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Last Updated : Sep 24, 2018 10:27 PM IST | Source:

Podcast | Editor’s Pick of the Day: Contagion? IL&FS saga gets RBI & SEBI to closely monitor developments

The podcast will seek to answer the questions you might have about what happened with DHFL stock on Friday, and why the RBI and SEBI have come out with a joint press statement that they will be monitoring things closely.

Moneycontrol News @moneycontrolcom
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Todays L/H

Friday, September 21 was a day of high drama on Dalal Street. At about one in the afternoon, things took a nosedive with the Sensex dropping as much as a thousand points and the Nifty giving up the 11000 mark. As Hillary Clinton would ask, What Happened?

On Monday, September 24, investors remained jittery about financial firms after a recent default by Infrastructure Leasing & Financial Services Ltd (IL&FS). A gauge of investor anxiety surged to its highest level in more than five months, after the Sensex on Friday had its wildest intraday move in more than four years before closing with a 0.8 percent loss.

And on our Story of the Day, we will try and answer the questions you might have about what happened on Friday, and why the RBI and SEBI have come out with a joint press statement that they will be monitoring things closely. What’s happening at IL&FS? How did Dewan Housing get caught in this swirl? Was DSP’s move merely to protect itself? You’ll find opinions about all these from a wide spectrum of industry watchers and analysts. My name is Rakesh, and you are listening to Moneycontrol.

India’s banking and financial market regulator SEBI, and its central bank, RBI, made a succinct joint statement on Sunday – “The Reserve Bank of India and the Securities and Exchange Board of India are closely monitoring recent developments in financial markets and are ready to take appropriate actions, if necessary.”

Which begs the question – what are these recent developments in the financial markets? Which brings us to the events of Freaky Friday.

BloombergQuint reported, “On Friday, equity markets plunged after a secondary market sale of debt securities of Dewan Housing Finance Ltd (DHFL) spooked markets. The sale took place at a yield higher than what the paper was trading at, leading to questions about liquidity and demand conditions in the market.

Prior to that incident, the credit markets had turned nervous because of a series of defaults by Infrastructure Leasing & Financial Services Ltd (IL&FS). The group has defaulted on inter-corporate deposits, commercial paper and also a Letter of Credit facility of IDBI Bank. This, despite the fact, the IL&FS was a AAA rated entity until August. Since then, it has been downgraded to ‘default’. This, in turn, has impacted mutual funds, insurance and pension funds holding IL&FS debt securities.”

There’s a lot to unpack there.

Why did DSP start selling DHFL stocks?

First of all, let’s remember that in the recent past, domestic inflows into mutual fund schemes have played a very important role in driving the Indian stock market to record highs – so much so, India is Asia’s best-performing stock market. In recent times, mutual funds have especially profited from betting heavily on non-banking finance companies (NBFCs). Worries over weak balance sheets of India’s NBFCs may well be the cause for the events we saw on Friday.

Pranay Lakshminarasimhan, in an explainer for Moneycontrol, says:

“The panic started when rumours started doing the rounds that Dewan Housing Finance (DHFL) may have defaulted on one of its debt payments. The reason for this rumour:  DSP Mutual Fund had sold short term DHFL paper at a significant discount. Dealers with domestic banks said the fund house sold DHFL's 1-year commercial paper, due to mature in June next year, at a yield of around 11 percent.

This sparked concerns about DHFL's ability to raise money from the market at a feasible rate. For one, DSP was finding it quite challenging to find takers for the instrument, even at 11 percent. If a fund house is forced to sell 1-year commercial paper at 11 percent, there is apparent that no one is willing to buy it. As a result, investors' outlook on DHFL's stock weakened and they started selling its shares in panic, pulling it down by over 55 percent intraday.

Doubts about DHFL eventually spread to other housing finance companies and later to other non-banking finance companies (NBFCs). Stocks of Indiabulls Housing Finance and LIC Housing Finance were also down by over 20 percent and 15 percent, respectively, at one point. Shares of Bajaj Finance and Bajaj Finserv also took a hit.”

The DHFL stock recouped some of the losses to close 42.5 percent lower. Still, it was DHFL’s worst day on the bourses yet as it lost Rs 8,158 crore in market value on Friday alone.

A few analysts that Moneycontrol spoke to said the move by DSP to sell the securities at a discount was an urgent need of cash. The fund house has a significant amount of IL&FS’s debt on its books, and given the current crisis surrounding the latter, it apparently wanted to shore up its liquidity position in case it faces any kind of redemption pressure in the near future. Fears of a contagion spreading through the money market took a hold on Friday, and we ended up seeing the panic selling that we did. (We will get to the IL&FS story in a bit.)

A dealer at a state-owned bank that we at Moneycontrol spoke to, said, “The initial reaction was that this has something to do with DHFL. But it did not make sense because logically, DHFL could not have defaulted. The nature of their business itself takes care of that.” Dwijendra Srivastav of Sundaram Asset Management, adding to that sentiment, said, “There is nothing fundamentally wrong with DHFL because most of its debtors pay monthly instalments for the loans they take, which means it won't have any problem repaying anything that it owes to investors.”

DHFL rose as much as 25 percent intraday today after the company said on Friday that it has Rs 197 billion of liquidity available to meet its obligations. Dewan has, since Friday, tried running from pillar to post to distance itself from the IL&FS mess, saying effectively that it has nothing to do with what’s happening there. Dewan has had to bear the brunt of the selloff sparked by the unrest in the money market caused by DSP MF (DSP Mutual Fund) selling DHFL stocks; DSP MF has exposure to IL&FS’s securities. DHFL meanwhile intervened, talking to various media outlets, and tried to allay investor fears. Kapil Wadhawan, its chairman and managing director, assured investors that his company’s liquidity and other fundamentals remained strong. Attributing the panic to rumours, he said to BloombergQuint, “The drop (in share price) shows complete disregard for company fundamentals.” DSP’s Kothari agreed with Wadhawan. “There is no (negative) information that we have on the company (DHFL) up till now,” he said to BQ. “People speculate, and I can’t prevent people from speculating. We are very unhappy that it has happened like that and there was no reason to stab somebody. There is nothing against DHFL and they are a good housing company,” he reiterated.

However, Hemindra Kothari, Chairman of DSP Mutual Fund, in interviews with CNBC-TV18 and Bloomberg said, “It’s not that we are the only ones that sold that day and the quotes that were coming were at around 10.25-10.50 percent. We sold nearly Rs 300 crore of debt paper on Wednesday at a yield of around 11 percent. We continue to hold DHFL paper worth Rs 900 crore.” Kothari added that the fund house wanted to position itself to take advantage of the rising interest rate cycle that is in play at the moment. In a press statement, the fund house said it had 'sold securities across issuers in the last few months' for various reasons.

Kalpen Parekh, the Chief Investment Officer at DSP Mutual Fund, added that their reason to sell DHFL bonds was to meet payment obligations coming up next week. The firm sold 3 billion rupees ($41.6 million) of the bonds to express “our interest view, not a credit view,” Parekh said to the Economic Times (ET). “This has been done across issuers over last few days.”

In other words, what was essentially a self-protective move by DSP Mutual Fund led to the beating that NBFCs took on Friday and Monday today, and Dewan Housing was unwittingly caught in the swirl of it all.

Now what does that have to do with IL&FS?

Speculation that a debt default by IL&FS may spread to other lenders may well have been the origin of the panic in the market.

IL&FS, whose sudden downgrade has led the debt market into fear and illiquidity, announced that it has defaulted on an LC (letter of credit) payment to IDBI Bank. Further, writes Latha Venkatesh for Moneycontrol, its financial services subsidiary announced the resignation of its MD, a director and 3 independent directors. The illiquidity in the debt market led the equity markets to hammer shares of two housing finance companies in particular and NBFCs in general.

The Times of India says, “The Company has been under pressure from the RBI to bring in more capital. Things got worse this month after it defaulted on commercial paper obligations, resulting in RBI putting a ban on the company, while tapping the short-term debt market. A circular issued by the Reserve Bank of India, late on Friday, which seem to be directing banks to use their own balance sheets of lending rather than routing loans through finance companies. This has added to the concern over this sector.”

IL&FS in a filing on Friday said it had missed payments yet again, causing concern among investors, including private individuals, who had regarded the group’s debt as “rock-solid” as described by ET. ET further said, “With the IL&FS cash crunch set to intensify, there are concerns that the impact may spill over into the wider infrastructure industry, pushing up funding costs. Its outstanding debentures and commercial paper accounted for 1 percent and 2 percent, respectively, of India’s domestic corporate debt market as of 31 March, according to Moody’s.”

Some state-run institutions such as SBI and LIC recently expressed apprehensions about supporting IL&FS, though the government is now said to be contemplating taking some remedial measures, regulatory and industry officials have said. There are also suggestions about invoking a rarely used provision for forcing management change at crisis ridden systemically important entities by utilising equity for debt-like instruments.

“Funding sources for IL&FS have all but dried up and around Rs 4,000 crore from the company is due to mutual funds in the next couple of months,” said Purvesh Shelatkar, senior vice president of institutional sales at Centrum Broking, speaking to ET. “If the company cannot arrange to pay back these funds, it could lead to a domino effect and other lenders could line up as well. This is a real threat.” Some mutual funds are said to be in talks with regulators including Sebi and RBI. Sebi has sought details of IL&FS exposure from mutual fund houses, said two other people familiar with the matter. Ashish Ghiya, MD of Derivium Tradition India, said that the debt market is undergoing a confidence crisis currently especially with rupee instability and volatile asset markets.

NBFC officials are worried that the situation may affect even well-placed entities, as it did on Friday, when investors dumped shares of mortgage companies like DHFL and Indiabulls Housing Finance on rumours that they do not have enough liquidity to make immediate payments. “There is a crisis of confidence among investors who bet on NBFCs,” said Umesh Revankar, CEO of Shriram Transport Finance. “It is going to be short-lived. We have no liquidity problem as we are sitting on cash. We always keep provisions for one or two months of loan disbursements.” (As reported by ET)

A debt fund manager of a large mutual fund, on condition of anonymity, said, “One thing is for sure. The cost of funds for NBFCs will certainly spike up in light of this IL&FS default. NBFC margins are definitely under threat in this quarter.” "The primary concern here is liquidity," Ajay Manglunia of Edelweiss Financial Services told Moneycontrol. "Although it is by no means a solvency crisis, there will be some doubt about whether or not these NBFCs will be able to continue borrowing at a viable rate from the market," he said.

Andy Mukherjee warns about the problems that might come along should the IL&FS problem remain unresolved. Likening the IL&FS situation to India’s own could’ve-been-mini-Lehman moment, he says, “IL&FS’s $12.5 billion in liabilities may be small beer compared with the $210 billion bad-loan debacle at deposit-taking Indian banks. But the poorly run state-owned banks still get 78 percent of sticky household deposits and have access to both interbank liquidity and the central bank’s emergency lines. They’re part of an inner circle of trust. IL&FS, despite its pretensions to being quasi-sovereign, isn’t in that circle.”

The fear now is that one bad example by way of IL&FS may rot the case for the other healthy NBFCs, even those which are prepared for difficult days, which as DHFL has shown, is more often than not the case. Indiabulls Housing Finance, another NBFC that was hit on Friday, echoed the DHFL sentiment. “We have followed very strict liquidity principles and pay a lot of negative carry through the year – it is for such times,” said Gagan Banga, vice-chairman of Indiabulls Housing Finance. The company has over Rs 23,000 crore of cash and cash equivalents, which cover more than 125 percent of its six-month liabilities.

Andy Mukherjee, in his piece for ET, concludes with this line: RBI and SEBI’s urgent first step must be an emergency bailout of IL&FS, before it does more harm.

But is it all gloom and doom?

Latha Venkatesh, writing for Moneycontrol, is of the view that there are a few positive takeaways from this situation. She lists five:

  1. IL&FS itself has only Rs 35 billion-odd of Commercial paper in a Rs 16 trillion fixed income mutual fund AUM (assets under management).

  2. While there has been general celebration that India’s mutual fund kitty has risen to Rs 25 trillion from Rs 10 trillion in 2014, this year itself debt funds saw a fall of one trillion rupees. So debt markets and NBFCs aren’t so unprepared for the illiquidity. Many saw it coming and have a decent amount of liquidity or cash equivalents.

  3. With September 30 drawing near and an expected rate hike in the October 6 monetary policy many debt funds had already gone into cash.

  4. Over the weekend, a source at one of the shareholders of IL&FS confirmed that RBI has called a meeting of the IL&FS shareholders. That will be a source of comfort that the lender of the last resort is taking control.

  5. The statement by the RBI and SEBI vowing to closely monitor the recent developments. She also adds SBI Chairman Rajnish Kumar coming out to say the banks won’t be averse to lending to NBFCs, IL&FS debacle notwithstanding, is certainly a positive takeaway.

She also emphasized that while these measures would help, the equity and debt markets would still want to see the money on the table.

The planned rights issue of 3,500 crores would hardly suffice. And roping in new investors takes time. Additionally, with the string of defaults by IL&FS, the chances of existing loans becoming NPAs is high. Latha goes on to add, “If the NPAs at PSU banks have been blamed on politicians, the losses at IL&FS have to be pinned on the professionals who ran the company. RBI, as the NBFC regulator, needs to order a forensic audit of the company and all its subsidiaries to check for malfeasance and/or conflict.”

Meanwhile, some money managers are still bullish, suggesting investors move capital into quality stocks. “We are not worried about overall India,” Arthur Kwong, head of Asia Pacific equities at BNP Paribas Asset Management to ET. “It is still bullish for me. We like private sector banks.”

For now, the Reserve Bank of India will meet with shareholders of IL&FS on the September 28, as reported BloombergQuint. The bankers, who spoke on conditions of anonymity, said that the meeting would be chaired by a deputy governor of the RBI.

Life Insurance Corporation of India, with a 25.34 percent stake in IL&FS, is the largest shareholder in the company. Orix Corporate, Japan with a 23.54 percent stake is the second largest shareholder. The State Bank of India holds a 6.42 percent stake.

Meanwhile, DHFL ended the day up 11.87 percent, and IL&FS up by 10.12 percent on the NSE.

Mint reported, “On 17 September, ICRA Ltd downgraded the credit rating of IL&FS to default after it failed to meet the repayment obligations of Rs 12,000 crore in short-term and long-term borrowings. The firm’s credit rating has been downgraded twice in the past two months. It also defaulted on a Rs 1,000 crore loan from the Small Industries Development Bank of India on 13 September. The next day, it failed to redeem commercial papers worth Rs 105 crore.”

IL&FS is now planning to boost its authorized share capital by Rs 4,000-5,000 crore to enable the cash-strapped group to raise money from its shareholders. The move is aimed at meeting the group’s immediate repayment obligations and avoiding further debt rating downgrades.

Between the RBI meeting its shareholders and this meeting on the September 29 to consider raising the authorized share capital, we will certainly be hearing more about this story.

Picture abhi baaki hain.

Thank you for joining us.






First Published on Sep 24, 2018 10:27 pm
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