Taking stock of the NBFC crisis

Will the NBFCs return to their green pastures? We back-track to the genesis of the liquidity issue ailing the sector, and help you navigate the turbulence

“Before, you are wise; after, you are wise. In between you are otherwise.” — David Zindell, The Broken God.

This just about sums up the turmoil and mayhem that the non-banking finance company (NBFC) sector has been going through over the past 10 months.

While the going was good, everything seemed like a fine idea — from riding the tide of easy money and incessantly rolling over short-term debt securities to funding risky assets and chasing heady growth figures. But when the cookie crumbled, everyone got wiser to point out the flaws.

Nearly 10 months after the IL&FS crisis first broke out and took the NBFC sector by storm, the market is still split between naysayers, who believe this is our very own Lehman crisis on the verge of snowballing into a financial contagion, and optimists relying on the storm to blow over soon. The RBI has remained on the sidelines though, giving meek assurances of intervention (when it deems fit) to ensure financial stability.

For investors in NBFC stocks, the entire episode has been a nightmare, with little respite from the spate of negative reports and rating downgrades. Recently, Dewan Housing Finance Corporation Ltd (DHFL), which has been in the eye of the storm, hopped back in focus as rating agencies downgraded its debt instruments and sent the stock into a tailspin. Indiabulls Housing Finance also took a knock recently, after a petition was filed (and subsequently withdrawn) alleging misappropriation of funds.

Reading the tea leaves on this ailing sector is difficult. Emerging governance issues and structural challenges emanating from past practices have made it difficult to hard-guess how the entire liquidity crisis will pan out in the coming months.

So, should you continue to invest in such stocks, or shun them altogether? We back-track to understand the core of the issue, take a look at the regulatory interventions so far, and deep dive into the financials of key NBFCs/housing finance companies (HFCs) to give you the big picture.

The spectacular journey

Niche offerings, dominance in certain geographical areas, competencies in specific segments such as non-salaried/self-employed, small businesses, and rural/semi-urban markets have led to NBFCs playing a vital role in the financing needs of the larger economy.

Sample this. Between FY13 and FY18, bank credit grew about 9.6 per cent compounded annual growth rate (CAGR) and the loan book of NBFCs by15.7 per cent.

While many NBFCs have been carving out a great success story, riding on their niche competencies, there were other factors that fuelled their heady growth. For one, interest rates were on a downward trend from January 2014 until August 2017 — the RBI’s policy repo rate had fallen from 8 per cent to 6 per cent during this period. Easy availability of low-cost funds contributed to the NBFCs’ growth. Secondly, banks, in particular public sector banks, saw very modest growth in credit between FY15 and FY18. More credit was, therefore, channelled to the thriving NBFCs; the share of NBFCs in total credit grew from about 15 per cent in FY13 to about 19 per cent in FY18.

Unlike banks, which rely primarily on deposits (savers), NBFCs raise money mainly from bank borrowings, bond market, deposits (in case of deposit-taking NBFCs), securitisation (sell part of the portfolio) and the National Housing Bank (in case of HFCs).

In the heady growth periods between FY13 and FY18, bank credit to the NBFC sector increased 14 per cent CAGR (above banks’ overall credit growth of 9-odd per cent). But despite banks upping their lending to NBFCs, the share of bank borrowings shrunk within the NBFCs’ funding basket. This was because the NBFCs’ reliance on short-term commercial papers (CP) increased notably. The share of CP in total borrowings went up from 5 per cent in FY13 to about 9 per cent in FY18.

Thanks to the flush of funds, post-demonetisation, there was a sharp growth in inflows of mutual funds, which, in turn, lapped up the CPs issued by the NBFCs. It is this aggressive shift in the funding mix that hurt many NBFCs, post the liquidity crisis last year.

What went wrong

The entire trouble began last year with IL&FS — touted as one of the largest infrastructure development and finance companies — defaulting on its dues. Subsequently, DSP Mutual Fund sold the CPs of DHFL at a higher yield in the secondary market — at a sharp discount. This triggered deep concern over the liquidity problem at NBFCs — the perceived risk for these once-fancied companies changed overnight. All NBFCs were painted with the same brush and hammered by the market.

The aggressive growth over the past few years, increasing over-reliance on short-term funds and wide asset-liability mismatches made matters worse. In practice, banks and NBFCs can run into liquidity issues mainly because of asset-liability mismatches. That is, their loans and borrowings do not come up for payment at the same time. Mismatches in the short term — six-month-to-one-year bucket — are particularly worrisome. While banks have access to short-term funds (they can borrow from the RBI through the repo window by pledging government securities), NBFCs do not have access to such stop-gap funding. And, hence, the inability to raise money from bond markets or banks (on fears of a heightened credit risk) can hit them severely.

Sifting through the annual report disclosures from NBFCs for 2017-18, revealed that some players had a wide mismatch, with deposits and borrowings in the up-to-six-month bucket coming up for payment faster than their loans in the same tenure.

Regulatory interventions

There has been a growing clamour for opening a special liquidity window for NBFCs, just as the RBI did in 2008. But the regulator is yet to yield, re-assuring that it would step in to ensure financial stability. The RBI has, instead, eased some norms to ensure smoother flow of credit from banks to NBFCs. While these may have helped a bit, only a few NBFCs appear to have gained. The growing concern is that if the unresolved liquidity issue hits some of them, the contagion impact could be severe.

Liquidity through OMOs

The RBI conducted significant open-market operations (OMOs) — buying nearly ₹2.5 lakh-crore of government securities between October 2018 and March 2019. With no direct taps of funding opened for NBFCs, the intent was to make ample liquidity available to banks, which could, in turn, lend to NBFCs.

Going by the data put out by the RBI, after growing 27 per cent Y-o-Y in FY18, bank lending to NBFCs grew by a higher 29 per cent in FY19. It would appear that banks have continued to lend to certain NBFCs, drawing comfort from their quality of loan books and businesses. Sundaram Finance, for instance, has been able to increase its share of bank borrowings to 25 per cent by the end of FY19, from about 20 per cent in FY18. HDFC, Can Fin Homes, Bajaj Finance, Repco Home Finance, and Cholamandalam Investment and Finance are a few other NBFCs that have seen their share of bank borrowings increase over the past four quarters.

NHB — the regulator and principal agency that promotes HFCs — also increased its refinance limit from ₹24,000 crore (July 2018-June 2019) to ₹30,000 crore.

Easing securitisation norms

One of the ways by which NBFCs raise funds is through securitisation — selling their loan portfolio. In November 2018, the central bank eased the securitisation norms for NBFCs. NBFCs have to hold loans on their books for a minimum period before they can sell them. Earlier, for loans of over five-year maturity, the minimum holding period was one year. The RBI has eased this requirement to a minimum six-month holding period. However, such relaxation is allowed only when the NBFC retains 20 per cent of the book value of these loans.

There has been a significant rise in the share of securitisation for many NBFCs. Indiabulls Housing Finance, for instance, saw the share of securitisation in its funding basket shoot up to 22 per cent as of March 2019, from 11 per cent in the June 2018 quarter. Mahindra and Mahindra Financial Services saw it increase from 2 per cent in the June 2018 quarter to 8 per cent by the end of FY19.

Other tweaks

From 10 per cent, the RBI raised banks’ single-borrower exposure limit for NBFCs that do not finance infrastructure to 15 per cent. In November, the RBI also allowed banks to offer partial credit enhancement (PCE) to bonds issued by some of the NBFCs. Credit enhancement is a facility by which a corporate can improve the rating of the bonds it issues, by securing a backing from other institutions such as banks.

Also, earlier, banks’ exposure to NBFCs was risk-weighted at a blanket 100 per cent. In February, the RBI allowed rated exposures of banks to all NBFCs, excluding Core Investment Companies (CICs), to be risk-weighted as per the ratings assigned by rating agencies.

Proposed liquidity framework

With the wide asset-liability mismatches on the books of NBFCs coming to light, the RBI in May proposed some guidelines on a liquidity risk management framework for NBFCs.

These are applicable to all non-deposit-taking NBFCs with an asset size of ₹100 crore and above, systemically important CICs, and all deposit-taking NBFCs, irrespective of their asset size. Key among the norms are breaking up the ‘up-to-one-month bucket’ into smaller buckets and setting tolerance limits for mismatches.

Also, all non-deposit taking NBFCs with an asset size of ₹5,000 crore and above, and all-deposit taking NBFCs, irrespective of their asset size, have to maintain a liquidity buffer in terms of a liquidity coverage ratio (LCR).

NBFCs will have to maintain sufficient liquid assets to meet obligations in a 30-day stress scenario — liquid assets equal 100 per cent of total net cash outflows over 30 days. This will be implemented in a phased manner. Starting from April 2020, the LCR requirement will be 60 per cent, reaching 100 per cent by April 2024. So, what does this imply for NBFCs?

For one, the norms will restore the confidence in the sector over the long run, with more discipline in managing liquidity. In the near term, however, the impact would vary across players.

For large NBFCs that already have a good asset and liability management (ALM) profile, the impact of the new norms would not be significant.

Many players also maintain ample liquidity buffer (liquid investments or undrawn credit lines) and, hence, complying with LCR norms may not be difficult. Also, some of the NBFCs now sport a healthier ALM profile than in FY18.

But LCR will also require NBFCs to maintain liquid investments on their balance sheet. This will reduce the funds available for lending, to some extent, and add pressure on their margins, as investments in government bonds will earn lesser interest. Also, a structural shift away from short- to long-term borrowings will increase funding cost, impacting margins.

 

 

What lies ahead?

Slowdown in growth

As is evident from the publicly available information of listed NBFCs, there has been a slowdown in disbursements since the December quarter. This sluggishness may continue over the next few quarters, as funding will remain a challenge for some players that have exposure to risky assets. While some have been able to resort to securitisation to raise funds, how long good assets can be monetised needs to be seen. If the negative sentiment around the sector continues, growth concerns can get accentuated.

Profitability to remain under pressure

Over the past three to four quarters, the cost of funds for NBFCs has gone up notably, impacting their margins. While some NBFCs have been able to pass on the cost increase to borrowers, the scope for such pass-through may get constrained with growing competition from private sector banks in certain pockets.

The RBI’s proposed norms around liquidity will also put pressure on margins. Here, players with good-quality loan portfolio, easier access to funds and better pricing power (passing through of costs) will be able to keep margin pressure under check.

Asset quality could slip

Some businesses, owing to their inherent business models, remain relatively more susceptible to market shocks. Hence, if tight liquidity conditions persist in FY20, asset-quality issues may arise for NBFCs having exposure to stressed real estate (in particular, the developer segment), infrastructure and loan against property (LAP), etc. Consumer, retail home loan and vehicle financiers would be better themes to bet on.

What should investors do?

Don’t tar with the same brush

The NBFC sector is vast with diverse businesses — from consumer financing, home loans, vehicle financing, infrastructure lending to catering and rural and self-employed customers. Hence, it would be unfair to paint all NBFCs with the same brush. It is important to remember that not everyone is affected in the same way by the various market conditions. Businesses with sound financials, good-quality loan portfolios, diversified funding bases and prudent risk-mitigating frameworks are better placed to weather interim shocks, as has been evident over the past year.

Scope for growth

Many NBFCs have seen strong growth in the past, thanks to their unique business model, niche offerings, ability to price risk well and, by and large, stable asset quality. Many players have re-balanced their funding portfolio and ironed out ALM issues over the past year. Adopting the RBI’s framework on liquidity will also bring in discipline within the sector. So, don’t write-off the sector just yet.

Avoid risky bets

Corporate governance concerns in some NBFCs are a cause for worry. In many cases, it is difficult for investors to gauge the true state of affairs until the damage has been done. Hence, stay clear of stocks caught in negative news flows until the air clears up. Also, tread with caution on NBFCs with high exposure to the developer segment, infrastructure and LAP. Worsening liquidity conditions can make them more vulnerable to shocks.

How the players have fared

Having looked at the big picture on NBFCs, how do you go about evaluating stocks in the sector? Radhika Merwin delves deeper to assess the key parameters.

Caveat: the analysis is based on corporate information available publicly and interactions with managements. Corporate governance issues, if they surface in future, can alter the analysis

 

Bajaj Finance

 

 

The company is one of the largest retail asset financing NBFCs, focussing on mass affluent customers. It has been following a stringent asset quality norm and high provision cover.

It has a good liquidity buffer — ₹6,612 crore of free cash as of March. Favourable asset-liability profile and relatively shorter tenure on loans are positives.

 

 

Repco Home Finance

 

 

 

Operating mainly in Tier II and Tier III cities, the company is tilted towards the non-salaried category. This has led to subdued asset quality. In FY19, GNPAs in the LAP book shot up to 6.8 per cent in the December quarter.

Its focus on the Tamil Nadu market has impacted growth, given the region’s specific challenges. Repco increased funding from banks in FY19.

 

 

Shriram Transport Finance

 

 

The company has strong market leadership in the used commercial vehicle financing segment. Growth in both used CV financing and new vehicle segments slowed in FY19. Given the underlying risk in its key small road operators’ segment, the company’s asset quality has been modest.

It has a well-diversified funding mix. Asset liability position is sound with cumulative positive gaps across maturity buckets.

 

Mahindra & Mahindra Financial Services

 

A subsidiary of Mahindra & Mahindra, the company has a good track record in financing tractors and utility vehicles. Asset quality is relatively stressed, given its focus on rural and semi-urban areas, though there was a sharp reduction in GNPAs in the March quarter.

Through the liquidity crisis, the company has been able to raise funds. The company has well-matched asset liability profile.

 

Housing Development Finance Corporation

 

Leading market position, good track record of performance and stable asset quality have been key strengths. Over the past year, it has managed to grow its loan book, keep bad loans under check and raise funds. HDFC’s diversified funding base and superior credit ratings have also helped it tide over volatile times better than its peers.

 

Cholamandalam Investment and Finance Company

 

The company has a well-established track record in the vehicle financing business. A relatively higher level of GNPAs in the LAP segment needs watching. However, a lower loan-to-value (LTV) and chunk of the book being self-occupied residential property helps mitigate the risk.

On the liquidity front, the company has been comfortable and its asset liability was well-matched as of March 2019.

 

Indiabulls Housing Finance

 

Disbursements have fallen in FY19. The proposed merger with LVB has kept investors on tenterhooks. Recently, the stock fell, after a petition was filed (later withdrawn) alleging misappropriation of funds.

Exposure to LAP and corporate mortgage loan make it vulnerable. It raised funds through selling its portfolio — ₹21,480 crore since September. It has liquidity buffer of more than ₹28,000 crore.

 

Can Fin Homes

 

With strong regional presence, the company focusses on the low-risk salaried home segment. Exposure to LAP is minimal. It has not faced liquidity issue. However, its asset-liability mismatch remains adverse, as on December 31, 2018, according to ICRA.

But the company enjoys undrawn overdraft facility from banks, which can be utilised, if needed. The liquidity buffer mitigates concerns on asset-liability mismatch.

 

Sundaram Finance

 

The company is predominantly a CV financier and has delivered steady performance, thanks to its focus on asset quality and strong positioning. It has been able to raise funds through multiple channels over the past several months.

Sundaram BNP Home Finance, its wholly-owned subsidiary, also maintained comfortable liquidity. Disbursements, however, slowed owing to sector slowdown and its conscious decision to decrease LAP portfolio.

 

Dewan Housing Finance

 

 

The company has been under liquidity stress. Recently, Crisil and ICRA downgraded the ratings of its commercial papers to default, owing to inadequate liquidity and limited visibility on fresh funding, though it settled some of its dues subsequently. Between September 24 and December 2018, it sold portfolio of loans (net) amounting to ₹11,873 crore. Rising share of LAP and project loans are a concern.

 

 

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