DHFL crisis. Photo: iStock
The fear over contagion that investors were worried about since September last year after the IL&FS saga is unfolding possibly faster than anticipated. Dewan Housing Finance (DHFL) became the first victim of the liquidity crunch when it didn’t meet interest payment milestone and its credit rating was downgraded to default status. Given the Rs 1-trillion exposure of banks and mutual funds industry to DHFL, many believe another crisis is waiting to hit the sector. But for investors, the larger question is what’s ahead over the next couple of years.
The question is particularly relevant for those who joined the NBFC stocks party late (around early last year) when NBFC stocks were the preferred bets for a majority of fund managers and stock market experts. Data shows that nearly three-fourths of stocks trade well below their early 2018 levels (see table). In other words, they’ve been quick to shed the tag of multi-baggers and assume another of portfolio destroyers. It also means that the days of super-normal or alpha returns are well behind them. In fact, considering the regulatory changes that the sector is currently undergoing, it may take at least a year or two for the sector to regain investor faith.
The requirement to maintain tight liquidity buffer, backed by highly liquid assets and stringent asset liability management (ALM) practices, could perhaps dilute the operational advantages that NBFCs enjoyed over banks. While one may say that well-run NBFCs function in a manner not too different from the proposed changes, analysts at Kotak Institutional Equities point out that with these guidelines, NBFCs will need to stick to ALM and liquidity discipline at all times. “A relaxed guideline poses the risk of NBFCs taking aggressive interest rate and liquidity calls in periods of rising interest rates,” the report adds.
With these changes, analysts peg the additional cost burden to be around 50–80 basis points. This is over and above the 30–70 basis points increase in cost that most NBFCs have to stomach post the liquidity crisis. IDFC Securities says while the cost of funds situation is easing a bit, longer-term funds of over two years are not easily available. A default by a stressed NBFC or housing finance company (HFC) will again lead to a spike in the marginal cost of funds and liquidity issues.
Elevated costs may be a bigger pain point for NBFCs exposed to wholesale or builder loans and loan against property (LAP). As analysts at Morgan Stanley warn that stocks of wholesale-lending NBFCs could be affected. Names such as L&T Finance Holding, PNB Housing, Indiabulls Housing Finance have already corrected 12–18 per cent year-to-date.
The unfavourable cost structure is also forcing lenders to be prudent on loan sanctions and disbursements -- a factor which was evident across players (barring Bajaj Finance) in the March quarter. If the cautious approach continues for long, it could reset the growth trajectory for NBFCs in the next two-three years; another reason why investors should revisit their expectations. NBFC stocks super-normal gains can largely be attributed to their ability to grow faster than the sector. “As the cost of funds rises, NBFCs will cut back on growth in low-margin areas like loan against shares and home loans to maintain spreads,” says Macquarie Capital’s Suresh Ganapathy.
Meanwhile, asset quality hasn’t been an issue just yet. However, prolonged periods of slow growth may change this. Analysts expect this factor to play out by the first half of FY20.
With many uncertainties gripping the sector, brokerages such as Normura, CLSA, Credit Suisse, and Morgan Stanley prefer banks over NBFCs.
“We have been cautious on NBFCs and HFCs as we expect the stress in construction finance to increase and that will impact HFCs and wholesale NBFCs. We see value in rural auto financing NBFCs on a relative basis but continue to prefer corporate banks as our preferred picks,” say analysts at Nomura.
However, the shift in preference has resulted in quality names such as HDFC Bank, ICICI Bank, Axis Bank and State Bank of India witnessing an increase in valuation multiples, leaving little room for further valuation re-rating.
For investors, this means that the pool of viable options will continue to shrink.
Source: Exchange; Compiled by BS Research Bureau