Troubles At DHFL, Reliance Capital: Whose Risk Is It Anyway?
The Indian financial system had another scare last week.
Non bank lender Dewan Housing Finance Corporation Ltd. missed Rs 962 crore in interest payments on non-convertible debentures. While the company made good on the dues within a seven day ‘cure period’, the missed payments prompted rating agencies to downgrade DHFL to ‘default’ grade.
Simultaneously, developments at Reliance Capital Ltd., which is registered as a ‘Core Investment Company’ and holds Reliance Home Finance Ltd. and Reliance Commercial Finance under its umbrella, have also been disquieting for investors.
The renewed bout of uncertainty has once again prompted calls for systemic intervention from the Reserve Bank of India. While the central bank has assured that it will act as the lender of last resort to protect financial stability, it has not felt the need to act in that capacity yet.
It may be best for the central bank to keep it that way, for the NBFC crisis is now concentrated in a few firms which are facing the market’s wrath because of reputational risk, which has manifested itself in the form of liquidity risk. For the rest, businesses are on the path of a slow mend, which should be allowed to take its natural course.
Trouble Spot 1: DHFL
DHFL continues to be the weakest spot in the market.
The company has been completely shut out of the financial markets since October. It has not been able to raise any fresh market debt or bank debt since then.
A key reason for this are the governance concerns at DHFL. In January, news website Cobrapost alleged that there was significant routing of public money into promoter-owned firms. The company denied this. However, an investigation by Aman Kapadia of BloombergQuint using documents filed with the Registrar of Companies had thrown up evidence of re-routing of funds via a web of companies.
With a governance cloud hanging over the company, few in the markets were willing to lend more money to DHFL. And so the company has been forced to securitise retail loan portfolios and divest assets to raise capital to repay its liabilities.
As of September-end, DHFL had outstanding liabilities of about Rs 1.1 lakh crore, according to an investor presentation by the company at the end of the second quarter. Since then, the company has publicly stated that it has repaid Rs 40,000 crore in financial obligations across instruments such as bank loans, commercial paper and non convertible debentures. That would mean that DHFL has outstanding liabilities of between Rs 60,000 crore to Rs 70,000 crore currently.
That, according to Macquarie Research, is less than 0.5 percent of system-level debt including bank loans, NBFC loans and assets under management of debt mutual funds.
Trouble Spot 2: Reliance Capital
Reliance Capital is other immediate concern and a more complex one.
Just like IL&FS, Reliance Capital is registered as a ‘Core Investment Company’ and has a number of businesses under it. Of these, the lending businesses are Reliance Home Finance Ltd. and Reliance Commercial Finance. But as rating agencies have pointed out, there are considerable inter-linkages within the group. This, itself, has made investors nervous.
Earlier this week, Price Waterhouse & Co, auditor at Reliance Capital Ltd. and Reliance Home Finance Ltd since 2017, resigned using a legal provision that pertains to fraud.
Just like in the case of DHFL, these governance concerns related to the group have played a role in its inability to raise much fresh funding from the markets. In a conference call organised by the company earlier this week, Reliance Capital chairman Anil Ambani said that despite little or no financial support, the group had managed to pay back about Rs 35,000 crore in debt.
What is left now is about Rs 42,000 crore in consolidated debt, as BloombergQuint reported earlier.
Within this, the two NBFC businesses — Reliance Home Finance and Reliance Commercial Finance — have both already been downgraded to ‘D’ by ICRA due to delays in making payments on bank dues. Reliance Home Finance had a loan book of roughly Rs 16,000 crore and Reliance Commercial Finance had a book of about Rs 13,000 crore as of December 2018.
Accounting for some repayments made since then, the total liabilities of the NBFCs would be to the tune Rs 20,000-25,000 crore now.
The Contagion Risk
At this stage, many will say that it is the indirect contagion risk that will hurt more than the direct impact. A comparison to the collapse of Lehman Brothers has now become fashionable.
That is indeed possible. But here are a few counter arguments.
First, the IL&FS crisis came unannounced to most. Till then, there was little or no recognition of the liability risk that NBFCs and HFCs were carrying.
In the nine months since, investors have combed through these balance sheets and understood where the risk lies. Based on that, markets have becoming more discerning. As such, another accident at this stage may not have the kind of extended system-wide impact that IL&FS did. To further ensure that the strong are differentiated from the weak, the RBI should conduct a stress-test or asset quality review, as some experts have suggested.
Second, these firms have realised that liability management needs focus. Reliance on short term debt has reduced and non-core businesses have been shed. The heady lending growth of earlier years has moderated. That makes the core NBFC business healthier. Those who have taken this time to reduce vulnerabilities emerging out of short term borrowings and built a liquidity cushion will find it easier to survive another accident.
Third, liquidity conditions in the economy have eased organically now that elections are over and government spending has picked up. This, together with a drop in the RBI’s repo rate has brought down rates in the markets. According to a Care Ratings report dated June 13, the weighted average yield in the corporate bond market in May’19 was at 8.49 percent - its lowest level since April 2018. Yields in the commercial paper market were 24 basis points lower than that in September 2018.
Fourth, fund flows to the economy have undoubtedly been impacted due to slower disbursement growth by NBFCs. But default by one or two other non-bank lenders, who have virtually stopped fresh disbursements, is not likely to hurt the incremental flow of funds significantly. Separately, some (not all) of the gap in lending has been filled by banks. Take, for instance, the housing finance segment. Bank lending to housing grew at 18 percent in the twelve-months to April 2019, compared to 14 percent earlier.
So what would a special RBI window do right now?
Depending on how it is structured, it could help some of these weak NBFCs hide the weakness in their businesses. It could help some of the others access funds more easily and at a better rate but, like in the past, the stigma attached to accessing an emergency funding window may mean the actual impact would be limited.
What it would do is give confidence to NBFCs and investors in NBFCs. But that confidence would come attached with a significant moral hazard.