Credit Suisse India on Tuesday said overall liquidity situation at non-banking financial companies (NBFCs) is still fairly manageable.
Talking to CNBC-TV18, Ashish Gupta, managing director, investment banking & India head of research, said, "The good thing in India is the size of NBFCs as a proportion of the overall financial system is still not very large, they still account for less than 20 percent of total credit in the system."
According to Gupta, "We think that at least on the corporate asset quality side, we have made very good progress in terms of recognition as more than 80-85 percent of corporate asset quality stress is recognised."
Edited excerpts: Q: What is the sense about non-banking financial companies (NBFCs)? We went to 5-7 times book and one or two guys are still at 7 times book, is there a big fall still waiting to happen?
A: What the market is recalibrating to is the fact that they were perhaps too optimistic on how large the entirely wholesale funded model could grow to. We have had for now, nearly three years of scenario, where the non-banking financial companies (NBFCs) sector as a whole was growing much faster than the overall financial system. I think that is not perhaps sustainable.
I think, what this will do is let market participants recalibrate their expectations of growth and size, what individual NBFCs can reach as well as the entire NBFC system can reach, which is not a bad thing. I think the assessment and recalibrations are much needed from time-to-time.
Having said that, I believe that the overall liquidity situation at NBFCs is still fairly manageable. The good thing in India is the size of NBFCs as a proportion of the overall financial system is still not very large, they still account for less than 20 percent of total credit in the system and even though, over the past couple of years, the ALM (asset and liability management) mismatches at NBFCs have gone up and they have increasingly resorted to short-term borrowings. This situation can be managed easily even if there were pressure at some NBFCs by intervention by the regulators. We have seen in the past, Reserve Bank of India (RBI) coming in at the time of crisis on liquidity, putting in steps like opening up the repo window for a mutual fund etc. So, I think concerns that this liquidity constraint will cascade into distress into NBFCs is probably exaggerated, but I think this is much needed recalibration to growth and valuations of NBFCs.
Q: The market is still quite concerned. Many of these stocks have already fallen about 20-25 percent this month. You think, since you mentioned that the situation can be managed easily, you think this is a good time for investors to be buying into some of these quality names?
A: One has to be cognizant of the fact that they have fallen 25 percent from what levels and after what period of price performance. While Latha was reading out the drop in stock prices over the past one month, but if you look at their stock price action from 12 months ago or even six months ago, many of these will still be in the positive territory. Therefore, one has to be cognizant of the multiples these NBFCs trade at and whether they are fair given the growth prospect as well as the fact that with what is happening with global liquidity and domestic liquidity, we are going to be in a tighter liquidity and higher rate environment for some time to come and that will indeed exert downward pressure on the margins of these NBFCs.
Q: Take a stock like Bajaj Finance for instance, many of the old advantages remain, 11-12 public sector banks cannot lend, even State Bank of India (SBI) has still out of the blue. There is an IL&FS problem that has to be provided for. You thought everything is provided and we thought that money will come from the steel companies, the money is taking its own time to come and new bombshells are coming out like IL&FS. So, if SBI will not lend aggressively, the other public sector banks, the next best is embroiled in a merger and the remaining tail is in prompt corrective action (PCA). So the terrain is still open for NBFCs, isnâ€™t it? Therefore, can the best still command five-six times?
A: Indeed, the opportunity for lending an asset side growth of the balance sheet is large for NBFCs, private banks, for all the reasons you mentioned. But for the financial entity, you have to manage both sides of the balance sheets, the assets as well as liabilities and we have been seeing this play out not just at NBFCs, but at private banks as well. Over the last two years as private banks grew rapidly and they gained market share on the lending side, they were accounting for 60-80 percent of incremental loans, but that has to be matched by the growth you have in market share on the deposit side as well. If you see most of the private banks today have more than 90 percent loan deposit ratio. So, even the private banks have very large headroom to grow on the asset side in terms of loans, but the growth for them is going to be constrained by what happens on the liability side.
That is true for NBFCs as well. So, in a sense, while the asset side opportunity is large enough for all the lenders, you have to now look at what is the liability side constraint for growth.
Q: Today, the finance minister is meeting heads of the various public sector undertaking (PSU) banks and one of the talking points of that meeting will be the progress as far as the reduction in non-performing assets (NPAs) is concerned. What is your own view on how much of the recognition of stressed assets is behind us and how much progress has been made so far?
A: We think that at least on the corporate asset quality side, we have made very good progress in terms of recognition as more than 80-85 percent of corporate asset quality stress is recognised. If you recollect on the last reported numbers, reported gross NPAs of banks is already about Rs 10 trillion and in addition, over the last five years or so, banks have already written off another Rs 5 trillion.
So already about Rs 15 trillion of stress has been recognised. This translates to about 16-17 percent of total loans and as much as 30 percent of corporate loans of the banks. So, we think that the residual corporate stress that needs to be recognised is relatively low, it's only about 2-3 percent of loans. Of course, as Latha also mentioned, things like IL&FS are big negative surprises, but we still think we are at the fag end of corporate NPA cycle.
Q: In that case, where do you hide in the financial sector and do you already start buying at current levels?
A: I cannot, for compliance reasons talk about specific stocks, but the characteristics we are looking for in the stocks is basically entities that are not just strong asset franchises, but also strong liability franchises, they have access to lower cost of funding in NBFC space. One is how good is the liability franchise, how liquid they are, what is the rating, and in addition, what product segment they are, because for sure NBFCs will see higher increase in funding costs relative to the banks. Therefore, it's important that if they are in a product segment, where their competitors are banks or other NBFCs in the product segment, where the competition is largely other NBFCs, they should have better ability to pass on the funding cost increase and therefore, mitigate some of the margin pressures that are visible.
A: We are actually hopeful that SBI will not be pulled into any this M&A and the primary reason for that is SBI is already large part of the banking system. I think regulators for the sake of prudence would not want one bank to become 30 percent of the banking system. So, we are hopeful that SBI does not get pulled into this M&A. However, for other state owned banks, unfortunately, even as the corporate asset quality cycle is kind of now playing out, we believe these M&A make most of the other state owned banks really uninvestable, because as an investor, you do not know or have visibility that what you are buying.
Q: You spoke about how the corporate stress has 80-85 percent of it has been recognised. I reckon a lot of this has to do with PSU banking as well. On that subject, what are your thoughts on the merger that the government just announced, the stocks fell quite a bit, Bank of Baroda, etc.? Is there a possibility of State Bank of India (SBI) being chosen as another candidate in round two of the mergers and how do you approach this entire news flow?