The resolution of the housing finance company, DHFL, is going to be very tough for all actors in the financial sector: banks, mutual funds, insurance companies, retail investors, as also for the regulators and the government.
And yet, this resolution needs to succeed because the financial sector can’t afford another Rs 1 lakh crore hit. The financial sector actors and the regulators and government need to treat DHFL as a test case and ensure a resolution template is hammered out.
Let us first acknowledge, the country doesn’t quite have a template to resolve stressed non-bank finance companies or NBFCs. The Bankruptcy Code is not meant for and cannot work in the case of NBFCs. The first big NBFC to default was IL&FS and there the government chose the National Company Law Tribunal or the NCLT route i.e. the resolution is being spearheaded by a special board led by banker Uday Kotak with the NCLT putting its stamp. This solution was probably inevitable in IL&FS because it has large assets and a complicated holding structure. But it is time-consuming and assumes the winding up of the company. DHFL is different because it is a slightly more straight forward case and hence the bankers are seeking to resolve it among themselves under RBI's June 7 circular.
CNBC-TV18 has reliably learnt that the company's proposed resolution plan requires, restructuring of loans, an extension of repayment tenors, some moratorium on some loans and fresh loans to complete commitments to some borrowers. Bankers say some private equity companies like Aion Capital may be interested in coming in with some money to buy a stake in DHFL, while other funds may be interested in buying part of the loan book.
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However, the answer is not so simple. Following are the sticky points:
Going by the latest audited result of the company, auditors are unsure about the quality of over Rs 35,000 crore or 40 percent of the loans. This is not counting the questions raised on another set of loans accused by Cobrapost as fraudulent loans. Many bankers now say around Rs 25,000 crore of DHFL’s total loans are unlikely to be repaid. So any private equity company or bank that comes as an equity partner is going to seek a Rs 25,000 crore hair cut in the very least.
That leads to the question who decides the haircut. Who leads the resolution? One assumes the banks since they have already signed an inter-creditor agreement (ICA) and hence represent the single largest block of lenders. But bankers account for only Rs 40,000 crore of the nearly Rs Rs 90,000 crore total liability of DHFL. Will all the mutual funds, insurance companies, pension funds and retail investors take a 30 percent hair-cut if that’s what the on-going audit by KPMG throws up. Unlike in the IL&FS case, there is no tribunal to stamp approval of fairness on the estimation. So any of the above-mentioned lenders can drag the company to the court or to the DRT and the entire process can be stymied. A legal solution is bad because time is of the essence in a finance company. If the company is not quickly restored as a going-concern, not just Rs 25,000 crore but all the loans can go bad. First, those borrowers who need last-mile funding will default. With no one to pay salaries, the collection mechanism of the company will go for a toss. Good employees will leave. And even well-serviced loans that have been securitised or assigned will start defaulting. It may be necessary to first “stabilise the ship” as bankers pointed out.
This leads to questions on the involvement of the promoter. Can he be allowed to continue to lead? If all the lenders are going to take haircuts or extend their loans, and banks are needed to convert part of the debt into equity and another entity is bringing equity, clearly the promoter’s role needs to be curtailed to the bare minimum. The lenders will have to appoint a new board and a new CEO who has the confidence of the lenders. This new CEO and board must be empowered to reassure the top management that they will do everything to keep the company alive. This requires extraordinary leadership. It may be tough to expect anyone from the financial sector to accept this job because it will be a difficult and thankless job. (Ask Ravneet Gill, he will tell you.) Investors will complain about the losses they have incurred and not thank the CEO for stopping the haemorrhage. And there is always the fear of the company being slapped with legal cases of fraud.
So what can government and regulators do? The RBI governor has repeatedly said they are watching the NBFC situation closely. The government has armed RBI will more powers over NBFCs and HFCs. May be one idea could be to create a high powered committee chaired by an RBI official and comprising members from SEBI, IRDA and PFRDA as also the ministries of finance and corporate affairs. This committee can hammer out a standard operating procedure in the form of a guideline, which can be issued by the government or the FSDC. The government and the regulators cannot directly bless the DHFL resolution, but the existence of such a guideline can be a guide to bankers as also provide comfort to financial market participants and hopefully avert legal challenges.Even assuming such an SOP or guideline comes, and the bankers and creditors and the elusive new investors in DHFL manage to put together a board and CEO, it is still unclear if the new DHFL will get fresh loans from banks and the bond market. But for the moment this appears to be the least bad idea.
First Published: Jul 29, 2019 6:49 AM IST
