As bank stocks steal the show, NBFCs must offer more

While the rally among banks has been more democratic, it has been restricted to only a few names among NBFCs.

The lending business has never looked better in India, and the 12 percent surge in the Nifty Bank index is testament to the pursuit of an exposure to this growth by investors. The nimbler counterparts of banks, non-bank finance companies (NBFC) have somewhat been second citizens in this rally.

While the rally among banks has been more democratic, it has been restricted to only a few names among NBFCs. That is because a rising interest rate cycle does not have the straightforward benefits for NBFCs as it does for banks. Even as interest income is boosted, non-bank lenders have to take a hit on the liabilities side as they are big borrowers from the market.

“Managing the cost of borrowing is not easy for NBFCs. Interest rate hikes are not the only factor here,” said Anand Dama, banking analyst At Emkay Global Financial Services. He added that the borrowing mix will determine which NBFCs are affected less by rising borrowing costs.

Indeed, cost of funds is a key factor that is keeping investors from going all out on NBFCs. But not everyone is worried on this count. “We are conservatively modelling marginal quarter-on-quarter (qoq) net interest margin (NIM) compression for most NBFCs under coverage, except for Muthoot Finance. The sharp rise in benchmark lending rates will be eventually passed on to NBFCs; however, rate transmission is gradual with a lag in banks raising the marginal cost of lending rate (MCLR),” analysts at Kotak Institutional Equities wrote in a note.

Bank loan rates have climbed about 70 basis points (bps) so far in FY23, and bond yields have risen roughly 50-60 bps. One basis point is one-hundredth of a percentage point.

Notably, short-term rates have surged the most and made access to liquidity costlier for NBFCs. Ergo, lenders that have an edge over others on cost of borrowing have been the top picks for investors. Here, Bajaj Finance and Cholamandalam Investment have hogged the limelight. Bajaj Finance shares have gained a massive 27 percent, while Cholamandalam has clocked a 15 percent gain.

Nuancing the growth story

Credit growth has been the main factor behind the optimism surrounding lenders. The ongoing festival season, and early signs of strengthening consumption demand, have meant that analysts foresee improved return ratios among NBFCs.

Bajaj Finance’s early peek into its second quarter performance has given credence to these expectations. The consumer lender reported a strong 31 percent year-on-year growth in its assets under management (AUM) for Q2FY22.

That said, the tepid growth in new loans booking left investors worried. Bajaj Finance’s new loan bookings were down 8 percent sequentially. Analysts at Macquarie Capital pointed out that new loan bookings have hardly grown from pre-pandemic levels. A faster AUM growth against a slower volume growth points to disbursals of large ticket-size loans. Analysts at CLSA, an investment firm, believe that if growth is driven by big ticket loans, it may not sustain.

The disbursement surge for lenders comes on a low base, analysts point out. “AUM growth alone is not a good enough indicator this time as disbursements are growing from a low base. But loan growth will be strong at least for two quarters more because of festivals and Q4 being a seasonally strong quarter for corporate loan disbursements,” Dama said.

The growth fillip lends support to NBFC valuations and perhaps is the key reason behind the 9 percent rise in the Nifty Financial Services index. At the same time, a counterbalance has been the cost of borrowing and asset quality expectations.

The second quarter performance on these parameters will determine whether the rally in NBFCs has more legs to it.