Debt schemes witnessed a massive shock yesterday as several schemes revealed sharp losses to their net asset values (NAVs). The worst hit was DHFL Pramerica Medium Term, which posted a loss of 52.99%! Yes, more than half of the schemes value disappeared in a single day.
The losses emerged as a consequence of the long-speculated crisis in Dewan Housing Finance Corp Ltd (DHFL), a non-banking finance company, which missed its bond interest payments on 4 June 2019.
There is a seven-day grace period available claims DHFL, to avoid an actual default scenario. But mutual funds have to mark down their exposure to DHFL by up to 75%, before an actual default is announced. The mark down caused severe losses, biting away a year’s worth of returns of a debt scheme, in a single day.
Mutual funds had lent to DHFL and had taken large risky bets. This backfired after the fund managers could not sell this debt position due to change in risk perception of DHFL in the market.
Buyers disappeared, and fund houses kept holding the debt papers, in the hopes of recovery. DHFL had not defaulted yet, and continued to service the interest payments on its outstanding debt. However, it found it difficult to raise further capital for its business which increased its fragility.
Investors in the affected mutual fund schemes took the exit, causing the assets under management in these schemes to erode, and consequently increasing the exposure to DHFL’s debt. The worst hit scheme DHFL Pramerica Medium Term had an exposure of 37% to debt papers of DHFL, as on 30 April 2019.
Manoj Nagpal, a mutual fund expert tweeted the disastrous but partial picture of debt fund losses.
The fiasco: where it all started
On 21 September 2018, the share price of Dewan Housing and Finance crashed 42% in a single after DSP Mutual Fund sold off Rs300 crore of DHFL’s bonds in the secondary market, at a higher yield. This started a snowball effect causing massive speculation and concern over DHFL’s financial health.
An expose by Cobrapost over DHFL’s promoters funneling bank loans worth several thousand crores into dubious and shell companies, without any security, further dented the company’s reputation.
Investors with any exposure to DHFL, either through their shares or exposure to debt paper, exited. Although the company clarified that all the allegations were wrong, investors turned a blind eye to it. These events made it difficult for DHFL to raise additional capital from the public and private investors, which skewed its liquidity profile.
Taking note of the liquidity crisis engulfing DHFL, credit rating agencies unleashed a series of downgrades on existing debt papers of DHFL. The downgrade panicked investors in debt mutual funds and others, which had purchased DHFL’s debt.
DHFL enjoyed the highest credit rating of AAA until September 2018, before the events unfolded. A gold standard AAA rating allowed DHFL to raise large sums of capital from investors, at a low rate. The ratings have now dropped to BBB- as on May 2019, nine notches from its prestigious AAA rating. The rating downgrades alone led to mark-down in the value of the debt by 10%-20%, suffered by investors exposed to it.
On 4 June 2019, the company missed its interest payment deadline on a set of outstanding bonds. This event triggered the deep losses witnessed in many schemes of mutual funds, which had exposure to DHFL. The Debenture Trust Deed allows a grace period of seven days within which interest payments can be made. The delay in payments will require MFs to mark down their NAVs by about 75% in the DHFL instruments.