Riding The Time Machine

Turn on the ignition, set the period back one year, and kick start the Time Machine. HG Wells had imagined an invasion of aliens, but he could never think that the onslaught of an earthly marauder would one day drive everything down into a darkness. A year later, when life and livelihood both are beginning to show green shoots of revival, economies have begun breathing again. The road to revival unfolds some speed-breakers as well as some fast lanes for every sector of the economy.

For lenders – both big and small – it has thrown up a challenge to bear the pain of the wound inflicted by the Corona virus and heal it to move on. Non-banking lenders, or the NBFCs, are in for a bumpier ride with a lot of blood set to spill out of default wounds. The sector has been facing repeated setbacks for the last several years but stayed resilient.

The Covid-19 pandemic and the disruption it triggered worsened the asset quality challenges the non-banking financial companies had been facing since the outbreak of the 2019 IL&FS scam and the subsequent liquidity crunch. Piling up of bad debt also partially choked the supply of funds from banks through the last two years, while a sustained slowdown in economy worsened the situation further. Delinquencies have begun increasing across most retail asset classes of the sector, particularly commercial vehicles, small and medium enterprises and unsecured loans. Delinquencies over 90 days past the due date have more than doubled for most of the rated NBFCs in these asset classes for the nine months between April and December 2020.

“While the recoveries may pick up at the year-end in March, we expect the 90 dpd for the CV and SME loans to exceed 6% as on March 2021,” says Suman Chowdhury, Chief Analytical Officer at Acuite Ratings and Research.

This will further impact the profitability of NBFCs due to a rise in provisions and write-downs which have been hit by modest loan disbursements in the current year.

Asset quality downgrade is not the only scare for the sector. Experts foresee an inherent churn due to cost of funds, asset monitoring and innovations or its lack thereof. The defaults in the NBFC sector could increase in the next few years leading to a spurt in non-performing assets (NPA). S Ravi, Former Chairman of the Bombay Stock Exchange Limited and Founder and Managing Partner of Ravi Rajan & Co, pegs the bad debt for NBFCs at 3% to 4% for the next few years. As Time Machine takes us through a maze of attacks by the invaders, human intelligence proves its resilience and realises the need to change. “We should strive to welcome change and challenges, because they are what help us grow… We need to constantly be challenging ourselves in order to strengthen our character and increase our intelligence,” Wells wrote.

The NBFCs largely cater to the base of the pyramid – the section which has been hit hardest by the pandemic – and that made them seem most vulnerable to the crisis. Flash forward one year and today they have proved their resilience despite the looming threats. “Look at fintech (financial technology) firms. They have played a vital role in servicing retail clients and driving India into the new normal,” says Ravi.

The NBFCs raised around $3.9 billion in the middle of the Covid-induced crisis. “While larger NBFCs had easy access to capital, the mid-size companies relied on stake sale and public offering of NCDs to raise funds,” says Vikrant Narang, Deputy CEO at Ambit Finvest.

Analysts point out that the Covid-19 crisis has brought about a change in the way the NBFCs do the business. They have raised the ratio of old clients to new clients to be in the black. “Old clients’ behaviour is more predictable and there is a sharp focus on cross-selling and up-selling to these clients using advanced analytics,” says Piyush Nagda, Head of Investment Products at Prabudas Lilladher.

The NBFCs depend primarily on bank funding to the extent of 30% to 40% of their balance sheet size. They may now face some headwinds in raising funds. Those with good governance mechanism in place will be able to tide over this crisis, experts believe. Banks are going to be conservative in their lending and this would be a challenge for NBFCs that have not performed. The cost of funds would finally depend on the rating of the NBFC. “Lending banks and the investors continue to have concerns on the asset quality of the sector particularly due to the disruptive impact of the pandemic on small businesses and self-employed borrowers. This may constrain funding to the sector in the absence of any regulatory support as was provided earlier. “Nevertheless, well-governed NBFCs with a strong track record and ability to raise capital are unlikely to face any challenges,” says Chowdhury.  

The government and the Reserve Bank of India have helped the sector regain stability and overcome the current crisis. “NBFCs, which have been able to ramp up their collection efficiencies in a sustained manner and have reduced leverage and improved capital adequacy, have witnessed significant reduction in cost of funds,” Narang says. A steady pickup in economic activities has also allayed the risk perception, which has translated into a reduction in the cost of funds. “There are really four dimensions, three of which we call the three planes of Space, and a fourth, Time.” It’s the fourth dimension that the non-bank lenders are harping on to revive and resurge.

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Will You Park Your Money Here?

NBFCs listed on the equity markets are worth investor attention. But, analysts stress that a sustainable business model is the key and the investor needs to look at the individual stock carefully. “Individual investors should definitely look at NBFC stocks as a part of their investment portfolio,” says Abhijit Tibrewal, Senior Research Analyst at Reliance Securities.

The caveat here is to invest in strong NBFC franchises which have a robust risk management framework and demonstrated the resilience of their asset quality across credit cycles. “Investors should evaluate each NBFC stock on individual merit rather than taking a sector-wide approach,” says Tanushree Banerjee, Co-Head of Research at Equitymaster. NBFCs tend to have niche business models with each being different from the other in terms of risk exposure and credit policy.

While almost all NBFCs were severely impacted during the lockdown, quite a few have emerged unscathed in terms of credit quality. While Tibrewal does not expect NBFC stocks to outperform the broader indices, he does recommend quality NBFC stocks for investors, including Bajaj Finance, HDFC Ltd, Cholamandalam and CanFin Homes. “We like Muthoot Finance, but in our view, gold financiers are longer-term bets despite near-term underperformance,” he says. “While I would not want to take a short-term call, it is a given that select NBFCs using technology and conservative credit policies, could go on to be major players in India’s financial landscape over the next 5 to 10 years,” says Banerjee.

The writer is a financial journalist