Mutual Funds

How recent policies have impacted NBFCs

Mahesh Patil | Updated on February 23, 2020 Published on February 22, 2020

Easy liquidity, softening rates and improved balance sheets have also helped

Over the past month, while the Nifty Bank index has underperformed the Nifty 50 index, the Nifty Financial has outperformed the Bank index. Select non-banking finance companies (NBFCs) /non-lending financial stocks have moved up 10-20 per cent.

Various policy measures that have been announced by the Centre and the RBI, an easy liquidity scenario with softening rates and improved balance sheets are some of the reasons for NBFCs doing well.

RBI lends helping hand

In its latest policy meeting, the Reserve Bank of India retained the repo rate at 5.15 per cent and continued to maintain an accommodative stance which helps keep the cost of funds low.

Various non-rate measures were announced to aid rate transmission and credit growth, which should give some breathing space to both banks and NBFCs.

A key measure which was announced was the long-term repo operation (LTRO) of ₹ 1-lakh crore, wherein banks and NBFCs can borrow for one or three years from the RBI at a fixed rate of 5.15 per cent, which is the current repo rate.

This can encourage large banks to dial in the risk and hence can be useful for small banks and retail-oriented NBFCs, in terms of getting access to capital and improving cost of funds.

A case in point is the European Central Bank’s (ECB) LTRO of € 1 trillion in 2011 where the cost of funds fell below 1 per cent. This spurred European banks to increase lending activities that boosted economic activity as well as to invest in higher-yielding assets in order to generate a profit, and repair their balance sheet. It also led to lower sovereign debt yields in European countries.

Currently, the RBI maintains an overall liquidity surplus in the system of almost ₹3 trillion.

Consequently, liquidity conditions have remained easy and credit flow from banks to NBFCs has improved. Considering the easy liquidity conditions, as well as higher deposit growth vs credit growth, funding costs can be expected to be benign.

Cost of funds for most banks has already come down in Q3FY20, and NBFCs (especially the better- rated ones) have started witnessing softening rates. Traded yields in the secondary markets are also continuing to come off for NBFCs.

Centre’s friendly policies

In addition, the Centre had announced various measures for NBFCs, such as reduced risk weightages, increased allocation for PSU banks and backstop measure for toxic assets, which should help.

Inclusion of NBFCs under the Insolvency and Bankruptcy Code (IBC) and recent moves of the RBI superseding the board of a housing finance company to accelerate resolution are positives.

We may see faster resolutions to troubled NBFC cases, which should help clean up the system and release capital.

Over the past one-and-a-half years, NBFCs have undergone a funding crisis. Only a handful of top-tier NBFCs continued to get funding. While tier II NBFCs faced a liquidity challenge and their cost of borrowing also shot up, tier III NBFCs with asset-quality issues and exposure to the troubled real-estate sector had no access to funding.

However, the funding crisis seems to be behind us, and tail risks on system stability seem unlikely. With easy liquidity, the risk appetite of banks has increased, and mutual funds have also started selectively evaluating lending to tier II NBFCs. This has led to improved access to funding for tier II NBFCs and their cost of funds coming down by more than 100 bps over the past few months.

Several NBFCs, where concerns on solvency had loomed over the past year, have improved their funding profile and accessed funding away from bond markets.

Many have additionally raised equity or reduced on-book wholesale assets, thus improving equity capitalisation and loss-absorbing buffers.

Almost no major bank/NBFC has highlighted any worsening in asset quality in Q3FY20 despite the growth in the sector not being at its strongest. Even early delinquency buckets have not shown any material worsening.

Going forward, the only area of concern is regarding NBFCs with an exposure to real estate.

The moratorium for loans to the real-estate sector is getting over in the next six months.

And unless there is a recovery in the sector, we could see some defaults, and a few of the NBFCs could see some stress.

Credit is the lifeblood of an economy and NBFCs play a key role as the last-mile lenders, which banks alone are not able to fulfil. Overall, the coordinated effort from the Centre and the RBI, as well as the efforts of the NBFCs to bolster their balance sheets, are helping get the NBFC sector back on track.

In terms of credit growth, while the overall system loan growth declined to 7 per cent y-o-y, reflecting the weaker growth momentum, unsecured loan growth continues to remain robust. Consumer spending, overall, has been holding up far more strongly than expectations, despite poor macro.

Retail-centric

Going forward, NBFCs, which have more retail-centric lending, and catering to under-penetrated segments and not catered to by banks, should continue to do well.

These can manage their spreads much better, and lower cost of funds should aid their bottom-line.

Also, those which have got a strong liability franchise, owing to strong parentage, should continue doing well.

The NBFC sector underwent a de-rating in the past year.

However, some of the better-quality NBFCs which withstood the tight liquidity environment and kept their books intact should continue to grow again.

They offer good opportunities for investors, as their valuations look attractive, given their growth, margins and ROEs.

They could offer good upside to long-term investors as the uncertainty around the sector reduces.

The writer is Co-CIO, Aditya Birla Sun Life AMC

Published on February 22, 2020
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