CHAPTER 1: TRUST DEFICIT
If someone painted India’s NBFC rout in the colors of Lehman crisis, we wouldn’t call it foul as there are uncanny similarities in the US sub-prime boom and India’s NBFC surge. Over a quarter of multi-baggers in the last five years would be an NBFC. These shadow banks have been witnessing spur in the growth in consumer lending space much faster than banks, particularly after the unravelling of NPAs can of worms.
But now, there is skepticism about the very ability of NBFCs to raise funds. With the cost of funds moving up, fears are growing that NBFCs, which are dependent on wholesale funding, will struggle to access capital. Borrowing costs have gone up with a rising yield and a widening current account deficit. Moreover, the RBI’s attempts to check decline in the rupee have driven out much of the liquidity in the market as the bank is sucking up rupees and selling dollars.
NBFCs raise funds mainly by issuing debentures & commercial papers and borrowing from banks. Despite a spike in systemic rates, their cost of funding has actually been falling as commercial papers became relatively cheaper. Many home finance companies (HFCs) migrated towards shorter-tenure borrowings in recent times, as the shorter-tenure borrowing became comparatively cheaper by about 100 basis points. But there lies the problem, as it has now created an asset-liability management (ALM) mismatch. Brokerage Emkay Global says 12 per cent of DHFL’s liabilities (nearly 17 per cent of market borrowings) are maturing in three months against 9 per cent of total assets (nearly 3 per cent advances).
About 50 per cent (NCDs-CPs) of NBFC borrowings are largely at a fixed rate, while over 35 per cent of bank borrowings get repriced on a quarterly or annual basis. As the share of bank borrowings begins to increase and borrowings with annual reset dates are expected to get repriced, retail NBFCs are expected to face increased pricing pressure in the second half of FY19, shrinking their net interest margins (NIM).
Since mid-September, rumours have been making rounds in the markets that there is already a systemic liquidity problem in the NBFC space. NBFC stocks have been on a free fall. A kind of contagion then spread to other financial stocks, and the benchmark indices crashed, creating bearishness all around. Some fund houses have already started cutting bond holdings, particularly from NBFCs, and are seeking to sit on cash, because of market uncertainty and apprehending a possible surge in redemptions. DSP mutual fund’s move to sell off DHFL papers also added to liquidity concerns over the commercial papers of NBFCs.
CHAPTER 2: DEFAULTS AND DOWNGRADES
On 21st June, IL&FS’s subsidiary IL&FS Transportation Networks (ILTN) defaulted on inter-corporate deposits and commercial papers worth Rs. 450 Cr. After the first default, between June and July, four of ITNL’s project special-purpose vehicles reported irregularities in debt servicing, showed an ICRA ratings note. “ITNL’s gross leverage (debt/EBITDA) remains high at 6.9 times and its interest coverage remains weak at 1.2 times”, said India Ratings in a note on July 25 while downgrading the company’s rating to BB from A.
Since IL&FS operates as an RBI registered “Core Investment Company”, its operations are restricted to investment in other group companies. Therefore, the health of its subsidiaries has a direct bearing on IL&FS’s own finances. For some of the outstanding debt instruments of the subsidiaries, IL&FS has guaranteed any shortfall in payments. In August, ICRA downgraded the long-term rating on Rs 4,475 Cr worth of debt securities from AAA to AA+ taking into account the “company’s elevated debt levels due to the funding commitments towards group ventures”.
On September 4, IL&FS again defaulted on a short-term loan of Rs 1,000 Cr from SIDBI (Small Industries Development Bank of India), while its subsidiary defaulted Rs 500 Cr of dues to the development finance institution. Following this, taking into account the liquidity pressure and over-leverage, ICRA downgraded IL&FS rating from AA+ to BB (junk or non-investment status) on 10th September and then to D on 17th September.
IL&FS long-term debt-to-equity ratio has risen to 3.08 times as of March 2018, compared to 2.60 times in March 2017. The group’s consolidated debt increased by Rs 11,211 Cr in financial year 2017-18 to Rs 91,091.30 Cr as of March 2018. With relatively high leverage, even selling strategic stakes in various projects/group companies had been inadequate to meet the further funding commitments to the group companies leading to an increase in the debt levels of IL&FS. In a letter to its employees, IL&FS claimed that if funds worth Rs 16,000 Cr stuck with concession authorities were released on time, it would not have landed in this mess, said a PTI report.
On Friday, 28th September, the RBI met large shareholders of IL&FS to decide on revival and capital infusion plans for the company. IL&FS’s investors include biggest Indian insurer LIC, top lender SBI, largest mortgage lender HDFC, Abu Dhabi Investment Authority and Japan’s Orix Corp.
On Saturday, 29th September, troubled Indian shadow bank IL&FS secured a lifeline after shareholders approved its plans to raise money through debt and equity. Stockholders voted in favour of IL&FS’s plans to raise as much as 15000 Cr rupees through a non-convertible debt issue, hike the firm’s borrowing limit by 40 percent to 35000 Cr rupees and increase its share capital to enable a rights offering
On 1st October, after all the drama, curtains went down when Government officials ousted IL&FS’s management and instituted a new six-member board including Uday Kotak and former head of the SEBI, GN Bajpai. Superseding the board of IL&FS, the government has pledged to ensure the beleaguered lender has the money to prevent further defaults.
The MF industry had more than Rs. 2,900 Cr exposure to IL&FS and its listed subsidiaries, said a Value Research report. NAVs of Mutual Fund Schemes were impacted by rating downgrades as well as defaults. AMCs exposed to such risk re-evaluated the impact on their NAVs and consequently provided for losses and devalued their NAVs considering the rise in credit risk & bond yields and fall in bond prices. And in this chain of events, cautious investors started exiting from mutual fund schemes having exposure to IL&FS, creating redemption pressure.
CHAPTER 3: COLLATERAL DAMAGE
In order to cater to such redemption pressures, DSP Mutual Fund was forced to sell NCDs, a short-term debt instrument, of DHFL worth Rs. 300 Cr at a higher yield of 11 per cent in the secondary market, as they didn’t find immediate buyers. This triggered a speculation that DHFL could be facing liquidity issues and there could be ratings downgrade in the HFCs. Even after DSP clarified the sale reflected its view on interest rates, rather than its credit view on a specific issuer, shares of non-bank finance companies (NBFCs) took a massive hit on 21st September, with DHFL and Indiabulls Housing Finance tumbling around 60% and 30% respectively in intraday trade. DHFL lost Rs 10000 Cr in the market capitalisation during the day.
If rumours were to be believed, in the wake of recent IL&FS papers downgrade, DHFL and Indiabulls Housing Finance could also find it difficult to meet their respective loan obligations going ahead leading to liquidity crisis. This contagion had a ripple effect and spread the panic to the entire NBFC space with Edelweiss Financial, Bajaj Finance, Shriram Transport Finance, M&M Financial Services & Indiabulls Housing plummeting. Ongoing crisis at IL&FS triggered the sell-off, as market feared that an ‘IL&FS-like’ situation might emerge across NBFCs.
As shares of the entire home-financing sector went into a tailspin, dragging the broader markets with them, the management of DHFL and Indiabulls Housing Finance clarified their stand on the issue and assured public investors that they do not face any liquidity crisis and are well placed to meet loan repayment obligations.
CHAPTER 4: THE SIDEKICK: BANKS
1. YES BANK
Shares of YES Bank have plunged around 45 per cent this month. The RBI had curtailed the 3-year term extension that the board had sought for Rana Kapoor, also one of the promoters, to January 31, 2019, and asked the bank to find a replacement. The scrip dropped further on Friday after reports that Madhu Kapur, wife of late Yes Bank co-founder Ashok Kapur, sold around 0.04 per cent of her stake in the bank in the open market on September 21.
The lender has been facing challenges in the form of doubts over bad debt and uncertainty over leadership since the RBI’s order. In a BSE filing, YES Bank clarified, “Over the past few days, some unfounded speculations regarding the bank’s asset quality have been brought to its notice. In this context, the management clarifies that the asset quality continues to be stable. The bank has a liquidity coverage ratio of 101 per cent as on September 30, 2018, which is 11 per cent points in excess of the minimum regulatory requirement of 90 per cent.”
The National Stock Exchange (NSE) had earlier sent a notice to the lender, seeking its response to allegations that Kapoor’s family office was running a parallel lending or investing business by compromising the interest of YES Bank. However, YES Bank vehemently denied any dealings with the Three Sisters Family Office, which is run by the bank’s founder CEO Rana Kapoor’s three daughters.
On account of the RBI’s action, CARE Ratings said, various debt instruments issued by the Bank, which were upgraded to AAA with a stable outlook from AA+ on July 5, 2018, now carry a rating of AAA credit watch with developing implications. Instruments include-Infrastructure Bonds, Lower Tier II Bonds, Tier II Bonds (Basel III), Additional Tier I Bonds (Basel III), Upper Tier II Bonds and Perpetual Bonds (Basel II).
2. BANDHAN BANK
RBI’s licensing norms require a private sector bank to bring down its promoter shareholding to 40 per cent within three years of operations. But Bandhan Bank was not able to bring down the shareholding of nonoperative financial holding company (NOFHC) to 40 percent as required under the licensing condition and hence general permission to open new branches stood withdrawn and the bank can now open branches only with prior approval of RBI. Also the remuneration of the MD & CEO of the bank stood frozen at the existing level, till further notice by RBI.
On 1st October, Shares of Bandhan Bank Ltd hit a lower circuit of 20%, their biggest single day decline since listing. Brokerage ICICI Securities reduced its target multiple on the stock from 6 times earlier to 4.7 times FY21E book. It said the stake sale may be highly EPS and RoE dilutive. The brokerage has however retained its buy rating citing robust growth, healthy margins and low cost to income. In the short-term, the stock could hover at a corrected level until there is clarity from management.
3. KOTAK MAHINDRA BANK
Kotak Mahindra Bank fell over 12% on Monday, its biggest fall in nine years, after analysts feared a similar action after the bank failed to reduce its promoter holding last month. Kotak Mahindra Bank has to pare its promoter stake to less than 20% in the next three months. Uday Kotak, vice chairman and managing director of the Kotak Bank, currently holds a 30.03% stake in the bank. The RBI in August rejected its proposal to issue non-convertible preference shares to reduce promoter holding.
The combination of confusion and panic emanating from above events has led to sharp fall in NBFCs, HFCs and finance Stocks. Liquidity concerns emerging from NBFC news have concerned many investors on the financial position of Small & Midcap Companies. We continue to hold well managed companies, not having liquidity concerns and find ourselves fortunate to not have any exposure in NBFCs currently. But we plan to add them as markets have thrown this opportunity and also that the overvaluation in a lot of quality companies have corrected and is expected to stabilise over the coming 4 to 5 months, which gives us a comfort on the downside protection with a good upside potential. These times of panic are opportunities in disguise to deploy lump-sum capital. We are more bullish than ever at such attractive valuations.