Questions Raised By DHFL’s Unaudited Earnings Release

Dewan Housing Finance Corporation Ltd. reported a Rs 2,223-crore loss in the January-March quarter due to a mark-down in the value of wholesale loans.

The earnings, which were unaudited, have left several unanswered questions. Among them, what is true level of stressed assets on the books of DHFL and whether lacunae found in loan documentation will reduce the chance recoverability of these loans.

An email sent to DHFL with detailed queries was not immediately answered.

Additional Rs 16,000 Crore In Stressed Loans?

The focus of troubles being faced by DHFL has so far been on the management of its liabilities and its ability to repay those on time. The focus on the asset side of DHFL’s books has been limited. This may change with the disclosures made by DHFL on Saturday.

In a media release, DHFL said that its non-performing assets rose to 2.74 percent as of March 2019 from 0.96 percent a year ago. The absolute level of bad loans, when calculated using the outstanding loans of Rs 89,387 crore, works out to Rs 2,449 crore. The bad loan amounts are not included in the statutory release as reporting requirements for non-bank lenders are not as stringent as those for banks.

However, in the notes accompanying the statutory release, the company disclosed two separate things:

• In note 9, the company said that certain developers are facing unforeseen liquidity mismatch. “Consequent to this, there have been instances where cheques received from the borrowers were accounted for as receipts, but were later not banked. The collections recorded in this manner aggregating Rs 1,875 crore have been remediated at the year-end and the corresponding loans have been dealt with in a manner as stated in note 11.”
• In note 11, the company says that it had marked down the fair value of loans worth Rs 34,818 crore, including Rs 16,487 crore related to note 9.

This pool of loans should rightfully be seen as stressed. If Rs 16,487 crore in loans is added to the already acknowledged non-performing assets of Rs 2,449 crore, the level of stressed assets is 21 percent. To be sure, these may not yet be non-performing assets as they may not be overdue by 90 days but they must be seen as stressed loans.

Loan Documentation Dispute Over Rs 20,750 Crore In Loans

The company also disclosed that there have been “lacunae” in loan documentation for certain project and mortgage loans. What is surprising is the large amount of loans where this problem has been detected.

The company disclosed the following:

• The management is actively engaged with the loanees to remediate certain lacunae in loan documentation and expects to complete this exercise by September 2019.
• The carrying value of these loans is Rs 20,750 crore and no adjustment has been made to the carrying value until the remediation process is complete.
• The management believes that deficiencies in documentation will not affect the enforceability of the underlying security. The company is confident that the loans extended are secured and recoverable basis the cash flows arising from such project/mortgage loans.

Recently, rating agency Brickwork Ratings had marked down the rating of a Rs 900-crore loan pool sold by DHFL while flagging disputes over loan documentation. When the loan pool was first rated on June 4, 2019, Brickwork rated it BBB. Within days, on June 7, 2019, Brickwork downgraded the loan pool to C. “BWR revises provisional rating assigned to above PTCs in pursuant to receipt of additional information received regarding the disputed nature of underlying mortgage and thereby the impact on its cash flows,” the rating agency said.

Should the loan documentation issues pertaining to the entire Rs 20,750 crore loan pool affect the enforceability of the underlying security, DHFL may find it difficult to sell developer loans as it hopes to.

More Fair Value Mark-Downs?

The net loss reported by DHFL was on account of a mark-down in the fair value of wholesale loans which the company intends to sell. However, that mark-down has been decided by the management.

• In note 11, DHFL says that loans aggregating Rs 34,818 crore have been reclassified as ‘fair value through profit or loss’ as on March 31, 2019 due to the change in business model.
• Based on internal valuations which involve the management’s judgment and assumptions, the fair value of these loans is pegged at Rs 31,628 crore, resulting in a fair value loss of Rs 3,190 crore. This has not been subjected to external scrutiny.
• Separately, the management disclosed that it is undertaking fresh valuation of loans which came under scrutiny following allegations made by Cobrapost. “The company is undertaking fresh valuation in respect of the loans including underlying securities that were a subject matter of the allegations, from reputed valuation specialists and have been advised by the lawyers that agreements entered into with the loanees are legally enforceable. Necessary adjustments to the carrying values of the loans advanced will be made upon conclusion of the above actions,” DHFL said in note 6.

Taken together, the lack of external scrutiny on the fair valuation report and the ongoing valuation exercise on a pool of loans leave open the possibility of further write-downs in fair value of loans.

Capital Adequacy Below Regulatory Minimum

DHFL also disclosed that its capital adequacy ratio has been pegged down due to observations made by NHB, without specifying the nature of these observations.

• In note 13, DHFL said that it received a letter from NHB dated July 3, 2019 following an inspection carried out by the regulator. The observations led to a reduction in the capital adequacy ratio to 10.24 percent compared to the 17.74 percent reported at the end of December 2018.
• In the note, DHFL discloses that there appears to be a difference in the fair value of certain assets. “In view of these results being prepared using Indian Accounting Standards while the NHB observations relate to numbers compiled on the basis of regulatory guidelines, the management believes that the aforesaid observations may not have any implications on the same.”

While there is no clarity on the concerns raised by NHB, at 10.24 percent, the capital adequacy ratio of DHFL is well below the regulatory minimum of 12 percent. Typically, a lending institution would need to bring its capital adequacy ratio back up to regulatory levels before it can think of lending again. As such, DHFL ability to restart lending by August, as it claimed in its press release, remains uncertain.

Unless the lender can raise capital and improve its liquidity position, its ability to continue as a ‘going concern’ will be in question. DHFL said as much in its notes. “The ability of the company to continue as a going concern is predicated upon its ability to monetize its assets, secure funding from the bankers/investors, restructure its liabilities and recommence its operations,” DHFL said.