Their View. Value buys emerge amid market corrections

The equity market witnessed a perfect storm in the past month. In addition to global macro factors, we saw disruption due to a re-pricing of risk in the credit market, and consequently in the equity markets.

Non-banking financial companies (NBFCs), including housing finance companies (HFCs), play a key role in funding the credit requirements of the Indian economy.

They accounted for 30-40 per cent of the incremental lending of ₹60 lakh crore over the past three years.

Recent developments, including a large financial institution defaulting on some of its debt obligations, have led to a crisis of confidence, resulting in tightening of liquidity and higher cost of funds for NBFCs.

Banks, debt fund managers and corporate treasuries have all become very selective of which NBFCs they want to finance. Corporate bond yields have increased and NBFCs have also seen a widening of credit spreads. Two-month commercial paper rates have increased by 100 bps over the past month.

Tighter liquidity implies potential paucity of funding for lower-rated NBFCs. Total credit growth is likely to moderate over the next few quarters till NBFCs recalibrate their business models. In turn, lower credit growth will impact the consumer discretionary sector ahead of the busy festival season.

Hence, policy-makers have responded with quick measures to ease liquidity, such as back-to-back open-market operations (OMOs) by the RBI totalling ₹20,000 crore in September and ₹36,000-crore worth OMOs announced for October. The RBI modifying the liquidity coverage ratio (LCR) calculations for banks, and the Centre reducing the borrowing programme by ₹70,000 crore have also helped. SBI has also announced that it will buy assets worth ₹45,000 crore from NBFCs.

Both the RBI and the government have indicated that adequate liquidity will be provided to NBFCs even as the RBI has cautioned that their current business model — wherein they fund long-term assets with short-term liabilities — is not sustainable.

What lies ahead

NBFCs will face short-term liquidity constraints and there will be some consolidation in the space as access to funding becomes difficult. However, most NBFCs will be able to tide over this environment. In addition, banks will take up some of the slack from NBFCs.

Once the liquidity flow streamlines again over the next few quarters, the situation will come back to normalcy. The festival season will be a good test of consumer sentiment and availability of financing.

A higher cost of capital will shrink NBFCs’ margins in the short term. Lower earnings-growth projections have already led to a decline in their valuation multiples. HFCs will face additional pressure as they have lower margins, and, hence, will face increased competition from banks. Consequently, even top NBFC stocks have corrected by 25-50 per cent over the past month. Stocks of banks and AMCs have also taken a hit, factoring in the risk of their exposure to NBFCs.

However, it will not be fair to paint all companies in the banking and financial sector with the same brush. Good-quality, large NBFCs with well-matched asset-liability management, a strong brand, and an ability to raise external commercial borrowings and public deposits can weather these transient storms.

Rural-oriented NBFCs have higher margins, and will come out ahead; as will NBFCs focussing on small-ticket items, and micro-finance companies. Some better-capitalised private banks that have good CASA and are geared towards retail on the asset side, will be able to capture market share from NBFCs.

Attractive valuations

Some of the NBFCs and banks that have seen sharp corrections offer good opportunities for investors as they have come down to a level where their valuations look attractive, given their growth, margins and return on equity. They could offer a good upside to long-term investors once the dust settles down.

The equity market has seen significant volatility and the Nifty 50 index has fallen around 12 per cent from its peak. While the market will likely bottom out, there is a risk that it may overshoot on the downside due to the domestic developments and ongoing global macro concerns.

Even though NBFCs and wholesale-oriented banks will have near-term pain in earnings, broader earnings growth for the market remains supportive. In addition, valuations are now at their long-term average, providing a cushion to overall markets.

Fear in the market has led to distressed prices, and good value is emerging in individual stocks. We saw a similar liquidity crisis in 2013 when interest rates shot up and bond yields nudged10 per cent. The valuations of banks and NBFCs saw significant corrections. Investors who stuck with the equity markets at that time saw good returns.

The recent correction provides a similar opportunity, and investors should continue to build equity exposure for the long term. Investors will be better off taking the SIP/STP (systematic investment/transfer plan) route for the next 6-9 months, rather than making lump-sum investments.

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

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