The resolution proposal mooted for Dewan Housing Finance Corp. Ltd (DHFL) appears stuck due to irreconcilable differences between banks and mutual funds (MFs). This puts a question mark over a speedy and satisfactory solution. The resolution plan involves, inter alia, elongation of debt repayment over a protracted period up to 20 years to align with projected cash flows, which would enable timely debt servicing. Banks find the arrangement agreeable, but funds don’t. To repay bank dues, DHFL further proposes to sell assets already securitized to MFs. With the above two developments, DHFL’s restructuring process—involving about 84,000 crore of debt from banks, depositors, retail investors and MFs—has come unstuck. Such conflicts among different lenders can make restructuring a challenging proposition.

Traditionally, banks have provided bulk of the long- and short-term borrowings of companies, including non-banking financial companies (NBFCs). Companies now increasingly borrow from MFs and other market sources due to quick approvals and cheaper cost. Corporates even rely on short-term borrowing to meet long-term requirements. With ample systemic liquidity, regular refinancing of short-term debt has enabled lower borrowing costs. Corporate books are now laden with short-term borrowings from varied sources—proprietary sources (banks and NBFCs), privately placed commercial papers (CPs)/bonds, or from MFs. With strengthening of market and recent Reserve Bank of India (RBI) guidelines restricting access to banks, corporate borrowings are expected to increasingly shift from banks to the market.

In a benign economic cycle, where debt servicing does not face challenges, banks and MFs/markets are not in conflict. During liquidity constraints, when debt servicing becomes tardy and restructuring becomes necessary, conflicts between creditors becomes irreconcilable.

Banks and NBFCs operate with proprietary funds, which are amenable to elongation or acceleration, depending on the needs. These do raise asset-liability complications which can be usually ameliorated through regular inflow of deposits, over the medium to long term. Restructuring of liabilities funded through market instruments, involving deferment of payments (elongation) and/or downward revision in interest rates, could lead to sub-optimal returns or, in extreme cases, even negative return to investors, if there is no financial intermediary to absorb the “proprietary" loss. This applies to private placement of market instruments with MFs. Trustees of MFs, acting to protect investor interests, may have difficulties accepting restructuring, which banks find favourable. Press reports indicate that, in DHFL, such conflicts have arisen through the action of a few MFs and trustees taking up cudgels on behalf of investors.

Meanwhile, a large bank has bought out a 3,000-crore pool of loan assets from DHFL and adjusted it against outstanding loans despite ongoing restructuring negotiations. MFs have objected, as such securitizations jeopardize recovery prospects.

This singular act has perhaps derailed the restructuring process. MFs have also abstained from joining the inter-creditor agreement with the lenders. Meanwhile, the Bombay high court has only partially relaxed its stay on further repayments by DHFL to its creditors. Consequently, Icra Ltd has downgraded six securitized loan pools of DHFL. As on 6 July, the company’s total debt stood at 83,873 crore, of which 38,342 crore was owed to banks. The larger share of market participants, MFs and depositors in the total debt makes them critical to the resolution process.

DHFL’s restructuring proposal and the ensuing conflict is a first. With a larger share in the outstanding credit, market participants appear to have a dominant position compared with banks. The proposed resolution process—involving elongation in repayment, reduction in interest rate and conversion of debt into equity—is not acceptable to MFs and their trustees, as it vitiates investors’ “proprietary" interest.

The proposal is now a subject of litigation and is reportedly also being considered for mediation. Meanwhile, reported proposals of buyback of MFs’ holdings, with a substantial haircut, have not found favour.

In the all-pervading discussion regarding the development of a corporate bond market, to facilitate increasing market access, we might increasingly see market participants holding a larger share of a corporate loan book.

Potential restructuring in all such cases could suffer from similar conflicts, as is being observed in this case. Such flashpoints can severely deter emergence of the corporate debt market. It is, therefore, necessary to rethink the way resolution is currently practised.

Debasish Mallick is former deputy managing director of Exim Bank, and former MD and CEO of IDBI Asset Management Ltd.

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