Fear of contagion looms over financial sector after DHFL's payment default

Nomura analysts said the Reserve Bank of India and the government would need to segregate the potential solvency issue at DHFL from liquidity issues at other larger wholesale NBFCs and HFCs

The latest default on interest payments by Dewan Housing Finance Corporation (DHFL) can accentuate contagion risk in India's financial sector as banks, pension and mutual funds, and insurance companies together have an exposure of around Rs 1 trillion to the company, warn analysts. It is crucial, they say, the company sell its assets in time and the government steps in to prevent the DHFL contagion from spreading to other financial firms.

“This default could accentuate contagion risk in the financial sector (in the backdrop of IL&FS’ default last year), leading to higher costs and polarisation of funds to better-rated NBFCs — those with liquid balance sheets will also be better off,” global financial firm CLSA said in a note on Thursday. 

Nomura analysts said the Reserve Bank of India and the government would need to segregate the potential solvency issue at DHFL from liquidity issues at other larger non-banking financial companies (NBFCs) and housing finance companies (HFCs). “A possible solution could be to provide a liquidity line to solvent NBFCs/HFCs so that the DHFL issue does not lead to a contagion,” they said in a statement.

The country’s largest lender, State Bank of India (SBI), issued a statement answering queries on the impact that developments in accounts like DHFL could have on the bank as well as on the system. A spokesperson said the bank had been very closely monitoring its exposures to the NBFC sector for the past 10 months and taking action as deemed appropriate. “The overall quality of the NBFC asset portfolio in our books continues to be good,” the statement said.

“Challenges faced by accounts like DHFL have already been factored in when we have given our estimate for the stress that the bank would have to deal with in FY20 and included in our estimates for slippage and loan loss provisioning for the current financial year,” the statement said. 

The fear of a contagion was highlighted by CARE Ratings on Wednesday when it said there had been a deterioration in the liquidity profile of DHFL, with cash and liquid investments decreasing within a month from Rs 4,668 crore (including reserve requirement) as on March this year to Rs 2,775 crore on April 30. DHFL is expecting a negative cumulative mismatch of around Rs 4,180 crore between June and August in its cash inflows and outflows, CARE said.

Indian banks will have to take a significant haircut and make provisions as they gave loans worth Rs 50,000 crore by way of loans and bonds to DHFL. Besides, life insurers, including Life Insurance Corporation (LIC), and pension funds have an exposure of another Rs 30,000 crore to the company. Dewan Housing also raised deposits of Rs 10,000 crore, or 10 per cent of its total liability, from retail investors. It raised another Rs 10,000 crore from mutual funds and via external commercial borrowings.

“Mutual funds, with an exposure of Rs 5,000 crore, or 0.4 per cent of debt AUM, will be the first to take mark-to-market (MTM) hits of as much as 75 per cent. Banks will also face similar MTM risks on bond books, but for loans they will follow 90 days past overdue for NPLs (non-performing loan) and time-based provisioning that starts from 15 per cent,” CLSA said. On Thursday, DHFL fell 16 per cent to close at Rs 94 a share on the BSE.