Ever since the liquidity crisis first came out in the open in September 2018, in the after math of the IL&FS crisis, the big casualty has been the housing finance companies. The reasons were not hard to seek. These HFCs had adopted a skewed asset liability mismatch to fund their loans and that was the genesis of the problem. Most the HFCs were borrowing in the short end of the debt markets via Commercial Paper (CP) and deploying the funds in the longer term mortgage loans. The situation was perfectly fine as long as the funds could be easily raised in the CP market. The problems arose when IL&FS defaulted and hence the market for short term lending to NBFCs almost dried up. Banks and mutual funds that were the biggest investors in the short term debt paper issued by these HFCs became a little wary of putting money. That is where the entire liquidity crisis exacerbated in the market.
Buying bonds at a discount
In the financial world it is often said that one man’s crisis is another man’s opportunity. Not surprisingly, these distressed bonds of companies like Dewan Housing are finding ready buyers and in fact, some of the leading PE funds like Barings, KKR and SSG Capital are now looking to buy these bonds at deep discounts. But why are these bonds available at such a deep discount. There are quite a few reasons.
- The DHFL bonds are held by a number of pension fund and provident fund investments. They have their own internal regulations about bond holdings and they would be looking at an exit route. Even a 15-20% discount may work better for them than holding on to the bonds at distress value.
- Then there are the mutual funds that have done funding of these housing finance companies via bond issues. With the regulator getting more stringent about portfolio quality and the sharp outflows in debt funds seen last year, most mutual funds are getting wary about such bonds. Exiting at a discount is still meaningful for them.
- Most of the bonds are available at a discount of around 16-20% on the face value in the open market. Most mutual funds are also directly talking to these P/E funds to buy these bonds at a discount through block deals. A discount of nearly 20% on the bond price works out to an annualized yield of 14-15%. That is the kind of yields you cannot even hope to get on any paper. For the global investors, it is well worth the risk of buying these bonds at distressed valuations.
- Ironically, some of the funds are not only sellers but they are also buyers of such bonds at distressed valuations. The current discount helps them to average the bond price and thus improve the overall yield of their holdings in DHFL bonds. Quite a few mutual funds like DSP, JM and Axis MF are also looking for opportunities to buy this kind of distressed debt.
What is so special about DHFL bonds?
For a long time, Dewan Housing had been a favourite among equity investors. The stock had rewarded investors handsomely over the years despite quoting at lower valuations compared to its housing finance peers. The company has a strong loan book with a quality portfolio and low levels of Gross NPAs. Also, DHFL has hardly had any issues of servicing debt in the past. In the last few months, the company has also substantially cleaned up its balance sheet and reduced the instances of maturity mismatches. All these have worked in favour of DHFL and that is the reason why PE funds are keen to buy these bonds at discounted prices.
The only catch is the pricing. For example, most holders are willing to sell the DHFL bond at a discount of 10-12%, whereas the PE funds are expecting around 15-20%. Both see the opportunity somewhere in between. The only catch is that in the meanwhile the financial condition or the liquidity situation of the company should not deteriorate. That could upset equations and calculations altogether.