DHFL a test case whose successful resolution is critical for banking sector

Reports suggest a potential recovery of 35 per cent from the bid process compared to an average recovery of seven per cent

In just about a week or so we will get to know who emerges successful in the bid for beleaguered housing financier Dewan Housing Finance Corporation’s (DHFL’s) business.

For banks leading the negotiations with DHFL’s administrator and interested investors, the outcome of the bid will be critical to reassure that systemic risks, like the one that the industry went through since September 2018, aren’t insurmountable.

DHFL was the first to suffer the brunt of the cost of funds which escalated after the Infrastructure Leasing & Financial Services (IL&FS) crisis. Since then, the lender never got back to its feet. It is also the only non-banking financial company (NBFC) whose loan outstanding was referred for restructuring under the June 7, 2019, circular issued by the Reserve Bank of India (RBI). With no consensus on recast, it was referred for insolvency by the central bank in November 2019. Abhinesh Vijayaraj of Spark Capital calls DHFL a test case in many ways.

Also, with the share of bank loans to NBFCs steadily on the rise, especially for those rated ‘A’ or lower, putting in place an established resolution plan is important. Since the IL&FS fallout, the share of bank loans to NBFCs’ liabilities has risen to 31.2 per cent in September 2020, from around 25 per cent.

On the other hand, NBFCs’ dependence on market borrowings (bond market instruments) is also increasing. The number stood at 42.7 per cent in September 2020, up from 41.8 per cent in June, thanks to a slew of liquidity-inducing measures, such as partial credit guarantee scheme, targeted long-term repo operations (TLTROs), and special liquidity scheme.

Analysts say with NBFCs continuing to replace short-term money with stable long-term funds, the dependence on bonds and bank facilities is set to increase. Banks are also an active player in the TLTRO segment and hence, it’s in their best interest that the NBFCs evolve a resolution mechanism to shield them from further contingencies.

Another important aspect is that of the quantum of recoveries. The data indicates that the Insolvency and Bankruptcy Code evoked recovery, which has been twice more effective, compared to the normal recovery process in terms of the quantum recovered.

In DHFL’s case, while most banks have written off their exposure, the potential recovery upon a successful bid could be a minimum of 35 per cent going by reports, which may also be the highest recoveries so far, given the average of 7 per cent. Vijayaraj feels this could go miles in boosting sentiments for the sector.

This is why, with the pandemic having displaced some of the smaller NBFCs, it’s in the system’s interest that DHFL is resolved successfully.