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• Name of the student: Ankush Singhal

• GR number.SDLVLP092011268

• Study centre name: Kolkata

• Year of Registration: JULY 2009

• Programme Name: PGDBM

• Semester 3

• Course (Subject): Financial Institutions and Markets

Q1

Analyze the reasons behind Classic’s failure. Do you agree that the company’s demise was
largely due to ITC’s poor handling of the company? Support your answer with reasons.

Ans 1

Since 1986, ITC Classic has been working as a NBFC. The company has been achieving a
descent response for its activities. Due to its recently generated good impression in the market and
also due to the impression of its parent company ITC, ITC Classic was able to capture a good deal of
deposits from public. The mistake made by ITC Classic was that it relied heavily on public deposits.
Although, it had 25% assets as liquid assets (in order to fund the demands of the public for
repayment of their deposits) and also its profits saw a rise of 13 times from Rs. 2.3 crores to Rs. 31
crores, ITC Classic did not keep its surplus for future requirements which would arise in the form of
depositors demanding back their investments. ITC Classic wanted to make a quick buck. So, it
invested its surplus 25% in the stock market (which has a very volatile nature from its very inception).
This was the greatest error committed by the company.

ITC Classic had also entered into an agreement with Rajasthan State Electricity Board (RSEB)
for lease and buy – back of electric meters. But RSEB had defaulted on payment of dues, resulting in
ITC Classic losing rentals worth Rs. 40 crores. In this case, ITC Classic has not forecasted the
requirement of obtaining the credibility report of RSEB from the market. Hence, ITC Classic had to
write the loss in its books. This shows the inability of the company of not able to judge the nature of
RSEB. Hence, the company had to suffer such a huge loss of Rs. 40 crores. Such activity had an
adverse effect on its image with the banks that became reluctant to fund NBFC operations after such
incident. This acted like sprinkling salt on the wound for ITC Classic.

Such refusal from the banks also had an adverse impact on the Credit rating agencies. CRISIL
degraded the public deposit schemes and non convertible debentures of ITC Classic from AA to A
and from FAA+ to FAA- and further from A- to FA. Such degradation was not acceptable by ITC Ltd.
as it would have had a very bad picture of its brand “Classic”

When ITC Classic commenced business, the parent company ITC was under the scanner of
police as its executives on board had committed fraud and violations in regards with FERA and
excise. So depositors were of the opinion that the sister concern ITC Classic would also have been
included in the fraud committed by the parent company. Hence, in order to safeguard their deposits
and to prevent any misuse and loss of the same, the depositors started withdrawing their deposits.
This also hampered the impression of ITC Classic in the eyes of potential investors and other parties.
International Finance Corporation (IFC) was also doubtful of the nature of ITC Classic and the
probability of its loan amount of $ 45 million being repaid in full. Hence, even IFC halted on providing
the loan amount.

The Board of Directors of the parent company ITC thought that by using the brand name
“Classic”, the sister concern would get better business opportunities. But ITC Classic did not take
utmost care of the brand name that was allocated with it. In fact, the Directors and executives of the
parent company were engaged in some illegal activities that lead to their being arrested by the police.
The executives of the company wanted to make quick money. Hence, they resorted to illegal activities
like activities in violation with FERA and Excise. From this point, it can also be known that the
executives were carrying out business in the grey market. Had such activities been carried out
further, this would have created a bad image for ITC Ltd. since ITC had commenced the new
business under the brand name of Classic.

This also brings out the image of the parent company ITC that it allowed such business to be
carried out till such time that the excise authorities had to interfere and stop this activity. Also ITC
should have kept a watch on the activities of ITC Classic. ITC Classic seems to have been given
extra freedom in handling the cash received in the form of public deposits. ITC Classic had around
Rs. 800 crores as public deposits. These deposits had been received based on the goodwill created
by ITC Classic with its activities like corporate leasing, bill discounting and equity trading (to a certain
extent). The company placed around 50% of the deposits in assets based for financing. This was one
of the errors made by ITC Classic because the public deposits were retail in nature but the assets
created were long term in nature. ITC Classic had kept only 25% as cash and cash equivalents in
order to meet the demands of public. ITC Classic had invested the surplus 25% deposits in those
shares which had a booming value at the time the stock market was at the top. This could have
become next to impossible in order to meet the demands of public for repayment of their deposits.
But stock market has always been a volatile market right from its inception and this was proved once
again when in 1995, the market crashed and the stocks that had a book value of Rs. 231 crores fell to
a market value of about Rs. 57 crores. This was followed by rise in costs of funds, increased
overheads and liquidity crunch. Along with such situation, the company had been borrowing loans
from the Directors. This was an addition to the woes for the company.
At one point of time, the parent company ITC thought that it would have been better if ITC
Classic would not have been incorporated. The initial high profits of ITC Classic made the parent
company ITC to invest more funds into ITC Classic, not realizing that these funds could be a cause of
downfall for ITC Classic.

Ever since 1986 the company was incorporated, ITC Classic has been making increasing
profits till the markets crashed in 1995-96. Due to these high profits, ITC Classic had opened other
companies like Classic Infrastructure Development Ltd., International Travel House Summit, Sage
Pinnacle, ITC Agrotech Finance, etc. These companies were aiming at different businesses, thereby
diverting the attention of ITC Classic from its main course of business.

ITC Classic had around 55% of its business in hire purchase and leasing; the rest 45% was in
stock market. The Directors of ITC Classic said that such entry in the stock markets was only to
safeguard the risks in asset leasing and financing. But such a huge amount invested in the stock
market would have only worsened the situation. This entry in the stock market proved to be a very big
disaster for the company since the shares in which the company had blocked its funds had a value of
less than half of their investments.

The parent company ITC was always ready to infuse more funds into ITC Classic since ITC
Classic had invested a major part of public deposits in the stock market and that the stock market had
crashed badly. So, ITC Classic had no choice but to accept funds from the parent company.

It seems that the ITC Classic directors have not been efficient enough to handle such great
deposits. It seems that they did not take enough care to check whether the company was conducting
the activities in the benefit of the stakeholders. The parent company ITC Ltd. can also be held
responsible for the downfall of ITC Classic. ITC Ltd. as always has been financing the company. It
seems that ITC Ltd. itself was not prepared to incorporate such an entity since the parent company
itself was in a state of dilemma since the directors were held up in cases of fraud in excise.

Such was the condition of ITC Classic that the Non Performing Assets were over Rs. 350
crores and an investment portfolio that had only artificial inflation but practically had illiquid companies
like Greenline Construction, Minota Aquatech and ITC Agrotech Finance. Such inflation was only to
have window dressing in the financial statements of ITC Classic. In reality, all these companies had
literally no existence.

ITC Classic has done haste in carrying out its activities. When there were good profits and
reserves, ITC Classic should have made enough provisions as there were huge amounts of public
deposits that were to be repaid. But ITC Classic invested a huge of the same in stock market. This
was one of the errors committed. Also ITC Ltd. did not give heed to the seven subsidiaries
incorporated by ITC Classic. This led to commitment of frauds. This shows the ignorance of Directors
of ITC Ltd. Either the Directors have not kept enough control in their hands or they have been a part
of the conspiracy. The Directors of ITC Ltd. seem to be unaware of the fraud going under their nose.
ITC Classic had incorporated many other companies like Classic Infrastructure Development
Ltd., International Travel House Summit, Sage Pinnacle, ITC Agrotech Finance, etc. The main motive
of these companies seemed to mainly absorb the profits which were earned by ITC Classic. Since
there were frauds going on in the sister concerns, no other corporate body from outside kept any
relations with them. The main business of ITC Classic included asset and automobile finance. Since
these subsidiaries were included in such businesses, ITC Classic could not concentrate on its main
business. It started to carry out the business of investment banking. This was not the main line of
business for ITC Classic.

Some of the greatest anomalies committed by ITC Classic were as follows:-

1) Changing of line of business from asset financing and leasing to investment banking and
investing in stock market.

2) Illegal activities carried on by the Directors of ITC Classic which lead to their arrest by Excise
authorities.

3) Using the brand name “Classic” by the parent company ITC Ltd. for incorporating ITC Classic,
thereby facing the risk of damaging the brand image in the eyes of corporate bodies.

4) Investing around 25% of public deposits in the stock market and not keeping enough reserves
for repayment of deposits in the public would demand the deposits.

5) Not being able to forecast the exact NPAs after the takeover of ITC Classic by ICICI Ltd. This
would mean that ICICI Ltd. had to incur a payment of Rs. 622 crores since the parent company
was not able to identify as to how many applications of loans have been approved and
sanctioned and how many were at the brink of getting declared insolvent, thereby losing the
scope of recovering dues from them.
Q2

Explain the reasons behind ICICI agreeing to merge with the loss – making Classic. Was the
merger truly a win – win situation for both the parties involved?

Ans 2

ICIC wanted to broaden the activities of its ICICI Credit (I – Credit), a subsidiary which ICICI
had floated in 1997. ICICI saw that ITC Classic, which was at the stage of bankruptcy, in fact had a
very vast base of retail network. Had ICICI Credit been required to set its own base of network, it
would have taken a time period of 2 – 3 years. This would have resulted in increased costs of
operations. Also ICICI had the benefit of utilizing the herculean loss that ITC Classic had been
carrying. This helped ICICI Credit to adjust its profit of Rs. 572 crores against the loss of Rs. 110
crores which had been carried forward by ITC Classic. Also ITC Classic had a network base
comprising of 8 offices, 26 outlets, 700 brokers and a depositor base of 7 lakh investors. This would
prove a boon for I – Credit as the consumer base was already established. Hence, this saved a lot of
resources for I – Credit.

ITC Classic had a very huge of fund through public deposits. So, ICICI Credit saw it as a good
opportunity to make better funds available. Also the funds which were made available to ICICI Ltd. by
ITC Classic were easily converted into books of ICICI Ltd. as the deposit holders were able to
deposits with better ratings. This step proved to be advantage for I – Credit since I – Credit had got
funds in place before its inception. This was helpful for I – Credit in carrying out the business.

Although ITC Classic gave ICICI the funds for its subsidiary ICICI Credit, these funds were at a
very high rate of interest, i.e. 16%, which was much higher than the prevailing interest rates in the
market. SO ICICI had no choice but to accept these funds and the interest at the prescribed rates.

ICICI Ltd. saw that a well established company with a well known brand name ‘Classic’ wanted
to be taken over. ICICI Ltd. has also forecasted what will be the expenses for the takeover of the
branded company.

This shows the wittiness of the Directors of ICICI Ltd. This move has been a boon for ICICI
Ltd. As ICICI Ltd. had floated a new subsidiary ICICI Credit (I – Credit) and this company was mainly
based with the business of consumer finance, ITC Classic had come with a very large retail network.
This move has made the task of expansion for I – Credit a more favorable process. This has helped I
– Credit to cater to more consumers and also help the company in widening the consumer base.
As for ITC Classic depositors, ICICI Ltd. had been a boon since the investors got AAA rated
public deposits, thereby giving the depositors a relief. ICICI Ltd. had tried to convince people to renew
their deposits (earlier with ITC Classic) with it. This was a success among the earlier depositors of
ITC Classic since they got a safety of their deposits and ICICI Ltd. was able average the interest
payment. This has acted positively for both the parties. ICICI Ltd. has been able to repay the deposits
which the depositors had in ITC Classic and those who wanted their amounts back.

The parent company ITC Ltd. was in no mood to let ITC Classic get wound up. So the parent
company was always trying to capture any opportunity that came in its way in order to keep ITC
Classic afloat. ITC Ltd. had also invested amounts like Rs. 75 crores (Credit line), Rs. 69 crores (Buy
back of Bhadrachalam shares which were a part of ITC Classic’s portfolio), Rs. 272 crores
(Repayment of secured creditors not taken up by ICICI Ltd. and to make up for the loss due to decline
in the investments made by the subsidiaries of ITC Classic) and Rs. 350 crores (Preferential Share
Issue of ICICI Ltd. to meet any future liabilities arising out if the merger). These were one of the most
important steps taken up by ITC Ltd. as winding up of ITC Classic would have created a negative
impression of the parent company among the industry and this could create a tear off relations in the
markets. Hence, this was also a win – win situation for ITC Ltd. since it did its maximum for saving its
brand in the market. This has been a great help to both ITC Classic and ICICI Ltd.

ITC Ltd. knew that any one of the country’s 3 herculean financial institutions, i.e., IDBI, IFCI or
ICICI were the only bodies which could take up ITC Classic. Talks with IDBI were on the move. But
ICICI Ltd. had captured the project. ICICI Ltd. saw that the assets were highly inflated; the cash
reserves had been squeezed to the maximum; ITC Classic had relied heavily on public deposits, a
highly volatile source of funds, etc. So, ICICI Ltd. kept a proposal of issuing 1 Equity Share of ICICI
Ltd. against 15 Equity Shares of ITC Classic. This is because on takeover, ITC Classic had an asset
base of only Rs. 1000 crores whereas ICICI Ltd. had a very vast asset base of over Rs. 41000 crores.

ICICI Ltd. had successfully carried out the takeover activity because ITC Ltd. had undertaken
to pay the Non Performing assets of ITC Classic amounting to Rs. 622 crores. Also the shares which
were taken up by ICICI Ltd. were sure to rise in their value in future.

ITC Ltd. was confident that if other corporate bodies had taken over ITC Classic, ITC Classic
would have fetched a much lower price tag than that offered by ICICI Ltd. Also no other corporate
body would be willing to take the nearly insolvent ITC Classic since there were more NPAs than
actual assets; more payables than reserves; more demands of repayment of deposits from public
than renewing the matured ones. In fact, ITC Classic was at an advantage since the parent company
ITC Ltd. was infusing funds in ITC Classic and ICICI Ltd. in order to keep ITC Classic, thereby
allowing the taken over company ITC Classic to remain afloat.
In real terms, ICICI Ltd. had to settle more than what was projected since many depositors
wanted their money back. Also ICICI Ltd. had to make provisions for Rs. 550 crores (deposits of
public with TC Classic) which was due for payment in 1999. Hence, there was a requirement of
provision for cash reserves for meeting such herculean task of repaying deposits worth Rs. 550
crores. These were from a deposit base of around 7 lakhs depositors / investors. Hence, this acted as
a perfect platform on which ICICI Ltd. floated I – Credit, a consumer finance company. Such merger
has not at all affected the dividend per share and ICICI Ltd’s own Non Performing Assets.

From the time of inception in 1986, ITC Classic has been a profitable organization. It has
always been in rising profits. The annual turnover was increased from 17.3 crores to Rs. 310 crores.
Also the net profit had increased from Rs. 2.3 crores to Rs. 31 crores, thereby showing a
compounded annual growth rate of 78% from 1991 to 1996.
Q3

‘Classic should have stuck to its leasing and asset financing business rather than entering
secondary market operations.’ Critically comment on the above statement.

Ans 3

ITC Classic has been a NBFC since inception in 1986. Its main business includes providing
finance for setting up of businesses, working capital financing, purchasing assets and giving them on
lease. Also the company has been in investment field on a substantial scale. This business had been
a great success in the market. So, there was a huge inflow of public deposits. This helped the
business in carrying out its business activities like corporate leasing, bill discounting and equity
trading. Although, share trading was not the prime type of business carried on by ITC Classic, ITC
Classic made a very heavy investment in the stocks that were booming during that period.

After enough profits were earned, ITC Classic incorporated other companies like Classic
Infrastructure Development Ltd., International House Summit, Sage, Pinnacle, ITC Agrotech Finance,
etc. These companies were concerned with other businesses like

There existed a group of sister concerns with parent company being ITC Classic like Classic
Infrastructure Development Ltd., International House Summit, Sage, Pinnacle, ITC Agrotech Finance,
etc. These sister concerns were actually companies which were created only for giving book entries
for the transactions so that ITC Classic

ITC Classic has been in for making a quick buck. Hence, when the stock market was at its
boom, ITC Classic invested its excess 25% in those stocks which had better prices. Since the stock
market has known to be a volatile market, the same was experienced by ITC Classic. The stock
market crashed in 1995 and the shares which had book value of above Rs. 200 crores fell to a market
value of Rs. 50 crores, thereby making ITC Classic face a herculean loss of its liquid assets for
meeting its demand of returning public deposits. Also banks were reluctant to allow loans to ITC
Classic during the crunch period. Hence, the company had to rely on public deposits. But the public
deposits, being a highly volatile source of funds, brought a strain on the company’s cash reserves.

Since the company had earned a good profit in the past, the Directors felt that such similar
profit would be earned.

ITC Classic has been an asset financing company right from its inception. This has been a
good business line which ITC Classic had been handling. Firstly, due to the brand name ‘Classic’, ITC
Classic had got a terrific response from the public for the receipts of the public deposits.
ITC Classic has not able to judge the requirements of the market in which it has been
functioning. It has only seen profit which is for short term in the stock market, not realizing that the
stock market should never be such a part of investment portfolio that it disturbs the whole portfolio.
When the market crashed in 1995, the whole burden was on the cash reserves on the company,
thereby making the company saturated out of liquid cash reserves. This proved to be a curse for the
parent company ITC Ltd. as it was also hampering the image of the brand name ‘Classic’.

When ITC Classic was in the stage of liquidation, two corporate entities GE Capital and Hnduja
Group showed interest in the takeover of ITC Classic. But the parent company ITC Ltd. found the
terms and conditions put up by these entities to be rigid and stringent. Also the value of assets,
liabilities and franchise was found to be much lower than what ITC Ltd. had expected. This shows
how the valuation of assets of ITC Classic has degenerated in the eyes of other corporate entities,
even though it has got a sound and solid foundation of ITC Ltd. This also shows the decrease in
value of services provided by ITC Classic and also that no one likes to continue business with such a
company which cannot sustain itself.

ITC Classic was specialized in asset financing and leasing activities. Hence, there were many
clients of ITC Classic for such business. Even Financial Institutions were willing to give ITC Classic
loans and advances for carrying out the business. But ITC Classic had now become a weak
company. So the relations which had prevailed since the time of inception in 1986 were shattered by
the news of the executives of ITC Classic being arrested by Excise authorities. This also made
financing institution like International Finance Corporation had to take a second thought and waited to
disburse the loan amount till talks were settled and the conditions became stable.

ITC Classic does not seem to have much required experience and expertise I the field of stock
trading. That is why, for just earning quick profits, ITC Classic invested such a huge amount in stock
market. But in 1995, the market crashed and ITC Classic had to face the music for the money
invested in the stock market was lost and the shares were valued at nearly one fourth of their original
values. Also ITC Classic had companies whose shares were just to show the name of investments
made. Actually they had negligible realizable value.

In 1990, when ITC Classic had been remarked as a fully functional company in financial
services, ITC Classic had never got a greater status than an asset financing subsidiary. This is
because ITC Classic had floated a number of subsidiaries and was involved in them. These
subsidiaries were actually assets just to show in the books of ITC Classic. In reality, their shares had
no trading value. Mc Kinsey, a consultancy firm, suggested why ITC Classic should shares in different
companies and carry out business and their name whereas the main service provider was ITC
Classic. Mc Kinsey further commented that ITC Classic was moving away from its main course of
business. Also there were queries raised on the portfolio design of the company as the portfolio did
not genuinely produce the accurate picture of the investments.
At one time, ITC Classic had also entered the real estate business. But it did not find any
exciting results and so it withdrew itself from the real estate business.

As the case would be, there was a decision taken up between ICICI Ltd. and the parent
company ITC Ltd. that Classic’s creditors would be prepaid in order to reduce the interest burden.
Also ITC Ltd. would be liable to pay the liabilities and obligations in respect of the guarantees and
indemnities undertaken by ITC Classic.

ICICI Ltd. was responsible only for the demand of repayment of demands of deposits made by
public. Since ICICI Ltd. did not want to take over the secured creditors, ITC Ltd. infused a more Rs.
272 crores in order to settle their accounts.