BL Research Bureau

 

Dewan Housing Finance Company (DHFL) was the darling of the stock market, just about a year back. But the value destruction in the stock that began in September last year has been unnerving. The June quarter results (after months of delay) of the housing finance company declared late on Thursday, only highlight deeper issues at hand which the lenders are deliberating on the resolution plan need to take note of while evaluating the quality of assets and ascertaining the real value of loans.

DHFL reported a loss of ₹206 crore in the June quarter, after the dismal performance in the March quarter when it reported a steep loss of ₹2,223 crore. But given that there has been minimal or no disbursements since the December 2018 quarter, earnings were expected to be muted in the June quarter.

What is of more concern is the fact that after the earlier statutory auditors-- Chaturvedi & Shah LLP and Deloitte Haskins & Sells LLP — raised several red flags over DHFL’s March quarter results, the newly appointed auditor KK Mankeshwar (after the earlier two resigned) has also stated that certain developments raise a significant doubt on the ability of the company to continue as a going concern.

Read also: DHFL - Haunted by a leaky roof and a shaky foundation

In respect of certain loans, the auditor stated that “it was unable to comment if they have been properly secured and hence these loans may have been granted in a manner that is prejudicial to the interest of the company”. Many of these concerns were already raised by the earlier auditors.

The company’s future operations hinge on two critical aspects. One, the company has formulated a resolution plan which is under discussion with the lenders. A quick decision on the resolution plan is imperative. Also, finding takers for its ₹35,000-odd crore of the wholesale book will be critical, given the concerns over the vulnerability of this segment to the ongoing stress.

Auditor observations

The earlier auditors had put forth several qualifications and observations to the March quarter results that could have a material impact on the financial statements of the company. The management has given an update on these observations in the June quarter results, which have been reviewed by the new auditor.

In respect of Inter-corporate deposits (ICDs) aggregating ₹5,652 crore as of March 2019, the earlier auditors had noted significant deficiencies in the grant and rollover of ICDs. While the management believes that no adjustments are required to the carrying value of the ICD, the new auditor has stated that it has not been able to comment on the recoverability of the ICD due to lack of sufficient audit evidence to support the management's assertion. As of June 2019, ICDs outstanding stood at ₹4,011.7 crore.

Post the Cobrapost allegations, the report by Independent Chartered Accountants looking into the allegations had highlighted certain procedural and documentation lapses (end-use monitoring of the funds loaned not performed). After the issuance of the audit report for the year ended March 2019, the audit committee and the board are yet to draw their responses in terms of a closure report in respect of the matter.

As noted, a) cheques (aggregating ₹16,487 crore in the March quarter) received from the borrowers were initially recorded in certain customer accounts for receipts, but were not deposited in the banks and later reversed. The management reported that no such instances exists as on June 2019.

b) The earlier auditors had observed certain deficiencies in the documentation of project/mortgage loans aggregating to ₹24,077 crore as on March 2019. In the June quarter, the management has reported that Rs 2165 crore of such loans have been closed on receipt of amount or have been securitised.

c) The company had marked down value of loans (wholesale) aggregating ₹34,881 crore and reclassified as Fair Value Through Profit or loss (FVTPL) as at March 2019; the resultant fair value loss of ₹3,253 crore was charged to P&L. As of June quarter, loans aggregating Rs 35,285 crore were reclassified as FVTPL and fairly valued at Rs 31,620 crore; the resultant fair value loss of Rs 408 crore has been charged to P&L in the June quarter

In respect of all these (a to c), the auditor has stated that it has been unable to obtain sufficient appropriate evidence to support the values of the loans.

Sharp and quick deterioration

From quarterly disbursements of ₹13,500-13,800 crore in the first half of FY19, DHFL’s disbursements shrank sharply to about ₹500 crore in the December quarter. Since then, there has been more or less no disbursement, which has impacted the company’s performance. Disbursements during FY19 stood at Rs 28,770.61 crore, as against Rs 44,800.31 crore in FY18. The company reported a net loss of Rs 1,036.05 crore in FY19 from the net profit of Rs 1239.9 crore in FY18.

Will the resolution plan work?

The company’s future operations now ride on its ability to secure funding from bankers and restructure its borrowings and also monetize its assets.

The company has submitted a resolution plan to lenders under which liabilities aggregating ₹48,826 crore (constituting 58 per cent of the total debt) has been identified as sustainable debt. This sustainable debt is proposed to be serviced fully through the cash flows generated from retail assets of DHFL and part of a wholesale book comprising of project and mortgage loans. The sustainable debt shall comprise various debt instruments having a blended coupon of 8.5 per cent and tenor of up to 10 years.

Remaining liabilities, aggregating to ₹32,622 crore, identified as unsustainable debt are proposed to be serviced through cash flows generated from the remaining assets forming part of the wholesale book of DHFL comprising of loans extended for SRA projects, other large project loans (OLPL) and other identified assets. The unsustainable debt shall comprise various debt instruments having a zero-coupon.

Remaining liabilities under the unsustainable debt are proposed to be converted into equity shares of DHFL (except public deposit holders).

While the formulation and implementation of the resolution plan is underway by the lenders, there are several issues raised by the auditors that need immediate attention. In particular, DHLF has marked down value of loans (wholesale), in respect of which both past and current auditors have been unable to obtain sufficient evidence to support the values of the loans. Hence significant mark-downs or write-offs in the value of loans may have to be done before selling off the assets.

Independent due diligence of the wholesale book has been undertaken, according to the DHFL’s June quarter communique, by various real estate consultants to look into the expected cash flows and underlying collateral. A full-scale revaluation of assets and legal due diligence, may imply significant write-offs and haircuts by lenders. Hence various lenders---bankers, mutual funds, provident fund, retail investors---reaching a consensus will be critical.

Hidden issues

But there are other less-talked about issues, which need immediate attention---a key one being collection of loans sold by DHFL.

According to the company, it has sold over ₹30,000 crore of retail loans (as of August) to meet its debt obligations. Most of the sale has been done through the direct assignment route--- transfer of a single asset or a portfolio of assets to financial entities through an assignment deed (mostly bilateral agreement). Technically under securitization, assets are pooled, and a special purpose vehicle (SPV) is created which issues the tradable securities such as pass-through certificates (PTCs) or bonds to buy assets. But under direct assignment, no SPV is created, and the company transfers a single asset or a portfolio of assets to financial entities through an assignment deed.

Usually, the responsibility of the collection of loans still lies with the seller (also called the servicing agent)—DHFL in this case, unless otherwise specified by the buyer (banks) in the agreement.

Hence the worry is: how will the ongoing turmoil in DHFL impact collections of the loans sold? Will the credit behaviour of borrowers of DHFL also impact collections?

Recently, ICRA had downgraded six mortgage loan pools originated by DHFL---three to ‘D’ (default) from ‘BBB’ rating. The downgrades follow a Bombay high court order (in the case of Reliance Nippon Life Insurance Limited vs DHFL) restraining it from making any payments except day to day operational expenses. DHFL hence acting as the collection agent has not been able to remit the funds collected to the assignee / buyer of the assigned pool resulting in a non-payment on the due date.

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