Hold Tight: Here’s Why The NBFC Scare Isn’t Over Yet
Nervousness around India’s non-bank lenders has persisted for the past fortnight, despite attempts by authorities to calm the markets. The Reserve Bank of India has ensured that liquidity is comfortable at the system level, while State Bank of India has expressed an intention to increase loan portfolio purchases from the non-banking finance companies.
Yet, analysts believe that the sector should brace for tough times.
Rating agency Moody’s Investors Service believes that the liquidity tightness could lead to sharply higher financing costs or even difficulty in rolling over liabilities for NBFCs because they rely heavily on market borrowing to fund asset growth.
Our analysis of these companies’ liquidity management practices suggests that they can cope with liquidity stress within a multi-week period, after which this ability will weaken considerably. A prolonged period of liquidity stress, which is not our basecase scenario, will severely weaken the credit standing of Indian NBFCs.Moody’s Investors Service.
High Dependence On Market Borrowings
A key reason behind the nervousness surrounding NBFCs is the increased reliance on market borrowings (commercial papers and bonds), said Moody’s. Market borrowings, however, may be tough at a time when some categories of debt mutual funds have seen outflows.
Corporate treasuries and high net worth individuals, who are also large investors in NBFC debt securities, have turned nervous, said a senior banker. NBFCs should prepare to have lower dependency on the commercial paper and corporate bond markets for the rest of this year, said Hitendra Dave, head of global banking and markets at HSBC India.
Significant Short-Term Funding
Moody’s also pointed out that an additional point of stress is that a substantial amount of this market debt is short-term in nature and will need to be rolled over.
At the end of March 2018, nearly 38 percent of the debt incurred by NBFCs required refinancing over a 12-month period. “In addition, most of their short-term debt was owed to non-bank sources such as market borrowings, which we associate with a higher risk of not being rolled over compared with borrowings from banks,” the rating agency said.
Poor Liquidity Management Practices
While NBFCs may want to blame their troubles away on adverse market conditions, Moody’s in its report points out that some of the companies have followed poor liquidity management practices.
Moody’s analysis of these companies’ liquidity management practices suggests that they are capable of coping with liquidity distress within a one-month period, after which this ability will weaken considerably.
Indian NBFCs have little excess liquidity on their balance sheets and manage their liquidity almost solely through matching the maturities of their assets and liabilities, the rating agency said. In current market conditions, where refinancing and rollovers may not be easy, low liquidity levels will make it tougher for these firms to tide over the stress.
Debt Market Funding Uncertain
The factors highlighted above mean that a re-opening of the debt markets for NBFC funding is critical. While precise data on the extent of rollovers is not available, Credit Suisse believes that funding via the commercial paper market will remain tough.
Ashish Gupta, head of research at Credit Suisse, explained in a note this week that mutual funds may need to sell debt securities of NBFCs and housing finance companies in order to stay within their board approved limit for sectoral exposures. Due to outflows from liquid funds in September, many funds may have breached these limits. Unless inflows pick up in October or secondary market sales of these securities rise, mutual funds will have to allow the paper to roll off.
Credit Suisse estimates that for the mutual fund industry, NBFC+HFC investments could have gone up to 35 percent compared with the regulatory sectoral cap of 25 percent.
“A reduction in NBFC/HFC exposure by 10 percent of total debt fund assets, assuming no change to overall industry figure, a total Rs 13,680 crore of run-down in exposure—would require ~2 months, in our analysis,” Gupta wrote.
Who’s At Risk?
According to Credit Suisse, among its coverage universe, JM Financial, IIFL and Edelweiss have the highest dependence on mutual funds among their sources of funds.
Aditya Birla Capital and IIFL have a higher share of their borrowings from mutual funds (bonds/CPs) maturing in the next six months.
Credit Suisse said that while HDFC Ltd. has the highest maturities of MF debt coming up over the next six months, the same is spread more evenly than some others.
In the case of DHFL and IIFL, most maturities are coming up in the next 2-3 months. Bajaj Finance, too, has a skewed maturity profile towards near-term maturities, data from the brokerage house shows.