DHFL Default Case Study

CAPITALx - 2022

Team Alexa
BITS Pilani, Hyderabad Campus

Tanmay Srivastava
Shrinivas Reddy
Introduction
Scams have hit India's non-banking financial institutions (NBFIs), which make up the country's less-regulated
shadow banking sector, causing a domino effect in the country's money market. With the revelation of the
ILF&S fraud, major corporate governance concerns in NBFIs were uncovered, effectively causing a sub-prime
crisis. In such a scenario, where the shadow banking sector was subject to new laws to enhance monitoring,
corporate governance lapses led to the collapse of Kapil Adhawan's Dewan Housing Finance Limited (DHFL).
DHFL was one of India's biggest housing financing organisations, with a total asset under management value of
'1.01 trillion and a net profit growth of 25% in the third quarter of fiscal year 2017. (AUM).

The corporation has plummeted from its lofty perch, losing '22.23 million in the fourth quarter of the fiscal year
2018–2019. The company's commercial paper and non-convertible debenture credit ratings were lowered;
non-payment of interest led to the implementation of a resolution plan, with the board of directors agreeing to
nationalised banks. The company's image had plummeted along with its stock values, following suspicions that
its promoters were syphoning funds through shell firms. In the context of the NBFC (non-banking financial
company) industry, the case describes DHFL's oversights and incompetence in terms of corporate governance
norms.

The jury is still out on whether Wadhawan followed corporate governance laws to the letter or whether the
tightening noose of regulations and market attitudes around India's "shadow banking" sector spelled doom for
DHFL.

About DHFL
DHFL was classified as an NBFC-D since it was a deposit-taking Housing Finance Company (HFC). DHFL was
founded in 1984 to provide housing finance to low- and lower-middle-income people in tier-II and tier-III cities.
Non-housing loans were also available, including loan against property (LAP), developer loans, and small and
medium enterprise (SME) loans. On March 31, 2019, DHFL had 322 locations in India.
Late Rajesh Kumar Wadhawan, DHFL's Founder Member, founded the company in 1984 with an egalitarian
aim, of 'Every Indian should have his own home.' Fast forward to July 2019, and the goal was a careful parody
of President George W Bush's 'American Dream' of 'working together as a nation to empower citizens to own
their own home'. Both ideas resulted in low-quality home loans; in America, government-mandated schemes
disbursed loans to low and very low-income borrowers at sub-prime lending rates, resulting in a global financial
crisis; in India, DHFL struggled to forward any new loans even as their existing loans turned into
non-performing assets (NPAs), rising from 0.96 percent in FY18 to 2.74 percent in FY19.

The Leading Directors on Board

While DHFL's management claimed to be focused on making the firm "the greatest organisation," the structure
of the board and the separate committees was notable. Under Kapil Wadhawan as the Chairman and Managing
Director, the board of DHFL included only one non-executive director, his brother Dheeraj Wadhawan (DHFL,
2019b) (DHFL, 2019b). Dheeraj was a director and shareholder of Wadhawan Global Capital, DHFL's largest

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promoter-driven holding firm (Exhibit 4). Apart from the Wadhawan brothers, the DHFL board had just four
additional members in the face of rising debt and stock-price declines (Exhibits 5 and 6).
; all of them served as extra non-executive independent directors. Wadhawan Global Capital was also led by
two members, Srinath Sridharan and Deepali Pant Joshi (WGC, 2019). Apart from being the Chairman and
Managing Director, Kapil Wadhawan was the only executive member of the board, as well as a member of the
Risk Management Committee, Finance Committee, and the newly formed special committee for the sale of key
investments.

DHFL's Ignorance of Regulations

In 2003, DHFL purchased ING Vysya Bank's housing finance unit, followed by the acquisition of Deutsche Post
Bank Home Finance Ltd. (DPBHFL) in 2010 to join the intermediate upper-middle-income sectors in tier-I cities.
In March 2013, DPBHFL was renamed First Blue Housing Finance Ltd. and amalgamated with DHFL (CRISIL,
2019). As a result, the firm strayed from its core specialty of low and extremely low-income housing loans. This
had an effect on both the company's business strategy and its book value. It was maintaining a greater level of
capital adequacy to meet increased risk exposure levels by disbursing larger ticket size loans.
The National Housing Bank (NHB), which operates under the auspices of the RBI, mandated that HFCs such as
DHFL keep a certain percentage of their assets in defined securities and put aside reserve cash in order to pay
out accumulated interest and accepted deposits at any time. When DHFL entered the medium and
upper-middle-income lending sectors, their risk skyrocketed to a level that DHFL couldn't handle. The audited
financials, on the other hand, revealed a different story.
HFC was required by NHB to match their borrowings to 12 times their net-owned funds. The capital adequacy
ratio was scheduled to climb to 13 percent by March 2020, 14 percent by March 2021, and 15 percent by
March 2022 from its current level of 10%. (Mint, 2019b). These requirements applied to financial statements
audited under Indian Accounting Standards (Ind As). In March 2019, the NHB determined that DHFL's capital
adequacy was 10.28 percent. The promoters could not have been uninformed of the same as it plummeted
from a stable 17.74 percent in December 2018. (Exhibit 7). The capital insufficiency discovered by NHB 'relate
to numbers generated based on regulatory rules,' according to the company's audited financials for FY 2019
(Exhibit 8), and 'the Management thinks that the observations as described before may not have any
repercussions on the same' (DHFL, 2019c).

DHFL is a non-bank financial institution. This means that all banks are required to lend a portion of their funds
to DHFL and similar companies. This is why money placed by small depositors in State Bank of India, Bank of
Baroda, and other banks finds up in the hands of NBFCs such as DHFL. According to current data, Indian banks
have put at least $3 billion into DHFL. DHFL has also borrowed substantially by issuing bonds and other debt
instruments in addition to this sum. The retail investor holds the majority of these instruments, and they faced
massive losses.

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The Charges Leveled Against DHFL
Loans to Shell Firms:
1. According to Cobrapost, DHFL has issued questionable loans to shell companies. Pass-through entities
are shell firms. This indicates that they are not the money's eventual destination. Instead, they are
merely a pit stop along a convoluted path designed to deceive tax and other regulatory authorities.
Cobrapost claims to have discovered 34 similar businesses. These businesses have indirect ties to the
DHFL group's promoters, and sources indicate that DHFL has granted these businesses almost $1.5
billion in unsecured loans.
2. The issue is that DHFL lent money to these businesses without adopting necessary security measures.
In India's banking industry, loans to businesses are secured through the use of assets as collateral.
Furthermore, promoters are required to provide personal guarantees in order to secure the security of
these loans.
3. These procedures have not been followed by DHFL. As a result, public funds have been lent to people
with no security. This money cannot be easily recovered because there is no collateral. Furthermore,
the promoters have no personal assets. As a result, they are also immune from prosecution. According
to Cobrapost, many of these loans to sham firms have now turned into non-performing assets (NPAs).

Round Tripping:
1. Loaning public money without going through the proper channels is just one element of the problem.
The bigger issue is that the money that was loaned out has since returned to organisations controlled
by the DHFL group. This is known as round-tripping in the financial world. As a result, DHFL effectively
provided its promoters an unsecured loan.

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 2. Shell corporations and other activities were little more than a ruse to hide these clearly illegal
operations. If Cobrapost can demonstrate round-tripping, DHFL's troubles will be amplified. DHFL is
simply negligent if it does not round-trip. Because of the round-tripping, DHFL has a malafide intent
and is thus guilty of fraud.

Purchasing Assets:
1. The funds obtained through round tripping were used by DHFL to purchase assets in other nations. It
is well known that DHFL has made investments in start-up businesses in the United Kingdom. The
DHFL has also been reported to have bought a cricket side in the Sri Lankan Premier League. The
profits of these loans are said to have been utilised to carry out these transactions.
2. Cobrapost further claims that the owners of DHFL have created other personal assets in countries
such as Mauritius and Dubai. Because all of the assets were generated in foreign jurisdictions, this
appears to be a hoax once again. As a result, neither the Indian government nor the tax authority will
be able to obtain the information.

The Fortitude of Faith

Kapil Wadhawan was one of 14 distinguished contestants for Ernst & Young's Entrepreneur of the Year award in
2011, riding high on achievement. 'Audacity of Hope' was the title of the nomination. Wadhawan was
recognised as having the "brains behind the design and implementation of new loan processing software,
culminating in an effective digital credit management platform" (E&Y, 2011). The auditors voiced concerns
about gaps in the documentation of loans totaling '207.50 billion' after implementing their Loan
Documentation procedure (Exhibit 9). Insufficient information and explanation of credit, legal, and
technological review were among the issues. The firm confessed that the loan payback checks were not
submitted for approval at the request of the borrower, but a receipt was sent. This was not a single incident,
but a total of '164.87 billion in gross value,' according to the auditors (Quint, 2019).

Poor Credit Offer

Companies having significant cash reserves provided unsecured Inter Corporate Deposits (ICDs) with high
interest rates. DHFL's status after December 2018 was not that of a corporation in a position to offer ICD
because it was barely able to satisfy its NCD interest payments. Despite this, it elected to rollover ICDs worth
$56.52 billion despite auditors' concerns about the borrowers' creditworthiness. (Figure 9)
During FY 2019, net ICDs of '48.20 billion were granted, according to audited financials. There were also gaps in
the documentation surrounding funding and ICD rollover, according to the audit. A temporary loan was issued
without a comprehensive appraisal of the project, which was being remedied. On a sad note, the report stated
that management anticipated the lack of paperwork would not influence the underlying asset's enforceability'
(DHFL, 2019c) (Exhibit 11). Furthermore, rumours of DHFL perpetrating a scam through shell businesses by
syphoning off its earnings had added fuel to the flames with these unsecured loans.

Feeding off of Loans

According to the World Bank's Responsible Lending Guidelines, when a household spends more than 30% of its
gross monthly income on debt repayment, it is a sure evidence of over-indebtedness (Prouza, 2013). The EMI
was anticipated to be less than 60% of the borrower's income in Indian Public Sector Banks. To meet its interest
payments commitments, DHFL bundled, rated, and marketed a total of '400 billion in such loans, all of which
had minimal default risks and a strong repayment history. Indian Public Sector Banks purchased loans totaling
'120 billion of them. This left DHFL with $348.18 billion in high-risk loans, including those for real estate
projects that had no takers. The sequence of events in March 2019 dealt a serious blow to Kapil Wadhawan's
business reputation. DHFL was no longer the best in the industry, and retail and institutional investors were
sceptical (Exhibit 10). He had no choice but to accept the baton from promoting institutions like State Bank of

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India and Union Bank within the current regulatory environment. In light of DHFL's default status on
outstanding NCDs, the NCD investors received a request for consent from DHFL's debenture trustee, Catalyst
Trusteeship Limited (CTL), about permitting CTL to meet the requirements of the intercreditor agreement (ICA)
of the NCD (Exhibit 12). One can ask if the start of the resolution procedure by trustees such as CTL resulted in
a total takeover of the DHFL board of directors and Wadhawan's departure. In the last two financial years,
substantial breaches and a lapse in corporate governance have occurred in the Indian NBFC sector. This was
eminent due to a domino effect in both the capital and money markets.

Indian Budget 2020-21

The liquidity crunch in India's shadow banking sector arose as a result of big non-banking financial companies
defaulting on loan obligations (NBFCs). Between June and September 2018, two subsidiaries of Infrastructure
Leasing & Financial Services (IL&FS) defaulted on payments, while Dewan Housing Finance Limited (DHFL) did
likewise between June and August 2019. Both of these companies defaulted on non-convertible debentures
and commercial paper liabilities in the range of'1500-1700 crore.
As a result of the defaults, mutual funds began selling their NBFC investments to reduce their exposure to
stressed NBFCs. In September 2018, DSP Mutual Fund sold DHFL commercial papers (CPs) worth'300 crore at a
significant discount. Panicked investors in debt mutual funds began hastily withdrawing their funds'
investments. The months of September 2018 and June 2019 had the biggest net withdrawals from LDMFs and
money market funds, coinciding with the news of IL&FS and DHFL payment failures reaching the wider market.

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Conclusion

DHFL is a housing finance company that offers house loans under PMAY scheme – which offers loans for the
economically weaker sections, low and middle income group of the society for buying land and houses. The CBI
said that DHFL had processed as many as 88,651 cases under the PMAY Scheme.

In the end, the allegations levelled against DHFL were explosive. A swindle of this nature had the potential to
harm Indian investors significantly. Cobrapost, on the other hand, made the claims with zeal and claimed to
have sufficient evidence to back up its claim. This information forced regulatory bodies to conduct a
comprehensive investigation into the claims.

According to report by the NDTV, the CBI said that Kapil and Dheeraj Wdhawan created fictitious home loan
accounts under PMAY Scheme, amounting to more than Rs 14,000 crore and availed ₹ 1,880 crore in interest
subsidy from the Centre.
In November 2019, the Reserve Bank of India (RBI) superseded the board of DHFL.

Conflict of Interests Declaration

In relation to the research, writing, and/or publishing of this paper, the authors disclosed no possible conflicts
of interest.

References
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