The resolution of housing finance company, DHFL, is an acid test for the Indian financial sector - for its banks, mutual funds, insurance companies, regulators and the government. Going by the latest audited result of the company, auditors are unsure about the quality of over 35000 crore or 40 percent of the loans. This leads to the questions such as who decides how much is bad, and who takes the hair cut and how much. The second set of questions is who decides. The bankers have signed an inter creditor agreement. But will mutual funds, insurance companies and retail investors agree to haircuts and loan extensions? A third question set of questions is how much should be involvement of the promoter.We posed all these questions to :
Sandeep Parekh, Founder, Finsec Law Advisors Sunil Srivastava, Former Dy MD, SBI
Mahendra Jajoo, Head- Fixed Income, Mirae Asset Global Investments
Below is the verbatim transcript of the interview. There are banks who are trying to get together and have signed the intercreditor agreement (ICA) but they form only 40 percent of the lenders. The proposal that the company has brought is asking for extension of repayment tenure, moratorium, new credit . Now how do you implement this across? Parekh: It is a very tough call and just to give you a little context in terms of time just two weeks before the Lehman Brothers collapsed they had a meeting to discuss bonuses for everybody and in a short period of 15 days the company collapsed. We are looking at essentially institutions which are highly leveraged and therefore even if little bit of shock happens it is likely to kind of cascade and with two very large players going down at the same time IL&FS and DHFL I think it is going to be quite difficult to sell assets. The best way to salvage the situation is to quickly sell assets, shrink your size and make sure that lenders are paid off which I said given the crisis kind of situation in the non-banking financial company (NBFC) space is tough. Quickly sell your assets & shrink the book would mean that whatever is left will be decayed assets because whoever buys will buy the good assets. So that would be a recipe for killing the company. So what you are saying is just reduce the kind of bad book and allow it to die, is that the way to go about? Parekh: Essentially, you have assets and you have liabilities and the two have to match. If suddenly one side shrinks, you are forced to shrink the other side. That combined with leverage means that any (leveraged entity) - whether it is a bank, NBFC - when they face liquidity pressures, they need to quickly unwind their positions which is always a tough thing because those are pretty much the times when there are few people who are buying the assets. It is an unwinding, which they will have to do, deleveraging, which they will have to do but subject to the market looking at purchasing those assets and allowing them to shrink, allowing them to deleverage. Mahendra Jajoo, What is your suggestion? Suppose the bankers were to agree to extend the loan by about a year. How would the mutual funds (MFs) oblige, have you all approached Securities and Exchange Board of India (SEBI) do you need the regulator to write new rules? Jajoo: As you rightly said there is not enough clarity in this regard and it is not clear as to whether the mutual funds can directly negotiate with the company or do we have to go through the debenture trustee and in this case there are so many different kinds of debenture holders including a lot of retail public. So in this case, it is a very complicated situation to restructure an NBFC. The first step will be to assess the viability of the company on a going-concern basis. So somebody has to evaluate the remaining assets and see how the asset liability management (ALM) pans out.
The most viable situation according to me here would be first for the wholesale lenders in the institutional space, to come around to some kind of restructuring plan either by way of moratorium or extension of the loans and also giving some concession on the rate of interest. Then to may be give fresh funding through fresh equity infusion which can then help the company to restart the business. So in that sense the resolution plan which the company is supposedly going with consists of infusing fresh equity and restructuring of the liabilities by the banks. This seems to be the most viable proposition.
In the current setup unless there is more clarity which it is not right now, we are all debating as to what are the possible options, any kind of concession or deviation by the market instrument holders like debenture holders looks very hazy at this point in time.
You are still arguing that they must try to save the company as a going concern and Sandeep if I got you right you are saying that they must just try and sell off all the good assets and allow the bad assets to just wither away that was your suggestion right? Parekh: Not exactly, what I am trying to say is that people assume that insolvency and illiquidity are kind of different concepts. But they are part of the same continuum. If an NBFC has borrowed money and it lends at say money out -- which is the leverage business they do because their own equity is small compared to what their loan book is so they have to borrow and naturally the maturity dates of both will be different, if they are exactly the same there will be never be liquidity crunch. Given the fact that there is this mismatch there are people who are asking for money back which are the lenders to the organisation before the time your assets matured, I am assuming the assets are good quality which likely they are. Given that they have to find the money by selling the equity, whatever assets they have whether it is good businesses...... Wait a minute..Sandeep, the DHFL auditor's note indicates there may be many holes. There are intercorporate deposits which may not be returned, borrowers whose cheques can't be banked. The whole may be at least 25%. Now who takes charge? and why should the rest listen to the bankers if they say all of you take a 25 percent cut? Sunil Srivastava, how should the bankers go about it? Srivastava: At the start, there has to be a clear-cut admission of the amount of whole bad debt. So on the asset side you will have a question on the quality and the composition of the assets, the liquidity of the assets whether they are securitisable or they are assignable. On the liability side, you will have a problem on the maturing liability pattern. Now definitely the starting point would be to recognise that there is a quantity of bad assets, and that there would have to be a haircut which perhaps would have to be factored in by every participants in this resolution process. Now whether you are doing it by way of giving an extended tenure or allowing them - the fact of the matter is that any participant in any financial system unless it is of a going-concern, you will never be able to realise its total value maybe with a haircut. It has to be an orderly resolution process.
That the beginning of the resolution process would be to look at their books which are probably toxic and stabilize the ship at the moment because unless you start lending the borrowers will not be paying you back. Your collection mechanism will fail, employees will start leaving you so first thing is to recognise what is the hole and stabilise the ship.
Will you have the guts as a banker to give more loans to this company at this stage? With one year to retirement, won't bankers worry that they will be investigated? Srivastava: There has to be an orderly resolution pattern which has to be accepted by all. That is the most logical thing to do otherwise you let the entire thing go. Let me assume that everybody has agreed, allowed the bankers to assess what is the hole, let us assume a forensic audit was done or already has been done and you all know the hole. How are you going to administer it to every pension fund and every retail depositor? There are about Rs 6,000-7,000 crore retail depositors? Srivastava: Everybody will perhaps have to take a pro-rata cut and realise it - I have told you about the composition of the assets, the composition of the assets for instance in DHFL's case, I would assume that there would be a whole lot of retail loans, there would be a securitised portfolio and there would perhaps be commercial real estate loans. On all these, we will have to ascertain as to what is the realisable value - what is the good accounts there. Either you do a clean cut and say okay, this is a good bank, bad bank thing and try and find somebody who will take over the good bank, realise the equity from there and plug in the hole on the other side or you stabilise the ship and reach the safe position after stabilising the ship and perhaps realize greater value. I did not get you because even Sandeep Parekh is saying the same thing. Suppose you are able to get a good bank, bad bank and you find the buyer; I am sure the Aions of the world only want to buy the good book. I don't think they want to buy the bad book or the grey book, what will you do with the bad book? Shrivastava: I am going a step beyond what Sandeep Parekh is saying; that first before you decide what is a good book or a bad book, you first have to stabilise the book. If you don't stabilise the book, it becomes a bad book. What do you mean by that? Shrivastava: In any participant in a financial system, unless you continue your main objective, purpose, if you have given a loan unless you are giving fresh disbursals, the earlier loans will never be repaid, the borrower will start delinquency and then defaults will follow. So the entire book will become bad.
If you want to prevent that situation, at some point of time, we will have to come in with a resolution plan, maybe convert a part of your debt into equity, stabilise the ship and then going forward, if you need to split the book, split the book and realise the equity from the good book to plug the hole on the bad book.
I am still not clear. Assuming that the bankers have decided on a plan, this is the way you have to go ahead as a going concern, 25% of our loans we are not going to get back and we are ready to extend loans, they will extend fresh loans only if everyone agrees to the hair cut or extending maturity, everyone including the retail depositor. Do you think that is implementable? Parekh: It is certainly difficult. The key factor here is how much is the grey. If people know it is a hole, you know it is a hole but if people don't know what this loss amount is, people really don't know how much of haircut people are expected to take. So it is kind of banks are not clear, retailers are not clear, it becomes a mess, which is why IL&FS kind of a situation is much better in a case like this where you have somebody to take ownership and guide the path down. But again, there are pros and cons to it. The con is that you have new people coming who don't know the business, who don't know how to get the loans back. So it is not a kind of slam-dunk answer but this is one possible answer where they just handover the company to somebody else. Maybe the committee of creditors on behalf of the creditors including retail creditors. There are multiple options available, none of them looked very pretty given that we don't have real information about the quality and the nature of the loan book they have. Sunil, do you think the current board and current management of DHFL can be trusted or do you think now RBI should do something like appoint a new board but keep the management in? Is there any role for the RBI in terms of the changing the board? Srivastava: The committee of creditors or all the creditors here would have to step in to the shoes of the management in some way or the other. It doesn't mean absolving the present promoters of their accountability or responsibility, rather they have to be made more accountable for resolving all this debt. At the same time, it may not require fresh infusion of fund because whatever you are collecting, part of that can go towards fresh disbursal to keep the engine running. So it is not going to be that but certainly I would not expect the banks to let the existing promoters run the show while they give the concessions. Mahendra Jajoo, Let me ask you whether you would be okay if the retail depositors were given their entire money because that was one of the suggestions bankers were making because they feared that otherwise some of the depositors could take you to the DRT or take you to court and just bring the whole process to a legal stalemate? Jajoo: Any solution that is arrived at has to be a practical one and there is obviously a lot of challenge in terms of having to deal with thousands of the retail debenture holders and therefore, any resolution that is contemplated has to be executable and realistic. I think the wholesale lenders have to first assess the viability of the ongoing operations. There has to be fresh infusion of equity either by the existing promoters or by a new set of people who understand the business and who can run the business alongside the promoters and as far as the MFs are concerned, MFs represent the retail investors and for every investment that MFs make, it is from the money collected from the retail investors. You can say that there are high networth individuals (HNIs) and all that, but of the retail debenture holders, there will be also HNIs. So for this purpose from a very narrow perspective, MFs should also be kept in the retail category. However, aside of that I think the big lenders who understand business, who have the capability to restructure, who have the capability to then monitor, I think they to take the lead and ascertain whether it is a viable proposition to restructure and keep the company going on and if that is found, I think the best solution is to let the company continue and then the recovery will be the best possible in that scenario. Do you think new rules need to be written, just by way of a notification or a guideline by SEBI, Reserve Bank of India (RBI), Insurance Regulatory and Development Authority (IRDA) putting their heads together asking that all of them cooperate. I believe there are some 220 institutions involved besides the retailers do you think the regulator have to put their heads together and write any new rules? Parekh: More than new rules, I think they need to have what we call standard operating procedures (SOPs). Financial organisations are different from regular companies and which is the fact that become illiquid and insolvent very quickly so regulators kind of need to get into action very quickly. If you remember Satyam, which is an operational company, they put together a team took it over, they resoled the issues. In financial companies, I think the time line is days and not weeks and months. So the regulators need to have an SOP to decide how to come together, setup a team which is constantly looking at this, have new people over seeing the management if you don't want to remove the management and kind of resolve it to the best ability of the regulators. I think that would be very interesting and it will also be kind of quite cutting edge even from an international perspective. I would highly recommend that.