The woes in the non-bank lenders space of the Indian fixed income segment appears to be far from over. In fact, the way some of the large Indian businesses have witnessed financial stress over the last year has taken the industry by surprise. What made matters worse is the fact that many Indian fixed income funds have lent to these companies in the form of debt securities. With these financially strapped companies struggling to meet their debt obligations, the fixed income funds having exposure in them are in a spot of bother. Expectedly, investors of fixed income mutual funds are a worried lot too.
DHFL downgrade - The background
One of the companies to recently get downgraded by the rating agencies is Dewan Housing Finance, or DHFL. In the light of DHFL delaying its interest rate payments scheduled on June 4
th, 2019, rating agencies such as CRISIL, Care Ratings and ICRA have downgraded its rating to the ‘D’ category indicating that certain debt instruments of DHFL have either defaulted or are expected to default soon.
Since the Infrastructure Leasing & Financial Services, or IL&FS crisis broke out last September, there have been a series of downgrades in the non-banking financial company, or NBFC sector. DHFL itself has faced a series of downgrades by rating agencies on its debt over the past few months due to liquidity concerns. The first signs of trouble in the housing finance behemoth appeared in September last year when DSP Mutual Fund sold INR 300 crore of DHFL papers in the secondary markets at a yield much higher than the traded rates. Although this sparked speculation that the company could be facing liquidity stress, it was strongly denied by the DHFL management then. Starting February 2019, the company saw a series of downgrades on various debt instruments across maturities, with most of them falling below investment grade as of May 2019.
Where do we stand today?
CRISIL in its ratings report states that “the downgrade reflects delays in debt servicing by DHFL on some of its non-convertible debentures (NCDs)”. The company, which has been facing liquidity issues over the past few months, was unable to make interest payments to the tune of INR 960 crores on their NCDs which was due on June 4
th, 2019. Further to this, they have INR 850 crores worth of outstanding commercial papers (CPs), of which INR 750 Crores are due to mature on June 7
th, 2019. Rating agencies expect the company to default on this payment. As a result of the current liquidity squeeze that the company is facing, CRISIL Ratings and ICRA downgraded its CPs worth INR 850 crores. CARE ratings on the other hand downgraded papers to the tune of INR 1.02 trillion on June 5
th, 2019.
It is important to note that this downgrade comes despite the fact that the company has ‘delayed’ the repayments and not ‘defaulted’ so far. The company has an additional 7-day window within which they are allowed to service their debt repayments. It is important to note that these downgrades are largely based on liquidity risks rather than asset quality issues. DHFL continues to have a high asset quality metric and this is reflected in the rating notes of agencies like CRISIL and ICRA. As per CRISIL’s report, the company’s collection efficiency remains at over 99% as of March 2019.
To tide over the liquidity crisis, its parent company Wadhawan Global is in the process of selling non-core businesses over the past few months to meet debt obligations. It sold its 70% stake in Aadhar Housing Finance to private equity firm Blackstone in February this year. In March 2019, Wadhawan Group entered into an agreement to sell its entire 49.04% stake in Avanse Financial Services to Warburg Pincus. The financial services group is also looking to sell its 50% stake in the DHFL Pramerica Mutual Fund and DHFL Pramerica Trustees to its joint venture partner PGLH of Delaware Inc, an entity owned by Prudential Financial. They are also in the process of selling their 51% stake in their life insurance joint venture with Prudential. Other businesses that the group is looking to exit include Andromeda Loan Distribution.
In addition to selling their stakes in non-core businesses, DHFL is also looking at selling down loan portfolios to private banks at a negotiated price. Since September 2018, DHFL has been able to sell retail loans worth INR 30,000 crores through securitization. The company has been able to repay debt to the tune of INR 40,000 crores during this period. In addition to this, the company has also signed a non-binding agreement with Oaktree (a US Based Company) to offload loans worth INR 17,000-18,000 crores.
All of these measures will aid in servicing their debt obligations, but the successful and timely execution of these transactions remains key for the street to regain comfort with DHFL.
Mutual funds and their exposure to DHFL
The overall exposure of fixed income mutual funds in DHFL is over INR 5,000 crores. UTI mutual funds have the highest exposure in DHFL of around INR 1736 crores followed by Reliance Mutual Fund which has exposure of around INR 1,182 crores. The table below outlines the top 10 funds that have an exposure to DHFL and the impact of the 75% haircut on their NAV’s.
As per SEBI’s regulation on valuations of money market and debt securities, mutual funds applied a 75% haircut on these holdings on June 4
th, 2019. The regulation states that the indicative haircuts (that are provided by the valuation agencies) shall be applied on the date of the credit event.
The impact of this markdown is clearly visible in the NAVs of funds - and its rather stark. The one-day return has turned negative for almost 165 fixed income schemes (both open and closed ended) with the highest one-day loss of 52.99% in case of DHFL Pramerica Medium Term Fund. Fixed income funds from DHFL Pramerica Mutual Fund, with their significantly higher exposure to DHFL debt instruments are the worst hit in terms of performance.
At an issuer level, mutual funds with exposure to DHFL have been impacted by a downgrade. However, it’s important to note that other subsidiary companies of the parent Wadhawan Group have not been impacted by this downgrade. The table below segregates the exposure that mutual funds have to Wadhawan Group’s flagship company DHFL and its other subsidiary companies.
Pressing the panic button : Will it help?
While the situation is unfavorable, in our opinion investors must use financial prudence in dealing with this situation rather than panic.
Given 75% haircut has already been applied and its impact on the NAV is apparent, redeeming investments at this stage and booking real losses could worsen things further and may prove to be counterproductive.
The company is making efforts to meet its debt obligations which could lead to some positive scenarios. If the company starts paying back its debts, there are chances of a re-rating of their debt instruments. However, the mark back up of valuations is expected to be more graded over a longer period of time. Also, as bond holdings in portfolios come up for maturity and the re-payment happens, then investors will benefit from it.
