Rating agency ICRA on June 25 downgraded long-term ratings of Edelweiss Financial Services and Piramal Capital & Housing Finance. This is because of the likelihood of higher defaults in their wholesale real- estate loan book, given the slowing economy.
The move confirms that wholesale lending non-banking financial companies (NBFCs) are staring at a double whammy – higher bad loans on the asset side and difficulties in refinancing its debt on the liability side.
Its been raining bad news for NBFCs in the last 10 months. This included the default by IL&FS group companies, set of ratings downgrade of Dewan Housing Finance (DHFL) and multiple NBFCs of Reliance ADAG group, and collapse in the stock price of Indiabulls Housing Finance due to its exposure to the real estate segment.
While NBFCs are still grappling with the liquidity crunch triggered by the IL&FS default in September last year, the ongoing downturn in the Indian real estate sector is inflicting new wounds.
Read: Sharp fall of NBFCs after Supertech’s default: Overreaction or justified?
Slump in the real estate sector The residential real estate space has been going through a slowdown for the past couple of years. This is visible in unsold inventory, lower launches, increase in the number of stalled projects, fall in sales and slump in prices.
And while the reasons and signs of real estate slowdown are manifold, the question then is why is the stress in the real estate sector so far not visible in the books of NBFCs? The answer is low seasoning of the real estate book and high refinancing. Both these factors have so far masked the stress in the real estate sector and has resulted in negligible credit cost for the NBFCs lending to property developers.
Tight liquidity conditions Till September 2018, mutual funds had no issues lending to NBFCs. They have now become extremely selective. The heightened risk-averse sentiment towards NBFCs, particularly wholesale lenders, has made it difficult for them to mobilise resources.
As a result, the financial flexibility of NBFCs have reduced -- this has made their borrowing costlier and at the same time shaken up the real estate market which heavily borrow from them.
If the risk aversion persists, the refinancing activity may be severely curtailed. As a spillover effect, the underlying stress in the real estate sector would start reflecting in the loan portfolio (asset side) of NBFCs. The fears of tight liquidity conditions causing a spike in bad loans, particularly in real estate, could therefore turn into a reality.
Against this backdrop, NBFCs' efforts in de-risking their portfolio and adjustment in the real estate sector to the dwindling liquidity are the key monitorables.
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Disclaimer: Moneycontrol Research analysts do not hold positions in the companies discussed here
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