No more high returns from low rated NBFCs

Unless NBFCs get investment grade they cannot raise fresh deposits. Existing deposits cannot be renewed if rating falls

Investors looking for higher returns from non-banking finance companies (NBFCs) might not be able to do so anymore. The Reserve Bank of India (RBI) has said NBFCs, asset finance companies and investment companies that do not get a minimum investment grade will not be allowed to raise fresh deposits. RBI has given them time till March 31, 2014, to get rated. In the interim, they can only renew existing deposits.

Similarly, if the rating of an NBFC falls below investment grade, it has to immediately stop raising fresh deposits or renew existing ones. Existing deposits can be allowed to run off till maturity, said RBI.

According to RBI guidelines, usually, NBFCs that don't have high rating raise money from public by offering higher rates of interest. The RBI’s step is advantageous to investors, as they would otherwise have been exposed to higher credit risk, says Vibha Batra, senior vice-president and co-head of financial sector for ratings, ICRA.

“In terms of risk, it is a positive move. Many small NBFCs raise money from people known to them. But these investors are putting themselves at a risk by investing in such unrated or poorly rated NBFCs,” she says.

“Retail investors who invest in company deposits offered by NBFCs are often not well-informed. They are lured by the high interest rates and commissions offered by brokers or agents, says Kishore Gandhi, managing director, India Ratings. “Retail investors have very limited capability to measure and price the risk. Hence, the practice of NBFCs and manufacturing companies offering high returns should be discouraged. Ideally, the rating cut-off should be significantly higher, say ‘AA’ and above,” he adds.

For retail investors, Gandhi recommends investing in bank fixed deposits and leaving the investment in NBFCs to banks and institutions, as they can manage risks while earning commensurate margins. For retail investors, the premium offered by such investments is often not commensurate with the high risk.

In fact, if a manufacturing company is heavily dependent on public deposits for funds, it could be a cause for concern. This may mean that it is facing a shortage of other sources of funds, such as bank loans, due to poor rating. This could be an indication that the financials of the company are under pressure,” Gandhi adds.

Usually most NBFCs that are below investment-grade raise money only from a closed group of investors. But if such an NBFC is listed and if you hold its shares, then you should be wary, says Feroze Azeez, director, Investment Products, Anand Rathi Private Wealth. “Most investors buy stocks based on profitability and not on rating. But if the rating falls then the NBFC may not be able to raise money. This can impact their performance and in turn the stock price,” he says.

But if you do hold deposits or debentures of such NBFCs and if it unsecured debt, you have very little option but to hold till maturity. If it is senior debt and listed on the exchange, then you can try to find buyers in the secondary market.