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NBFC crisis: What went wrong & can it blow up in your face?

NEW DELHI: There is a reason why IL&FS defaults have prompte..

NEW DELHI: There is a reason why IL&FS defaults have prompted many market writers to invoke the Lehman crisis: there was an uncanny similarity in the absence of cynicism during the US sub-prime boom and Indias NBFC surge.

Every third multibagger of last five years would be an NBFC. India has been witnessing a huge surge in consumer leverage in recent years and these non-bank intermediaries have been growing this lending faster than banks.

Brokerage UBS says NBFCs book grew 14 per cent CAGR over FY13-18. They moved from 21 per cent of bank credit in FY10 to 34 per cent now.

When IL&FS first defaulted on its obligations, it made some analysts sit up and take note. The company has defaulted on over five of its obligations since August, put its headquarters on the block, and its MD & CEO of the financial services arm has since resigned.

And when fund house DSP offloaded Rs 200-300 crore worth of commercial papers of housing finance company DHFL at higher yields, it sparked off fears.

Rumour mills went abuzz about a systemic liquidity problem in the NBFC space, while some analysts dug deeper to claim asset-liability mismatch among most players.

From then on, NBFC stocks have been on a free fall. A kind of contagion then spread to other financial stocks, and the benchmark indices crashed, creating bearishness all around.

Was the issue overblown? Or was it too much of cynicism?

DSPs move triggered rumours of a payment default by DHFL, which the company strongly denied. It said there had not been a single instance of delay on any repayment of any liability.

DSP said the sale reflected its view on interest rates, rather than its credit view on a specific issuer. Economists and analysts have been projecting another rate hike by RBI, the third this year, in October to stem the rupee slide.

Mondays clarification from DHFL management helped the stock stage a smart recovery on Monday, but it fell some 22 per cent on Tuesday. A number of its peers such as PNB Housing and CanFin Home continue to slide.
Traders and analysts say the default by a big institute like IL&FS would make it difficult for NBFCs to borrow from the market.

DSP move to sell off DHFL papers also added to liquidity concerns over the commercial papers of NBFCs.

Lure of CPs and ALM mismatch
NBFCs raise funds mainly by issuing debentures and commercial papers and borrow from banks. As such, their cost of funding has actually been falling, despite a spike in systemic rates, as commercial papers were relatively cheaper.

Many home finance companies migrated towards shorter-tenure borrowings in recent times, as the shorter-tenure borrowing became cheaper by about 100 basis points that longer-tenure ones, said JM Financial.

But there lies the problem, as it has now created an asset-liability management (ALM) mismatch in the shorter tenure bucket of up to one year, says brokerage JM Financial.

Heres a chart showing their funding mix till March quarter

Source: Boston Consulting Group

(Chart source: Boston Consultancy Group)

Brokerage Emkay Global says 12 per cent DHFLs liabilities (nearly 17 per cent of market borrowings) are maturing in three months against 9 per cent of total assets (nearly 3 per cent advances).
Among asset finance companies (AFCs), Cholamandalam Finance has 15 per cent of liabilities (14 per cent of market borrowings) maturing in 3 months against 7 per cent of total assets (7 per cent advances). Shriram Transport also has an adverse ALM mismatch with faster liability maturity.

As liabilities get re-priced faster than assets, many of these NBFCs would face pressure on their interest margins or NIM, says India Ratings. “Any liquidity tightness could also create refinancing challenges. This is more so in light of the challenges being faced by the banking sector, which have constrained funding avenues,” it said.

Some of the NBFCs wont be able to roll over their short-term positions. If they raise funds at higher yields and charge fixed rate to borrowers, it will lead to NIM (net interest margin) compression,” IIFL said in a note.

UBS says any reversal in liquidity would imply funding for NBFCs may remain tight. The recent adverse sentiment in bond market could mean higher borrowing costs for them. Plus, they are likely to see lower growth and/or margins ahead, it said.
Liquidity conditions to tighten
With the IL&FS group defaulting on commercial papers, a short-term debt instrument, there are concerns that the banks would be reluctant in lending to NBFCs.

The market was already preparing for a cash crunch in the system due to advance tax liabilities. Should the IL&FS contagion spread further, it will only accentuate the problem.

Some fund houses have already started cutting bond holdings, particularly from NBFCs, and are seeking to sit on cash, because of market uncertainty and apprehending a possible surge in redemptions.

Banks have started redeeming units of liquid funds, where investors park their short-term funds, a common phenomenon towards the end of every quarter. But this time the redemptions started earlier.

In June, ICRA estimated that retail-focused NBFCs – with an estimated portfolio size of Rs 7.5 lakh crore – would need Rs 3.8-4 lakh crore of fresh debt funding in FY2019 to support their envisaged portfolio growth of about 20 per cent in FY2019. Those maths have gone for a toss now.

The rating agency anticipated annual average borrowing cost of retail NBFCs to increase by a minimum of 45 basis points in FY2019.

“About 50 per cent (NCDs-CPs) of NBFC borrowings were largely at a fixed rate, while 35-37 per cent of bank borrowings get repriced on a quarterly or annual basis. As the share of bank borrowings begins to increase from Q2 FY2018 and borrowings with annual reset dates are expected to get repriced from August-September, retail NBFCs are expected to face increased pricing pressure in the second half of FY2019,” it noted.

Analysts say banks would be constrained by their internal sectoral lending caps from taking incremental exposure to NBFCs.

Will this crisis blow up in the face?
Experts said even though lenders would now take a more measured stand on NBFCs, well-run NBFCs with proven business models across cycles and those focusing on the retail segment that have generally lower credit and concentration risks may be less affected.

“We dont find liquidity risk, but the risk-averse stance of debt markets will likely lead to higher funding costs in the near term,” Kotak Securities said.

Morgan Stanley believes the asset side of HFCs is strong, with primarily amortising loans, hence, default risk is low. But funding costs will rise, affecting NIMs and growth, it said.

NBFCs with strong parentage i.e. sovereign/ large financial institutions, will continue to earn support from debt markets and banks. More importantly, underlying business trends in most asset classes (CVs, rural auto and retail housing) have been robust over the past few quarters, Kotak said.

Rating agencies told to track bond spreads
Baffled by the rapid downgrades of IL&FS debt paper — from triple-A to D (or, default) in less than two months — Sebi has asked rating agencies to take cues from the market in evaluating bond issuers.

The strategy to track widening bond spreads — the difference between a corporate bond yield and that of a government bond of similar maturity — was emphasised by Sebi officials at a recent meeting with large rating agencies, ET reported on Tuesday. READ MORE

Thus, while the problem looked like isolated, the systemic issues that the market had ignored thus far have come to fore, denting investor confidence.

A poll conducted by ETMarkets.com on its website and social networking platforms showed 72 per cent of participants feel the liquidity problem being faced by some of the NBFCs is a systemic issue.

Jaitley assures investors
Finance Minister Arun Jaitley tried to allay fears in the market by asserting that the government would ensure that credit is available to the non-banking financial companies (NBFCs). The assurance came after market watchdog Sebi and RBI said they were closely monitoring developments in the financial markets and stood ready to act, if needed.

Stocks to look at
While many brokerages have downgraded earnings for HFCs, expecting narrowing of NIMs due to a rise in cost of borrowing, analysts feel one should not paint all NBFCs with the same brush.

Kotak Securities has upgraded Mahindra Finance to add from reduce as it believes a strong rural cash flows in the near term will continue to drive growth and improvement in ECL.

It believes Shriram Transport Finance, at 1.6 times FY2020E book, provides a good entry point. While CV sales may moderate from current high levels, while the increase in axel load norms will benefit asset quality performance, it said.

Other than the two stocks, the brokerage believes a sharp stock correction provides an opportunity to add Cholamandalam, which it feels is one of the best NBFC play and a core holding in the sector.

The brokerage also feels LIC Housings valuation is compelling, even though NIM may come under pressure in the near term.

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