Morgan Stanley said in its view, the existence of the NBFC/HFC business model is not under threat as these companies lend to diverse sections of the economy.
For the last couple of months, non-banking and housing finance companies (especially wholesale-funded lenders) have been facing liquidity crunch especially after IL&FS-led debt crisis in September.
The default by IL&FS and its subsequent downgrade to "D" by credit rating agencies from being rated AAA just a few months ago triggered a crisis of confidence in the wholesale funding markets.
The crisis was so severe that not only NBFCs & HFCs but also banks fell sharply by 10-60 percent which resulted in a steep correction in the equity market.
Morgan Stanley said there are three major underlying factors compounded this issue, which are:
1. A buildup of asset liability mismatches at NBFCs/HFCs, more so over the past six months, as they borrowed heavily via short-tenor instruments like commercial paper in view of higher longer-tenor interest rates.
2. These short-term issuances were largely subscribed by mutual funds whose exposures to NBFCs/HFCs were almost at sectoral caps.
3. Increased exposures to illiquid and relatively opaque segments like real estate by the NBFCs/HFCs in recent years.
There are meaningful commercial paper maturities lined up in coming months. Mutual funds remain cautious about investing in NBFC papers. Banks are also cautious in extending new credit lines to these entities as concerns about asset quality have increased.
But that does not mean all NBFCs and HFCs are facing a credit crisis. There are companies which have strong parentage and long experience in the field and will continue to get good funding.
Morgan Stanley said in its view, the existence of the NBFC/HFC business model is not under threat as these companies lend to diverse sections of the economy and have specialised in and developed origination, underwriting, and collection abilities in many credit-starved segments.
The investment firm feels that while the current problems will cause a slowdown in loan growth for the overall NBFC/HFC group, the stronger entities will continue to get funding to build their loan books at a healthy pace.
Pricing will be higher than historical rates and spreads lower, but the availability of funding should not be a problem for these entities, it believes.
Morgan Stanley divided these companies into those with strong parentage/long vintage and those with lesser vintage.
The research house said that approximately two-thirds of the overall loan book of NBFCs and HFCs belongs to entities with strong parentage and long business vintage which have posted a 15 percent loan CAGR during FY15-18. Lesser vintage companies grew at 26 percent in the same period, buoyed by easy and cheap liquidity.
Morgan Stanley said it expects stronger entities to sustain mid-to high-teens growth rates as they get a disproportionate share of the liquidity available to the group while the lesser-vintage entities will face sustained funding challenges (against a backdrop of higher global rates), causing a slowdown from the high growth rates of recent years.
Two groups – wholesale lending NBFCs and some large, fast-growing HFCs – clocked loan CAGRs of around 35 percent over the past four years. their loan share within NBFCs/HFCs rose around 900bp, to around 22 percent. The research house estimated that real estate exposures of NBFCs/HFCs have risen at around 30 percent CAGR, to around 3.5 percent of system credit.
These are not large numbers, but any major asset quality issues could cause the current crisis of confidence to last longer, it said.
It expects that system credit growth could slip around 220bp over FY19/20 if challenged wholesale-funded entities do not grow.
Funding from mutual funds to NBFCs/HFCs will depend on confidence and inflows; it is unlikely to go up soon, it said, adding banks will also be constrained by internal sectoral caps.
It estimated that for public sector banks to pick up this slack, they require around Rs 40,000 crore in additional capital. "They lack origination and collection machinery; hence, aggressive buyout of retail loans from NBFCs/HFCs via pass through certificates is easier to implement and more capital-efficient, in our view."
Hence Morgan Stanley has come with a list of stocks in non-banks space, where the risk-reward is attractive given parentage, vintage, reasonable loan growth levels, and attractive valuations.
The global research firm has an overweight call on HDFC, Mahindra & Mahindra Financial Services, Shriram Transport Finance Corporation and Edelweiss Financial which all can grow more than 20 percent over a period of one year. However, it is underweight on Aditya Birla Capital, Shriram City Union Finance and Indiabulls Housing Finance.