Dewan Housing Finance Limited (DHFL), a deposit-taking housing finance company and India’s fourth largest Non-Banking Finance Company (NBFC), ended FY 2018-19 on an extremely bad note with a reported net loss of over Rs. 2,200 crores for Q4 FY 19 and a capital adequacy ratio of 10.24%, well below the regulatory minimum of 12%. On June 05, 2019 the Commercial Papers (CPs) of DHFL worth over Rs. 850 crores were downgraded to default grade – “D” by ICRA, CRISIL, CARE and Brickwork Ratings.
DHFL – The story till now:
- DHFL was flashed in the news for the first time in September 2018 when DSP Mutual Fund sold Rs. 300 crores of NCDs of DHFL at 11 percent, a yield higher than the ones prevailing then in the secondary market. This deal sparked speculation that DHFL could be facing liquidity issues.
- In January 2019, it was alleged that DHFL promoters had lent money to ‘shell companies’ allegedly linked to the promoters who had used this money to buy assets abroad.
- In March 2019, CARE Ratings downgraded the ratings of various debt instruments of DHFL by a notch.
- Another major blow came in May 2019, when CARE Ratings downgraded DHFL’s Fixed Deposit (FD) programme worth Rs. 20,000 crores from ‘A’ (low credit risk) to ‘BBB -’ (moderate credit risk). DHFL immediately stopped acceptance and renewal of FDs. It also stopped renewals and premature withdrawals from existing fixed deposits on hold. It also informed the stock exchanges that it will not be able to furnish the audited standalone and consolidated financial statements for FY19 within the time stipulated by SEBI norms.
- Finally, DHFL defaulted on interest payment on its bonds and bond repayments worth over Rs. 960 crores due on June 4, 2019.
- On June 26, 2019 it defaulted on CPs, paying only Rs. 150 crores out of the Rs. 375 crores due.
What happened at DHFL and what does it mean?
- Liquidity crunch
DHFL, being an NBFC (also called as a shadow bank) does not have access to central bank liquidity. It primarily gives out home loans in Tier 2 and Tier 3 cities in India. DHFL, like many NBFCs relies on bank finance and borrowing from the debt market to further lend to its customers. In 2018, after IL&FS went bust, banks became much more cautious about lending money to NBFCs. This triggered a liquidity crisis, since there was limited access to credit. Also, many NBFCs resort to short-term borrowing to finance long-term lending which can aggravate the situation in case of a liquidity problem. This may cause financial pain when borrowing costs rise and it becomes difficult to rollover short term loans multiple times.
- Large exposure to developer loans
Around 23% of the loan portfolio of DHFL comprises of loans to real estate developers which are not securitized by banks. With the real estate sector in India facing a gloomy phase, DHFL is facing the heat of lending to project finance.
- Mutual Funds have taken a beating
As on April 30, 2019, 163 debt oriented mutual fund schemes from 22 fund houses had an exposure of Rs. 5,582 crores to the debt instruments of DHFL group companies. In line with SEBI regulations, following the downgrade, MFs have immediately marked down all DHFL debt in their portfolios by 75%. This has sharply impacted their Net Asset Values (NAVs) as they fell by 6 – 53% on June 04, 2019. UTI Mutual Fund, for example, which owns a large amount of DHFL paper has written down all of that debt completely, meaning it doesn’t expect to get anything back.
- Impact on the broader Indian economy
Failure of a mega-institution like DHFL can have serious repercussions on the Indian economy which already struggling to deal with the twin-balance sheet crisis – a high number of non-performing assets and heavily indebted corporates. A complete default would lead to a much tighter liquidity crunch, further fears about the viability of NBFCs, and a ripple effect on other industries. It will also cloud doubts about the current regulations for the NBFC space.
Where is DHFL headed?
- Default rating means “No more funding”
Credit rating agencies have downgraded DHFL to default grade and hence, raising money will remain a challenge for the company even though it is a large player in the housing finance industry. They have no option but to sell assets and loan books to pump funds into the company.
- Wadhwan forced to sell Family Silver
The promoter of the company, Mr., Kapil Wadhwan is making all efforts to save his father’s venture from a lock down. In the last four months, since the crisis peaked, Wadhawan Global Capital Ltd. (WGC), the parent company which holds 37.30% stake in DHFL, has been on an asset selling spree in order to infuse cash in DHFL. Aadhar Housing Finance Ltd., a subsidiary of DHFL which caters to low income households saw a stake sale by WGC and DHFL to Blackstone for Rs. 2,200 crores earlier this year. In March 2019, WGC and DHFL also sold their stake in Avanse Financial Services, an education focused NBFC to Olive Vine Investment, an affiliate of the Warburg Pincus Group, for about Rs. 1,100 crores. DHFL also has plans to exit its joint venture businesses, viz., DHFL Pramerica Life Insurance and DHFL Pramerica Mutual Fund. However, market fears that selling off non-core businesses and portions of its loan book to raise money and meet short-term repayment obligations may not be of long-term help. The bigger question in picture is how long can DHFL continue selling its assets to meet short-term repayment obligations. As on date, business remains at a standstill as no new disbursements are being made. Markets are not willing to lend money to DHFL. Moreover, the asset sale talk has been in the market for quite a long time and is progressing at a slow rate, raising market anxiety.
- “Acceleration clause” may worsen the situation:
Many of the loans availed by DHFL have acceleration clauses. This means that the lender may demand immediate repayment of entire loan if the rating of the company falls below a certain level. If this clause is triggered, it will worsen the situation for DHFL.
- Inter – Credit Agreement (ICA) with Banks
Around 35 banks cumulatively have an exposure of around Rs. 46,000 crores (including about Rs.32,000 crores direct loan exposure and about Rs.14,000 crores by way of investments in debt instruments issued by the company) to DHFL and have considered to opt for debt restructuring to avoid insolvency of the debt-laden NBFC. Bankers, including State Bank of India, Axis Bank, HDFC Bank and ICICI Bank, have agreed to sign ICA as per the RBI’s new framework for restructuring of stressed assets, which came into effect from June 07, 2019. Under this, lenders have to decide on a debt resolution plan in 30 days. This plan may give a breather to DHFL by allowing postponement of its dues to the banks.
- A Strategic Investor in sight?
At the moment, DHFL desperately needs a strategic investor who can ease the short-term pressure on liquidity and also allow it to raise further capital from the market by lending its credibility. The investor should also encourage more transparency in disclosing real issues and the requisite measures taken to address them which will help to regain market confidence. Regaining market confidence is a long-term solution rather than arranging funds to meet short-term obligations. According to multiple sources, DHFL’s promoters are in talks with Private Equity (PE) players to sell about three-fourths of the 39.21% stake in the company. These PE players include AION Capital (a special situations PE firm that is a joint venture between ICICI Venture and Apollo Global Management, with assets under management of about a billion dollars); True North (formerly India Value Fund, invests in mid-sized businesses in India); and global investment firm KKR (AUM of $194.7 billion in December 2018), besides others. They could pump in Rs. 4,000 – 5,000 crores into the company, taking over debt as well as equity.
- Valuation – a big concern
Given the current situation, DHFL may not command a rosy valuation for the promoters. Shares of DHFL closed at Rs. 55 per share on July 26, 2019 from a high of Rs. 690 in September, 2018.
The real estate sector in India continues to remain weak without any major recovery in sight and hence, asset quality issues could persist and valuations may remain subdued.Many analysts believe that if a strategic investor can pump in Rs. 4,000 – 5,000 crores into DHFL, the company could have a leverage of 9.5 – 10 times, which means that the company could raise 10 times the money or up to Rs. 50,000 crores approximately from the market, which is enough to take care of its upcoming obligations.
- Union Budget 2019 – some relief to NBFCs
The Union Budget 2019 has allowed banks to buy NBFC assets in the form of a partial guarantee against loss. This may provide DHFL with some additional liquidity.
- Case for NBFC stress test:
The failure of DHFL has cast a doubt on the collection efficiency of NBFCs and has made the case for stress testing of NBFCs stronger to restore investor confidence, especially of Foreign Portfolio Investors (FPIs).Under the stress test, the banking regulator calculates capital ratio of the financial service companies under several adverse scenarios. The US Federal Reserve conducted a stress test for the banking sector after the financial crisis in 2008 to ensure banks have enough reserves.
Poor recovery of loans by NBFCs can potentially slow down securitization of loans by banks from NBFCs which be detrimental for NBFCs. Data compiled by Kotak Institutional Equities shows that the securitization of loans from NBFC to banks rose to Rs. 1.90 lakh crores in FY19 compared with Rs. 0.83 lakh crores in the FY18.
Better late than never that DHFL gets a mega bailout or a strategic investor. Even though the entry of a new investor will mean restructuring of the business, it is better than letting a huge housing finance company collapse under the weight of its own legacy.