DHFL lessons for shadow banks: Turning blind eye to risk management for quick growth makes profit-hungry NBFCs vulnerable

  • The company claimed that it has enough cash balance to withstand any temporary crisis but that assurance didn't hold for long

  • For several years, DHFL grew its loan book at a much faster rate than its competitors even when things were not looking good in the broader economy

  • The total debt of DHFL is estimated at Rs 88,000 crore, including mutual funds and bondholders

Not long ago, DHFL enjoyed stardom in India’s booming housing finance market. The brand was everywhere, looking to cash in on the middle-class dream of owning their first home. For other smaller, aspiring home lenders, Dewan Housing Finance Corporation Ltd (DHFL) used to be a model. Then the aura began to fade one day. The stock price nosedived (from its all-time peak of Rs 678 on 3 September 2018, the share has lost 97 percent to Rs 21.15 till now), DHFL initially denied any stress on its books. The company claimed that it has enough cash balance to withstand any temporary crisis but that assurance didn’t hold for long. Soon, DHFL started defaulting on payments.

In May this year, DHFL announced that it will not accept any fresh deposits or renew the existing ones. Also, premature withdrawals have been put on hold except in cases where there is a proven medical or financial emergency. By then, panic had gripped lenders, investors and customers of DHFL. The writing was on the wall. Rating agencies too started giving thumbs down to DHFL one after another.

 DHFL lessons for shadow banks: Turning blind eye to risk management for quick growth makes profit-hungry NBFCs vulnerable

Representational image. Reuters.

In May, CARE downgraded the fixed deposit programme of DHFL worth Rs 20,000 crore from CARE A to CARE BBB- (Credit Watch with negative implications). This, according to CARE Ratings, means ‘moderate’ credit risk. According to the existing regulations, a non-banking finance company (NBFC) can’t accept public deposits with such low ratings. This is one reason why DHFL has now stopped taking deposits. Restriction of premature withdrawals may be due to the company’s tight liquidity situation.

CRISIL downgraded DHFL commercial paper worth Rs 850 crore too on account of the weak liquidity condition of the company. DHFL's commercial papers were downgraded to A4+ from A3+. Its rating also continues to be on 'Rating Watch with negative implications'.

CRISIL noted that the downgrade is driven by a more-than-expected reduction in the company's liquidity because of further delays in fundraising from sell down of project finance loans and lower inflows from the securitisation of non-housing loans.

In the subsequent days, marathon negotiations between DHFL management and lenders for a resolution didn’t work out. Finally, on Wednesday, the Reserve Bank of India (RBI) said it will supersede the board of the company taking the firm one step close to bankruptcy proceedings. When that happens, DHFL will be the first NBFC in lending business to be dragged to the National Company Law Tribunal (NCLT) after a change in the rules recently. The news is good for DHFL's lenders and investors. At least, they have an assurance that things won’t worsen further from this point and a time-bound resolution is on the cards.

What went wrong with DHFL? “The biggest lesson for other NBFCs and lending institutions from the DHFL episode is that there is a danger in growing too fast, undermining risks and living with a huge asset-liability mismatch,” said Siddharth Purohit, research analyst, SMC Global Securities.

For several years, DHFL grew its loan book at a much faster rate than its competitors even when things weren’t looking good in the broader economy. DHFL’s loans were given to 15-20 years while it borrowed funds for the short-term. This is how most NBFCs work but since DHFL grew too fast (loan growth 25-30 percent in several quarters), somewhere down the line, the firm gave a major miss to risk management. The constant rolling over of short-term borrowings such as commercial papers came to a grinding halt when funds were no longer available to the company in tight liquidity scenario. Everyone knew that the company has been facing a liquidity crunch for a while.

At the time of the Infrastructure Leasing & Financial Services Ltd (IL&FS) crisis, the whole NBFC industry came under a shock. DHFL got attention when DSP Mutual Fund sold Rs 300 crore of DHFL papers at 11 percent in the secondary market, way higher than the traded rates raising fears that borrowing costs may be shooting through the roof. The stock markets panicked as large investors dumped these shares along with other NBFC stocks.

Mutual funds smelled the danger and began offloading DHFL holdings, leaving only banks and retail investors having fixed deposits with the housing finance company at the receiving end. According to reports, DHFL owes close to Rs 15,000 crore to fixed deposit holders and another Rs 38,000 crore to banks. The total debt of DHFL is estimated at Rs 88,000 crore, including mutual funds and bondholders. What will happen to retail FD holders when the company goes to bankruptcy court? One needs to wait and watch since this is the first such case being admitted for bankruptcy. It all depends on how the courts rule in favour of different creditors.

In the IL&FS case too, almost the same mistake was committed—the company had grown too big and too fast riding on the boom period and rolling over its loans, finally coming to a point of collapse when funds were no longer available. DHFL and IL&FS episodes send a clear warning signal to the shadow banks. Focusing merely on industry outsmarting business growth with no attention on risk management can upset even large, established institutions. Lending institutions cannot outperform the growth of the larger economy; if they do, that’ll be inviting a tragedy sooner than later.

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Updated Date: Nov 21, 2019 16:28:39 IST