Dealing with DHFL

Dewan Housing Finance Limited (DHFL) has released its unaudited and uninspected financial results for the March quarter, setting off fears for its continued survival. Its stock tanked after the markets ope­ned this week to the lowest point in years, as the results reported a loss of Rs 2,223 crore in the March quarter. Earlier in July, DHFL defaulted on its obligations to repay Rs 2,858 crore. The company also reported major possible stress in its wholesale loan book. It further said that regulators found its capital adequacy ratio below the required 12 per cent, and there were “gaps” in docume­n­tation for loans worth more than Rs 20,000 crore. Since DHFL is a listed company, it has raised money from retail investors, including through public deposits. Al­mo­st 30 banks have lent it almost Rs 40,000 crore of its total loan book of over Rs 90,000 crore, and 10 mutual fund houses have lent it about Rs 5,000 crore under 165 schemes. 

The banks have come up with an inter-creditor agreement (ICA) to restructure DHFL’s loan book. The issue here, however, is that banks have less than 75 per cent of the outstanding loans to DHFL — which means that the ICA is not binding on other creditors. Mutual funds are rightly concerned about two aspects of the ICA. For one, they are reluctant after their experience with a standstill agreement that was offered to the promoters of Essel earlier this year which attracted adverse regulatory attention. In addition, the banks’ plan to pay off retail investors and provident funds with exposure to DHFL. Presumably, this is a consequence of the nationalised banks’ political concerns. However, the mutual funds correctly point out that such unsecured investors cannot be treated at par with secured investments by debt funds. This would severely undermine the credit markets, already shaken by legal decisions that appear to de-prioritise the repayment of secured loans. 

The crisis in DHFL is a regulatory error, and also reflects poorly on the credit rating agencies. In dealing with the consequences of the default, three ordered principles should be kept in mind. First, the stability of financial markets — in particular, secured creditors should be given preference. Second, the viability of the housing finance market. The difference between the wholesale and retail loan books of DHFL — the former far less secure than the latter — needs to be taken into consideration. And, finally, asset destruction should be minimised. That last principle means that if DHFL is merely illiquid and not insolvent, it should ideally be saved by an infusion of capital. The question is whether that is true — and, if it is, why banks are not insisting on a closer probe of its books, or threatening a change in management unless the promoters infuse cash into the company.

Crucially, when it comes to the question of evaluating the usefulness of additional capital, banks must not take an over-optimistic view of the possibility of completing projects. The DHFL crisis is also a reminder that a legal framework for the resolution of financial companies should not be further delayed.