Explained: Why RBI Took Over Srei Infrastructure Finance

On Monday (4 October), Reserve Bank of India (RBI) said that it would be superseding the boards of two Srei group companies — Srei Infrastructure Finance (SIFL) and its subsidiary Srei Equipment Finance (SEFL) — both of which have defaulted on payments to lenders. The journey has been particularly painful for Srei Infrastructure’s public shareholders, who saw immense wealth erosion within a small period of time.

Asset Quality Issues

The company initially began lending in the equipment financing business and lease-purchase business, but began diversifying into infrastructure financing, mutual funds, merchant banking, insurance broking and other financial services. Nevertheless, equipment financing, which involved financing productive assets like infrastructure equipment, remained the leading business. The assets under management grew from Rs 13,265 crore in FY10 (financial year 2010) to Rs 45,000 crore in FY2020, a compounded annual growth rate of 13 per cent per annum.

According to the company’s annual reports, the tide began turning in 2017, when the company’s gross non-performing assets (NPAs) went up from around 2.93 per cent to 8.12 per cent. Both the equipment financing and infrastructure financing businesses are heavily dependent on the infrastructure sector in India, which has been in a slowdown for a few years. Infrastructure projects also have long gestation periods, and is quite capital intensive. Projects often face opposition from local communities, regulatory scrutiny and require several clearances. Unsurprisingly, Srei’s infrastructure financing segment saw a higher incidence of NPAs and payment delays by debtors.

The Beginning Of The End

In 2018, infrastructure financing firm, IL&FS Financial Services, defaulted on its bonds resulting in a liquidity crunch in the markets. The infrastructure sector was worst hit as money could not be rolled over easily, and the cost of capital increased.

Given the uncertainty in project-based lending and its weak lending book, Srei decided to wind down its infrastructure portfolio. It planned to focus on growing its equipment financing, co-lending and fee-based business. It had also been financing long-term infrastructure projects with shorter term loans. The plans to list Srei Equipment Finance did not pan out as expected, and hence, the company decided to merge the infrastructure lending business and equipment finance business in July 2019 through a slump sale. However, the company’s asset quality had already deteriorated and both investors and bankers had begun losing faith in the company. The Reserve Bank of India (RBI) began looking into the company during this period.

“The loan book of SIFL was largely wholesale in nature with big ticket size advances having long tenure in the infrastructure sector. The advances of SIFL were to companies which are involved into execution of infrastructure projects where the gestation period is long and accordingly has weaker financial profile. Some of these have low coupons with higher returns expected on maturity and have accordingly impacted the yield of SEFL. Also, SIFL had significant advances to projects under the same management or related to the group,” said a report by CARE Ratings.

Pandemic Woes

The Covid-19 pandemic hastened Srei's decline as a majority of its debtors used the moratorium to delay payments and asked for loan restructurings.

A finance company borrows at a lower rate and lends out at a higher rate and retains the difference. Hence, matching its cash inflows and outflow is critical. A cash flow mismatch, resulting in a constrained liquidity position could spell doom for the company. Its heavy losses had impacted the company’s capitalisation adversely as well.

Srei approached the National Company Law Tribunal (NCLT) in Kolkata to get some leeway to make the payments to creditors. The NCLT granted the company some relaxations that prevented it from being declared a defaulter. Therefore, despite its non-payment of dues, its debt was not reduced to junk status.

Default Status

However, the ratings agency CARE filed an appeal with the Delhi NCLT against the order by the Kolkata tribunal. The order was reversed and Srei was declared as a defaulter with a large chunk of its debt declared as junk. But the company has not given up and has said that it is considering a legal route.

“The Company believes that the rating given as above is blatantly wrong, misleading and baseless. The rating agency has recognised default arbitrarily even though there’s or can be no default in terms of the Order dated 30th December, 2020 passed by the Honourable National Company Law Tribunal, Kolkata Bench in an application filed under Section 230 of the Companies Act, 2013. The Company is in the process of availing appropriate legal remedy, among others, to set aside the rating since the Company believes that the rating agency has acted in a wrongful and contumacious manner,” said the company.

In July 2021, the RBI said that it had found that Srei had extended loans worth Rs 8,576 crore to related or probably related parties during an audit. In the past, several bank and non-bank lenders have been apprehended by the RBI for lending heavily to related parties. According to experts, Srei's objections and explanations do not hold much water, which made the RBI’s case stronger.

Quite possibly, the combination of these factors caused the RBI to supersede the boards of both companies. It has previously managed to resolve a similar crisis at Dewan Housing Finance Limited, which was bought out by the Piramal Group. Meanwhile, creditors will have to keep waiting for repayments until the matter is settled.