending default. Some plan to increase the risk weightage for “refinancing gap" while others plan to closely monitor short-term instruments issued by firms.

The executive said also that irrespective of the management and quality of the board, rating agencies need to give higher weightage to the refinancing risks.

Manjunatha said that a framework for “active" monitoring of short-term instruments is needed. “CPs should now be monitored on due date basis. For every paper which is issued by the company, the ratings agencies should be notified the amount and due date. Moreover, source and availability of funds should also be monitored by the rating firms ahead of the due date."

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