Banking license benefits priced in most NBFC scrips

Stocks of non-banking finance companies (NBFCs) such as L&T Finance, Shriram Transport Finance (STFC), Mahindra & Mahindra Financial Services (MMFS) and Bajaj Finserv among others have rallied significantly since the Banking Amendment Bill was passed in the winter session-outperforming the Sensex.

Post announcement of final guidelines on Friday, the stocks rallied by 2-10% in Monday's trading session. This investor enthusiasm is driven by the potential benefits that these NBFCs will derive after bagging a banking license such as lower cost of funds, diversified lending book, better regulatory environment, etc.

Interestingly, companies that won the banking license previously have given handsome returns post listing (see table). However, experts believe, this time around the new banking license aspirants will have quite a few hurdles along their way as the RBI's objective of financial inclusion is likely to impact their profitability. What's more is that the rally in stock prices also factors in most of the expected near-term gains.

"We believe companies such as L&T Finance have run ahead of their fundamentals as investors have already factored in the benefits of a banking license. We advise investors to tread with caution given that it will take a lot of time before the new banks will be able to leverage the benefits of a banking license," says Santosh Singh, Banking analyst at Espirito Santo Securities.

While most NBFCs have delivered consistent financial performance in the recent years and have a profitable business model, some of the requirements of the new banking licenses can dilute their profitability significantly.
"We understand that the requirement of 25% branches being in centres of sub-10,000 population could impact the economics of the business (of the aspirants) negatively versus existing banks", believes Ashish Gupta, research analyst at Credit Suisse.
 

Additionally, if the NBFCs will have to meet the priority sector lending requirements from the start, their profitability is again likely to be hurt, believe analysts. Similarly, providing for the statutory lending and cash reserve ratios will also have an impact on their return ratios in the near-term.

"We believe the re-rating potential underpinning the current rally in NBFCs may not be realised. The only way to play this theme is to buy the stocks of front-runners now and sell on the day of license announcement. It is important to identity these potential license holders correct. We believe well-capitalised, retail-focussed NBFCs with reputable promoters such as Aditya Birla Nuvo, Shriram Transport, MMFS, Cholamandalam will be the front-runners. However, we believe the economic returns of being a bank will only come 4-5 years after operations", says Saurabh Mukherjea, Head of equities at Ambit Capital.

Among the new bank aspirants, Singh of Espirito Santo Securities, says, "We believe MMFSL is the best placed company to achieve the government's intention of financial inclusion, and is our top pick to play this theme." He is neutral on Shriram Transport Finance.
Overall, analysts say the company’s ability to build a feasible business model will be the key driver for its stock's long-term re-rating.