NBFCs are among top mutual fund buys. Here's why

Between May and June, asset management companies upped their stake in HDFC, Shriram Finance, Creditaccess Grameen and Mahindra & Mahindra Financial Services among several other names.

Financials remain the darlings of Dalal Street with non-banking financial companies (NBFCs) now grabbing the spotlight within this sector. In June, mutual funds heavily invested in NBFC stocks while booking profits from private banking stocks.

The current market sentiment suggests that the peak of the interest cycle is approaching its end, according to analysts and fund managers. As central banks in developed markets begin to cut interest rates, India is expected to follow suit. Resultantly, the liability costs for NBFCs are likely to decrease, leading to higher profit margins and increased profitability.

Mutual funds in June raised their holdings across various NBFC segments, be it housing finance, consumer finance, or microfinance. Loan demand remains strong across product categories like vehicle, SME/consumer segments, and gold finance. The Street expects assets under management (AUM) growth above 20 percent year on year for most NBFCs in Q1 FY24.

“Credit growth is now well-entrenched and can continue for the medium term. The credit cycle also looks good and predictable. The probability of any big NPL (non-performing loans) shocks coming over the next few quarters is very low,” Vinay Sharma, Fund Manager - Equity Investments, Nippon India Mutual Fund, said.

In June, asset management companies upped their stake in HDFC, Shriram Finance, Creditaccess Grameen and Mahindra & Mahindra Financial Services among several other names. While HDFC can be looked at as MFs jumping on an arbitrage opportunity ahead of merger with HDFC Bank, inflows for other NBFCs were largely on the back of improving outlook on their asset quality and margins.

Why the optimism?

NBFCs borrow from banks or raise money from non-convertible debentures. In both cases, they are borrowing at high rates but at the same time, they are lending at even higher rates. “For instance, select NBFCs are raising funds while offering yields up to 10 percent per annum, but lending rates are also north of 14 percent. In that sense, the gross margin picture for NBFCs looks better than that of many banks that accept deposits at 7.5 percent and lend at around the 9 percent range,” explained Nirav Karkera of Fisdom.

While some NBFCs could see their NIMs (net interest margins) contract by 5-15 basis points, given the increase in the cost of funds, analysts at Systematix Institutional Equities believe other NBFCs will likely maintain or see a marginal increase in NIMs, aided by a change in their portfolio mix and upward revision in lending rates.

Moreover, when it comes to high-yield segments like SME (small and medium enterprise) loans, loans against property and unsecured personal B2C (business-to-consumer) loans, NBFCs are more willing to extend credit compared to several regulatory checks by banks. This is why NBFCs will be able to serve the increasing trend of financialisation better as they are playing the credit-risk game better, said analysts.

According to Krishna Sanghavi - CIO Equity, Mahindra Manulife Mutual Fund, NBFCs will continue to re-rate as the focus shifts from margin pressures. “FY23 saw some de-rating for NBFCs on concerns over margins while banks saw profit gains as well as re-rating. Q1FY24 saw a re-rating for NBFCs as post the policy pause by RBI, market expectations shifted away from margin pressure,” he said.

Bargain buys

Moreover, mutual funds also jumped at the opportunity to buy NBFC stocks at a bargain. For instance, CreditAccess Grameen and Shriram Finance both saw big block deals in June at a slight discount to the then market price. Canara Robeco, Axis Mutual Fund and HDFC AMC upped their stake in CreditAccess Grameen while Aditya Birla Sun Life AMC and Kotak Mahindra AMC, among others, bought into Shriram Finance.

“Meanwhile, cash flows have held up well and contributed to better collection efficiencies which will translate into benign credit costs across most of the NBFCs,” Ritesh Bhagwati - Head of Research - Rockstud Capital. In Q1 FY24, analysts expect the credit cost of most NBFCs likely to be maintained at Q4 levels, except for a few like Mahindra Finance and Cholamandalam Finance, which could see a normalised credit cost.

And finally, the space is also heating up with the entry of Jio Financial Services soon. While it is expected that JFS will disrupt the sector and heat up the competition, fund managers do not seem to mind loading up on the already listed names to capitalise on India's growth story.

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