NBFCs gorge on bonds

Indian non-banking finance companies (NBFCs) are borrowing record amounts from the rupee bond market as they take advantage of cheap funding to grab market share from public-sector banks.

NBFCs are on course to issue more than Rs 3 lakh crore ($36 billion) of bonds in calendar year 2017 after borrowing a record Rs 2.4 lakh crore from the debt market in 2016, according to Pranav Haldea, managing director at Prime Database.

Bajaj Finance, Mahindra Finance, Shriram Transport Finance, L&T Finance, Citicorp Finance and Aditya Birla Finance have all sold rupee bonds in the past eight months, driving total issuance from the NBFC sector this year to Rs 1.9 lakh crore, based on Prime's numbers.

Improved access to bond market funding is helping non-bank lenders win market share from cash-strapped state-owned banks, which are reining in corporate lending to conserve capital as they deal with mountains of bad loans. Credit growth in the NBFC sector hit 17 per cent in fiscal 2017, versus just 4.4 per cent for banks.

Parag Sharma, chief financial officer at Shriram Transport Finance, sees the bond market as an opportunity to lower funding costs. The commercial-vehicle financier has raised Rs 7,750 crore from the bond market so far in 2017 and is targeting 12 to 15 per cent growth this year.

Even after a lending rate cut on August 2, the marginal cost-of-funds-based lending rate (MCLR) for banks is still higher than bond yields, according to Sharma. “The banks MCLR continues to be 8.25 per cent-plus monthly, whereas bond rates are well below 7.75 per cent annualised, he said. Also, there continues to be enough liquidity for easy placements of bonds.

There is ample demand for paper issued by high-rated NBFCs as mutual funds look to deploy more cash into fixed-rate assets. The yield on the five-year government benchmark has fallen more than 50 basis points (bps) in the past four months. “The bond markets transmit the interest-rate cuts at a much quicker rate to the borrowers than the banks,” said Pawan Agrawal, chief analytical officer at Crisil Ratings. Funding costs for NBFCs have declined 80-100bps in the past year as yields have softened.

Earlier, only the biggest NBFCs, such as Power Finance Corp and Rural Electrification Corp, were tapping the bond market, but smaller NBFCs were now raising large amounts from bonds to diversify their funding profiles and reduce interest costs, said Karthik Srinivasan, senior vice president at rating agency Icra.

However, a few analysts are highlighting concentration risks to investors in an event of downgrade or a major correction in the bond market.

The debt market today is skewed with a significant part of issuance coming from the financial sector, including NBFCs now,” said Jiju Vidyadharan, senior director of funds and fixed income business at rating agency Crisil Research.

From the perspective of investors, such as mutual funds and insurance companies, it is, therefore, imperative for fund managers to deploy deeper risk practices in order to review their exposures.

Moreover, “there is a concern regarding NBFCs' credit profiles potentially deteriorating given the degree of lending to the informal sector and small and medium enterprises (SMEs). These sectors are likely to be most adversely affected by the crackdown on black money and by the implementation of the goods and services tax,” said Ritika Mankar Mukherjee, vice president and research analyst at Ambit Capital.

“If the borrower is under economic stress, then NBFCs will come under stress and this is a risk to watch out for.”

Stricter provisioning requirements are due to take effect from March 2018, after the Reserve Bank of India (RBI) in November 2014 said it would require all lenders to make provisions once debts are 90 days overdue, down from the previous threshold of 180 days.

Some NBFCs, mainly microfinance institutions exposed to the informal economy, have faced downgrade pressures in the past few months.

Last month, Icra revised its outlook on bonds from Janalakshmi Financial Services to A (negative) from A (stable), citing asset quality pain due to weakness in collection efficiency.

However, not all investors agree that a greater allocation to NBFC bonds is an immediate cause for concern.

“There are sectoral caps that mutual funds have to adhere to,” said Suyash Choudhary, head of fixed income at IDFC Mutual Fund. “However, there could be some outliers based on their business model and rapid growth rate which could pose a risk.”

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