Non-Banking Finance Corporations (NBFCs) have played a pivotal role when it comes to nation building. The sector has provided the much-needed fillip to the infrastructure, employment generation, and wealth creation.

The industry has provided access to financial services for the rural and weaker sections of the society. The success of the sector has had far-reaching implications on the inclusive development of the economy including capital formation and eventually the growth in GDP.

Off late, the shares of non­banking financial companies (NBFCs) have been under pressure since the second quarter of fiscal 2019. The pressure has been built owing to tightening liquidity, asset-liability mismatch, and reduction in lending by the banks.

Are you scared because you own a few NBFCs in your portfolio? Or, are you looking to invest in NBFCs which are trading at an attractive valuation?

I believe the NBFCs have the right liquidity position with decent balance sheets and Asset Liability position.

Also, NBFCs have an adequate capital position, diversified borrowing and predominantly retail asset books. Thus, the volatility, which may continue owing to macro factors, could result in further correction. Therefore, any downward price revision in some of the scrips could provide a golden opportunity to buy.

Let us look at the NBFC sector, its future and some of the names that an investor could evaluate this season.

Background

NBFC sector has undergone a transition over the past decade and has become big enough to place itself in GDP heatmap of the economy. The industry has played a critical role in the development of infrastructure, transportation, employment generation, and wealth creation while making financial services accessible to people in remote locations.
Thus, the sector continues to remain at the forefront in driving new credit disbursals for the underserved retail and SME market.

What has happened?

Recently, since September 2018, the industry has taken a beating in the capital market with defaults and liquidity challenges. It all began with one large NBFC that reported a default on its debt obligation.
Although the problem looks isolated, it has concerned regulators due to the risk of the contagion effect. The overall governance system in the industry was questioned and as much as 60 names in the space corrected up to 50 percent since September 2018. This correction includes some of the notable names such as Dewan Housing Finance Corporation Ltd, Reliance Capital Ltd, Bajaj Finance, etc.

What is the impact?

Given the industry is of importance to the overall economy, the slowdown entails some potential implications, including new compliance measures, a slowdown in lending, and consolidation.

The business model is also under pressure owing to the internal and external forces including fierce competition from incumbents and entry of fintech players. The dynamic regulatory system has resulted in the rising cost of compliance thereby restricting the ability to impose pricing freely.

What to expect?

Despite concerns surrounding the sector, I think that companies with a robust business model, strong liquidity, strong governance, and sound risk management standards are well positioned to take advantage of the opportunity.
I believe robust operating models catering to the retail segment ensure strong liquidity. Stress, if any, remains only to near-term net interest margin (NIM). Thus, I don’t see any liquidity risk to any of the NBFCs. However, the risk-averse stand of debt market is likely to increase the funding cost in the near-term.

Future of NBFCs

I believe a roadmap for consistent growth and evolution should include the following action points –

  1. Segment strategy with a defined target customer segment, product proposition, distribution channels and geographical locations for operations.
  2. Customized solutions with 24×7 sales and service interaction
  3. Well-designed engagement programs for customer attraction and retention
  4. Leverage technology to transform underwriting and decision making to improve risk management
  5. Collections to adopt a customer-focused, data-driven, relationship-based approach
  6. Efficient risk detection, control, and mitigation

I believe the NBFC sector is in a healthy space. The industry is likely to continue to be relevant for the economy in years to come. And, this is why I see so much attention from the government and regulators.

In India, I believe, there is a considerable credit shortfall, particularly in the SME space. This is where the NBFCs are likely to play a pivotal role over the next decade. Having said so, the NBFCs, I believe, will have to upgrade their model, to suit the needs of the SME segment, while keeping the basics intact. Also, the new and smaller NBFCs today should upgrade faster as in the next two years will be a whole lot of consolidation.

Some best NBFCs to invest?

The price revision on the back of liquidity concerns in the debt market has promoted the analyst community to review some of the strong NBFCs.

HDFC Ltd.

HDFC stock

HDFC is a known borrower in the bond market accounting for a sizeable share in both the Non-convertible Debentures and Commercial Papers. The investor comfort on HDFC is likely to ensure liquidity remains comfortable for the company.
In addition to the bond market, the company has a dynamic deposit mobilization program. The program can help in generating fund if the debt market dries up as seen in fiscal 2018.

The company’s loan growth of 17% YoY in individual loan book remained decent, but the non-individual side slowed down for the quarter. Slight moderation in spreads both on individual and non-individual book proved to be a dampener, but the Net Interest Margins remained healthy at 3.5% up. With a superior track record and resilient balance sheet, I continue to stay bullish on the company.

Mahindra and Mahindra Financial Services Ltd.

Mahindra and Mahindra Financial stock

The company is a subsidiary of Indian conglomerate Mahindra & Mahindra. Over the last decade, the company has transformed itself from a captive lender to the largest semi-urban and rural-focused diversified
NBFC.

I believe the business environment for the company is getting better, with multiple tailwinds in each product class and market share gains. The asset quality has improved consistently over the past few quarters. With the changing product mix, improving the efficiency of branches and declining credit cost, I believe there could be an expansion in return on equity.

LIC Housing Finance Ltd

LIC Housing Finance stock

Promoted by the government-owned largest insurance company, LIC Housing Finance is the second largest
housing finance company with a 10% mortgage market share in India.

Over the past 2-3 years, the company has grown at ~15% CAGR, primarily driven by its non-core loans. The company has experienced an elevated repayment rate due to heightened competition. Now that liquidity is less abundant, I believe the company is better placed given its parentage and AAA credit rating. Thus, with the expectation of competitive intensity to subside, I feel the company could witness better growth.

Bajaj Finance Ltd

Bajaj Finance stock

Bajaj Finance Ltd is a subsidiary of Bajaj Finserv. The company deals in Consumer Finance, SME (Small and Medium-sized Enterprises) and Commercial Lending, and Wealth Management.

A strong performance, despite volatile economic scenario, with healthy return ratios – Return on Asset >3.5%, Return on Equity ~20%, and Gross Non-Performing Asset of less than 2% lead to investor interest even at higher P/ABV multiple with strong growth momentum.

With the company’s improving cost to income ratio, adequate liquidity & limited exposure to IL&FS depict management strength. Thus, I continue to maintain conviction in the company for the long-term horizon.

Shriram City Union Finance

Shriram City Union Finance stock

The company is a deposit-taking NBFC focusing on retail lending. The company remains a niche financier in MSME and the two-wheeler segment. The company is working on workforce rationalization which is likely to provide operating leverage. Also, the new SME underwriting model is expected to result in better asset quality which could lead to improving return on equity. Thus, I maintain a positive view of the stock.

L&T Finance Holdings Ltd

L&T Finance Holdings stock

LTFH is a financial holding company offering a diverse range of financial products and services across retail, corporate, housing and infrastructure finance sectors.

The company has delivered a commendable performance across parameters in Q3FY19 and is now on its journey of ‘retailization’ of the balance sheet.

I am confident that the company would continue to generate strong return ratios over the medium term and project Return on Equity of 19-20%.

While there could be some near-term hang owing to the company’s exposure to IL&FS and Supertech, I believe it is an attractive buy for the long-term horizon.

Disclaimer: The views expressed here are of the author and do not reflect those of Groww. 

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