As competition in NBFC space rises, asset quality bound to take a hit

With PSU Banks reeling under crisis, the NBFCs had a field day in the last 3-4 years

Last week we witnessed the contagion effect of the tightness in money market amid continuing financial crisis at IL&FS. This led to stock prices of most Housing Finance and NBFCs witnessing heavy selling losing 10-60 per cent range of Rs 2-3 bn) in the secondary market at a higher yield due to tight liquidity in the system. Other housing finance companies and NBFCs too witnessed sell-off, as borrowing cost for NBFCs is expected to rise and they could face challenges in raising funds. Commercial papers is a major source of funding for NBFCs and HFCs. According to Moodys’, NBFCs rely on debt capital markets as a major funding source and are vulnerable to a tightening in overall market liquidity. Given that around 5 per cent of banking system loans are made to finance companies, a deterioration in the credit profiles of finance companies will have a negative impact on banks as well.

DHFL management tried to soothe investors’ nerves by saying that they have not defaulted on any bonds and it holds a strong liquidity of Rs Rs 100 bn in the system, which equates to six months of cash. As per management, its ratings on any of its debt instruments or fixed deposits are neither under watch and there is no downgrade in the existing credit rating.

In a euphoric market, management quality and corporate governance always takes a back seat as eager investors tend to concentrate more on stories, reported figures and future prospects based on the former two. With PSU Banks reeling under crisis, the NBFCs had field day in the last 3-4 years. It has been an attractive sector helping a number of existing as well as new players gain prominence. With increasing competition, they had to “innovate” to remain relevant for investors.

And about the credit rating agencies, the lesser said the better…. They downgrade after the “horse is bolted”.

I have been circumspect especially of the Housing Finance Companies which were part of the chain providing interest subvention schemes. Especially in a scenario where most of the real estate firms are finding it difficult to sell but HFCs are doing booming business. Such a scheme is a boon when all the three parties viz. the developer, the home buyer and the HFC plays by the rule book. However, the problems arise when any two or all three of them try to hoodwink the system. Similarly, with competition increasing in the NBFC space, the asset quality was bound to take a hit going ahead which, the markets had not discounted till last week.

A typical dilemma a fund manager faces in such expensive out-performing stocks is:

1. Exit poses a risk of the portfolio under-performing 

2. Ability to buy alternate investments which will outperform in the short to medium term. However, when the tide turns, everyone heads for the exit door resulting in a pandemonium.

The happenings in the last few days again bring to fore that there is no alternative to holding quality management stocks for a stable portfolio.

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Ambareesh Baliga is an independent market expert