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DHFL : Will Creditors get their Dues Back?

DHFL : What Went Wrong?

Dewan Housing Finance Corporation Ltd. was one of the top housing finance companies in India. It is a non-banking finance company, sometimes also known as a shadow bank. The company has an outsized network across the country that caters to many customers within the low-to-moderate income category. DHFL provides its client base with a variety of home equity credit products including loans on homes residential plots construction LAP or loan against property as also mortgage non-residential and project loans. The company has a big presence in 2 tier and 3 tier cities with almost 330 locations and it also has two international representative offices in London and Dubai.

When it was incorporated in 1984, it was originally called Dewan Housing Finance & Leasing and then it was later renamed as Dewan Housing Development Finance, then after to Dewan Housing Finance Corporation. As of March of last year, the Company has 4 wholly-owned subsidiaries 3 joint ventures and 3 associate companies.

What happened at DHFL?

In 2018, when another NBFC, IL&FS, went bust, it alarmed the entire industry. Banks became much more careful about lending their money to NBFCs. But this led to a liquidity crunch since there was limited access to credit. Many NBFCs rely on short-term borrowing to finance long-term lending, which puts them in a difficult spot when there is a liquidity crunch.

In September 2018, after the emergence of the IL&FS crisis, DHFL’s stock also took a beating, by as much as 60%. Then, in January, Cobrapost claimed that the company’s promoters were involved in a Rs 31,000 crore scam to siphon off money. The blog claimed that their primary stakeholders Kapil Wadhawan, Aruna Wadhawan and Dheeraj Wadhawan, sanctioned and disbursed astronomical amounts in secured and unsecured loans to dubious shell companies related to them through their proxies and associates, which have in turn passed the money on to companies controlled by the Wadhawans. The blog also mentioned how the money has been used to buy shares/equity and other private assets in India and abroad, including in countries like the UK, Dubai, Sri Lanka and Mauritius. The company denied these claims and later said that an independent chartered accountant’s inquiry found them to be untrue.

The scam has consequences for the larger financial system in India. What generally happens in the industry is that loans are advanced to companies and are secured by not only mortgaging the properties of the borrower company but also by personal guarantees of promoters of companies. By lending to shell companies without due diligence, DHFL has ensured that the recovery of such dubious loans is impossible since the companies or their directors themselves don’t own any assets. This way the private assets acquired by the Wadhawans and their associates by using the funds from these dubious loans are completely protected from any recovery process that may be initiated by authorities under the SARFAESI Act or Insolvency and Bankruptcy Code of India. Thus, the people losing in the process would be the public sector banks, such as State Bank of India and Bank of Baroda, with an exposure of over Rs. 11,000 crore and Rs. 4,000 crores, respectively, foreign banks and shareholders from among the public or investors of DHFL.

Debt recovery is an important system of measurement on which ease of doing business is judged. Such scams, if not identified, resolved and persons responsible punished will only damage India’s standing on the world stage.

DHFL termed the entire incident as a mischievous misadventure by CobraPost.

In the forensic investigation done by Grant Thornton, it found out that the company was siphoning off funds since 2006-07 through 91 fictitious entities operating from a Mumbai branch. In their report, they uncovered frauds of ₹14,000 crores in DHFL’s books, including ₹9,320 crores in the wholesale book, ₹1,707 crore loss in the SRA (Slum Redevelopment Authority) book and ₹3,000 crores of fund diversion in retail loans and according to the report, the recovery of these loans is doubtful.

After CobraPost’s allegations, the government announced that the Ministry of Corporate Affairs will look into these allegations.

The company then announced that they would sell assets and some of its businesses to improve its liquidity. The company also stopped fresh deposits and premature withdrawals of its deposits, with immediate effect, to reorganise its liability management. They also stopped with the renewals of their existing deposits.

The credit rating agencies then downgraded their ratings putting them on credit watch with developing implications. ICRA cut its rating on DHFL’s commercial papers and CRISIL later followed suit by downgrading DHFL’s commercial paper program and short-term deposits.

The mutual fund industry was the largest investor in corporate debt instruments and bonds of the stressed NBFC. Data suggests that around 265 schemes were exposed to DHFL's shares and debt instruments with a total investment of Rs 6,161 crore across 26 mutual fund houses, as on June 06 last year.

The company owed Rs 960 crore to mutual funds as interest payment towards its bonds. However, on 4th of June last year, the company missed its deadline to make Rs 1,150 crore payment to all bondholders and informed investors, that the payment would be done within seven days. This delay of seven days caused the mutual funds to mark down the net asset values of DHFL bonds by 75 per cent, that means that, if a mutual fund owns DHFL debt – even if it is not the bonds that the company was unable to pay in time – it has to be marked down 75%. 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. It led to a 30-40 per cent single-day fall in NAV of schemes that invested in DHFL debt papers.

CRISIL then proceeded to downgrade commercial papers issued by the debt-ridden company to ‘default’ or ‘D’ category from A4+. The rating agency cited the mortgage lender's deteriorating liquidity condition as the main reason for downgrading its rating. It was a little too late as the company had already missed a payment and asked for a grace period of seven days. Meanwhile, the company was scrambling to help meet its Rs 1,000crore plus obligation.

As a result, their stocks fell to double digits, hitting a low of 94.90, which was its lowest since 2013.

The failing of the company will affect all of those that have extended credit to the company. That includes about Rs 50,000 crore from banks, another Rs 30,000 crore from the Life Insurance Corporation, pension funds and more. In other words, this isn’t about just one company failing: it is a danger to the already- troubled banking system.

Rating Agencies: what was wrong?

Credit rating agencies are vital in the financial world in the value chain of credit risk assessment. They rate the creditworthiness of the borrowers and act as intermediaries between borrower and investor to minimise information irregularities about the risks associated with the investment products on offer. Out of our seven rating agencies, two have financial and technology tie-ups with global leaders, while one is subsidiary to a global leader. So, three out of seven companies have access to global best practice.

The global trust in the credit rating agencies had already been declining post the 2008 housing crisis. The rating agencies once again failed numerous investors by giving A+++ rating to IL&FS which triggered an NBFC crisis and therefore a liquidly crunch. The sharp downgrade of DHFL debt put the spotlight on credit rating agencies. The rating agencies are supposed to alert the investors if they see a default coming for the issuers they rate. Defaults have occurred in companies such as IL&FS and DHFL even as their long-term ratings indicated very low to moderate risk of non-payment. CRISIL downgraded DHFLs corporate bonds after they actually missed their interest payments.

One major reason for this crisis can be – ‘rating shopping’. The agencies’ main clientele are the issuers. They work to maximise their customer base by increasing their income from the said issuers. All the agencies have the same clients and hence they have little bargaining power. Most of the times they quote lower prices for their ratings or they might even promise better rating beforehand. They also face the problem of issuers not disclosing critical details. While giving out final rating on an instrument, they also have to be mindful of their clients’ future business opportunities. And on top of that, the system does not permit the agencies to publish the ratings without the issuers' consent. So, if the rating is not as high as the issuer would like it to be, he can essentially go to another rating agency to look for a better rating. This whole system is flawed as it is not fair for the investors who park their life savings in these instruments and then lose it all. This competition has resulted in malpractices and a decrease in the quality of ratings.

Aftermath

The Corporate Insolvency Resolution Process was initiated against the company as per the provisions of the Insolvency and Bankruptcy Code, 2016 with effect from December 3, 2019, by the RBI. RBI asked all its fixed deposit and non-convertible debenture holders to file their claims before December 17 of the previous year.

The company said it won’t make any interest or principal payment to lenders as well as bondholders due to the company being under the resolution process. DHFL said all the rated debt papers of the company were carrying default grade ratings and disclosures on the same had been made to the exchanges.

The creditors of the company were accordingly informed about the commencement of the insolvency process and were requested to submit their claims to the company in the prescribed manner as per the provisions of the Code. The amounts to be received towards the dues by the creditors were supposed to be based on a resolution plan to be approved in due course by the NCLT, Mumbai. The non-banking finance company (NBFC) further said that it is under moratorium and dues to lenders and bondholders will remain in suspension until the insolvency process is completed. Public deposits contribute 7% of the overall borrowing mix of Rs 83,900 crore. Debenture holders have 37% exposure followed by 31% bank term.

RBI had superseded the board on and they referred DHFL to National Company Law Tribunal under the Insolvency and Bankruptcy Code. An administrator was appointed and he was supposed to take stock of assets and liabilities.

DHFL fixed deposit holders do not have the recourse to the debt resolution tribunal was free to apply to the Supreme Court to be part of the committee of creditors.

Under the IBC’s waterfall mechanism, during liquidation debts to secured financial creditors and workmen are to be paid fully before payments to unsecured financial creditors and operational creditors. Fixed deposit holders are unsecured creditors under the priority of claims. The first charge on claims is with secured creditors both lenders and debenture holders and second charge holders will be unsecured.

The promoters of Dewan Housing Finance have given personal guarantees to more than Rs 80,000 crore of loans on the firm’s books The personal guarantees cover various borrowings and include a guarantee on secured non-convertible debenture of Rs 42,344 crore, Rs 31,975 crore worth term loans from banks, Rs 2,435 crore of term loans from NHB and foreign debt worth Rs 2,807 crore. The total debt covered by personal guarantees of the Wadhawan family is Rs 82,949 crore.

If the company fails to get any viable resolution plan and goes for the liquidation or there are dues left after the resolution of the company, the lenders can seek recovery from the individuals who have extended personal guarantee

A successful resolution will help banks and other lenders recover a part of their money and they can then decide whether to also invoke the personal guarantees to recover the full amount. Failure of resolution or liquidation will put more pressure on the promoters and the changes in the Insolvency code will help them get relief from the courts.

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