Bloomberg.com
(N)ow (B)etter & (F)itter (C)ompanies

I haven’t participated in the ‘financial’ roller coaster at all; initially because of my ignorance and later because anyone and everyone was owning some or the other financial stock and were wanting to add more to their holdings. And all of them (well, mostly) were making money. Every other private bank was termed to be the next HDFC Bank in the making and every other NBFC was touted to be the next Bajaj Finance (or any other fancied stock) in the making! Other than having missed the rally early on, this one reason (over confidence) was sufficient enough to dissuading me from initiating any fresh positions in the sector. The ‘financials’ theme played perfectly well, till IL&FS happened. And then, all of a sudden, the entire space kind of collapsed. Even before investors could comprehend and digest the situation, stock prices across the board corrected sharply.

The last 12 months (post IL&FS) have probably been the toughest times (over the last decade) that players in the financial space in India may have witnessed. A strained economy warranting increased regulatory supervision, asset quality issues suddenly propping up (including borrowers who may not necessarily be wilful defaulters) and tightening liquidity situation et al continue to haunt industry players. The tight liquidity situation and the asset liability mismatch that some NBFCs ran, may possibly exert pressure on their short-term repayment abilities, thereby keeping investors on the tenterhooks.

That said, it is this difficult operating environment which has actually helped separate the wheat from the chaff and bring sanity in valuations in the sector, aiding increased clarity for investors.

Developments over the last 12 months and how the players in the space have responded to it, segregates them into 3 clear buckets:

  • Bucket 1 – There are some who followed stringent lending practices in the bull run, effectively helping them keep their books clean even in the tough times, reflecting in a superior stock price performance during this period. Bajaj Finance, HDFC etc and their likes can be classified in this bucket.
  • Bucket 2 – Then there are some who are believed to have lent diligently in the good times, but head winds in some of the sectors they might have taken exposure to pose a threat to their asset quality performance thereby resulting in disinterest / a muted stock performance during this period. Cholamandalam, Aditya Birla Capital, Repco Home and their likes can be classified in this bucket.
  • Bucket 3 – And then there are those who spooked the investing fraternity with a sudden surge in bad assets, as a result of having resorted to aggressive lending practices (to spruce up their loan books) and compromising on diligence during the bull run, denting investor faith and sending their stock prices spiralling down over the last couple of months. One may want to classify stocks like Dewan Housing, IndiaBulls Housing Finance, Reliance Home Finance and their likes in this bucket.

In the current environment (flight to safety), players in bucket 1 could continue attracting investors, probably stretching their valuations further. As economic conditions slowly start improving and risk aversion starts declining, investors will start shifting allocations and hunt for value in pockets, hitherto ignored. Players from the 2nd bucket, especially those who have managed to hold their fort (good assets, proven ability to have raised capital, demonstrated some growth in their loan book etc) in the slowdown, will start attracting attention, helping them get re-rated.

The 3rd bucket will have a mixed bunch of stocks –

  • A few, who were feared to collapse, but whose corporate governance issues never actually made it to the surface. These stocks ‘could’ get attention in the last leg of a bull run as the FOMO effect, on retail investors, may make them go down the quality curve in search of quick/high returns.
  • Most of them, with proven corporate governance issues and scams, will die a natural death and/or will be totally forgotten

In my opinion, it’s now time to take a look at the 2nd bucket.

With the economy showing some green shoots, it’s a matter of time before the situation actually starts improving. And those who have managed to stay afloat during the slowdown, will only do significantly better during the recovery and then the bull phase.

NBFC

NBFC2

Broking

Ins

Micro

Take a look at the yearly stock price movements, across financials. A closer look at the table reveal stress, mostly with Housing Finance companies, NBFCs and Stock Broking companies. The AMC, Micro finance, Gold financing and Insurance pack seem to be doing much better in that sense. The stock performance, broadly, reflect what the investment fraternity seem to think about (a) these individual sub-sectors and (b) the individual companies within these sub-sectors. With all this performance in mind, I’m incrementally getting inclined to take a look at the NBFC space and identify potential gainers over the next 1-3 years.

My core belief: NBFCs are here to stay

  • NBFCs complement the mainstream banking system in the process of financial inclusion and intermediation
  • NBFCs play an important role because of their ability to (a) reach out to inaccessible areas; and (b) act as not just complements but also substitutes to banks when the banks are confronted with stricter regulatory constraints
  • NBFCs are quick in their decision-making ability, prompt provision of services and expertise in niche segments

and the last, but not the least

  • Being promoter-led companies (accountability), NBFCs generally tend to have better asset recovery intent and abilities in place

On account of the on-going liquidity crisis, the share of non-banking financial companies in loans extended to the commercial sector dropped to ~27% from ~40% a year earlier. Despite a drop in the market share of the credit flow in the system, the RBI acknowledges NBFCs to be an important part of the financial sector.

Interestingly, as per recent media (Business Standard) reports, Private equity (PE) and venture capital (VC) firms have invested around $2.01 billion in NBFCs in 2019 compared to $1.42 billion a year ago, up by 42 per cent. This has been done across 33 deals. As also, after contracting for several months, banks’ credit growth was also reported to have picked up at the onset of the festive season, spurred by loans to retail sectors like housing and non-banking financial sector. According to latest data released by the Reserve Bank of India (RBI) on deployment of bank credit by major sectors, banks had extended ₹33,150 crore to the NBFC sector between August 30 and September 27, marking a double-digit YoY growth. With the central banker proactively tightening regulations to control any incremental shocks, it is learnt that more than 1850 NBFCs have had their registrations cancelled! The number of NBFCs have apparently dropped down to the lowest in 10 years, decongesting the space and leaving the market open for the better managed NBFCs to capitalise.

To summarise:

Unravelling of shocks and subsequent tightening of regulatory controls have corrected valuations and, more importantly, tamed investor expectations in the space

Space is getting decongested, with the number of players shrinking

Green shoots (credit pick up and credit raising options) are visible

Well managed players should be able to capitalise on future opportunities and show renewed growth, thereby meriting investor attention.

  I would love to hear your thoughts on the same.

Cheers!!!

Sudhir

Image credit: Bloomberg.com

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