Three choices before wobbly NBFCs

On March 15, bad debt-laden private sector lender Lakshmi Vilas Bank raised Rs 459.59 crore equity. The money will raise its capital base, said a stock market notice which also scotched the speculations about three non-banking finance companies (NBFCs) — Indiabulls Housing Finance, Edelweiss Financial Services and Srei Infrastructure — exploring possibilities of a merger with the bank. Or, did it?

One of the three even planned to hold a board meeting to discuss the merger but didn’t go ahead. Apparently, the idea has not been dropped; it’s shelved for the time being. 

India’s large NBFCs have realised that the dream run of the last three years cannot last. If they want to grow, they need to reinvent themselves as niche players in high-margin businesses and create new markets where most banks fear to tread. The other choice is converting themselves into banks. 

The merger of Capital First with IDFC Bank is the beacon before them. Incidentally, all three that have reportedly looked into the southern bank had applied for a universal banking licence when India’s banking regulator opened the window in 2013 but none of them got it. 

Will the Reserve Bank of India (RBI) allow any one of them to be merged with a bank? Or, give its nod if they seek licence to become a bank? For the record, Indiabulls Housing had picked up a 39.8 per cent stake in OakNorth Bank in the UK in November 2015. It could not have been done with RBI’s approval! 

Meanwhile, the NBFC sector is still busy putting its house in order, selling portfolios and even group companies to generate liquidity and restraining from creation of new assets. Of course, there are a few exceptions, just a few yards away from the business-as-usual days but many, including a few big ones, are licking their wounds after the liquidity crisis, beginning end-August 2018. 

The compounded annual growth rate (CAGR) of NBFCs in the past five years has been 17 per cent versus 9.4 per cent growth of the banking system; the housing finance companies (HFCs) grew even faster, at 20 per cent. Clearly, it was a disaster waiting to happen.

Indeed, different ways are being explored to get back to health but the central theme of the industry is cutting down growth. When one grows too fast, the quality of assets becomes a casualty. One large NBFC has raised interest rates for its existing customers by a hefty margin — 3 per cent for home loans, 5 per cent for LAP or loans against property and, hold your breath, 8 per cent for developers! The idea is to drive the borrowers out to knock at others’ doors for money.

In some sense, the fate of the NBFCs, particularly those that have large exposures to the developers, is intertwined with India’s real estate sector. A February report of Liases Foras, a real estate research firm, says the developers’ sales in the past decade, between 2009 and 2018, have grown 1.28 times in units and 1.56 times in value but the inventory during the decade has grown 3.33 times in units and 4.72 times in value. The total debt of the industry has risen from Rs 1.2 trillion to Rs 4 trillion.

Analysing the business of the top 90 developers, including the listed ones, the study says they have a disposable income of Rs 57,000 crore to meet the annual debt repayment obligation of Rs 1.29 trillion. The industry is at an inflexion point and the developers are “an elephant in a well” which cannot come out on its own. It will not be a nasty surprise if a few of them drown and pull down some of the NBFCs deep into the well in the process.

The combined market share of NBFCs and HFCs in the Indian financial sector has grown from 13 per cent to 21 per cent since 2008 and the 10-year CAGR of some of the NBFCs has been as much as 35-40 per cent against a sensible 18 per cent of the Housing Development Finance Corp. It’s no secret that many of them financed this growth by taking short-term low-cost liabilities and rolling them over. Once the cost of borrowing rose, that window was nearly shut and the growth engine started grunting. 

What’s the future looks like for them? After selling portfolios and driving many borrowers out, the quality of asset is bound to suffer. This is not a good story as not all NBFCs have impeccable assets. Even if the RBI does not conduct an industry-wide asset quality review or AQR — which it had done for banks in 2015 — some of the NBFCs will definitely be under the regulator’s scanner. Simply put, they cannot get away without exposing there warts and providing for bad assets.

Under these circumstances, there are three options before the industry:

  • The most preferred path is becoming a bank — either merging with one (there are quite a few in south India) a la Capital First or applying for a fresh licence. The RBI has put universal banking licence on tap but there has not been any serious contender as yet. However, unless the regulator changes its approach to what defines a “fit and proper” candidate for a bank, it will be difficult for all of them. Many had applied for a licence in 2013 but did not get and quite a few are owned by corporations that cannot get a banking licence till the norms are changed.
  • Those that are primarily in the high-margin retail space will continue to do well for their better understanding of customer behaviour, technology, collection and cost structure compared with banks. They can continue to create new credit markets. But those that have been competing with banks on the home loan turf at a wafer-thin margin and giving LAP and wholesale loans to developers to compensate for that, need course correction.
  • Finally, using their wide network some of the large NBFCs can go big time for securitisation. They can originate loans and convert them into debt instruments and sell to banks. Securitisation is the practice of pooling various types of debt — home loans, commercial mortgages, auto loans etc — and selling their related cash flows to investors as securities in the form of bonds. The banks will be too happy to buy such securities if they are convinced about their quality.

In sum, life for most NBFCs will never be the same again. My guess is it will be lights, camera, action after general election.
The columnist, a consulting editor with Business Standard, is an author and senior adviser to Jana Small Finance Bank Ltd Twitter: @TamalBandyo




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