CEO, ICICI Prudential Mutual Fund
Alan Greenspan worried about the ‘irrational exuberance’ in markets. What we are witnessing in Indian debt markets can possibly be termed as ‘irrational pessimism’. The chain of defaults and downgrades set off by IL&FS group last year has led to bleak headlines about a Lehman moment for India and a domino effect on financial markets. But such fears could be overdone. Both the tightness in liquidity available for NBFCs and mark-downs in net asset values (NAV) of mutual fund portfolios can be looked at as isolated events restricted to a few players rather than the sector as a whole. While such events may have adverse impact on the players involved, they are unlikely to materially impact players who have managed their risks prudently.
NO SYSTEMIC RISK
Let’s tackle fears about a systemic risk first. Given the relatively large size of the Indian banking system, a potential Rs 50,000-crore non-performing asset may cause pain but is unlikely to turn into any systemic issue. Further, Indian NBFCs are not permitted to invest in complex structured products, like in the case of Lehman which made it difficult to quantify the problem. Similar crises did play out in India in 2008 and 2013, but the financial services industry at large was relatively unaffected. The stresses in asset-liability profiles of the beleaguered NBFCs are known and debt market participants have access to granular information on this. In the financial markets, what is well-known rarely triggers a crisis.
Mutual funds are unlikely to face a domino effect either. Investors in individual schemes that held these bonds have faced NAV write-downs. It is possible for the better-managed AMCs, to contain such risks by building dedicated credit teams, avoiding issuers with a doubtful record, avoiding concentration and managing liabilities astutely.
Focus needs to be on ensuring adequate diversification. This ensures that even under the event wherein liquidity of a particular instrument gets adversely impacted, the overall scheme level liquidity does not come under stress.
There has been a flight to better managed funds. As can be seen from the monthly data, investors have moved on to funds with better risk management practices.
NBFC A MISNOMER
Despite the common perception, NBFCs in India are a heterogeneous space where there are some extraordinary business models, some mediocre ones and some vulnerable spots. A gold loan NBFC extends three- to six-month loans while a housing finance NBFC extends 15- to 20-year loans. If they’re worried, borrowers of a gold loan NBFC are more likely to prepay their loans and get their collateral (jewellery) freed!
Thus, a loss of confidence actually may trigger prepayments thereby making asset side of the balance sheet more liquid, thereby staving off the pressure on liabilities. The typical client for a two-wheeler financing company is poles apart from one for a HCV financier. This diversity makes for a unique asset-liability profile for each type of NBFC. A housing finance NBFC can run into assetliability mismatches by borrowing shortterm to lend long-term but a two-wheeler or a consumer finance NBFC with 18-24 month loans is unlikely to. One can make a distinction between an NBFC that extends wholesale credit and one that caters to retail customers; the latter feature securitisable portfolios.
Between September 2018 and April 2019, mutual funds’ aggregate exposure to NBFCs decreased from Rs 3.79 lakh crore to Rs 3.12 lakh crore. But lending is now skewed towards NBFCs/HFCs with strong parentage and AAA ratings, while credit spreads have widened for others. Over two-thirds of the NBFCs in India are promoted by large industrial groups or banks, who are far betterplaced than standalone NBFCs to weather this storm. Therefore, credit-worthy NBFCs with good franchises are unlikely to face significant funding issues and may emerge stronger from this crisis. Growth and margins may take a temporary hit, but the good business models will survive and emerge stronger because they cater to genuine needs of the economy.
Today, much of the worries centre around NBFCs’ real estate exposure. The problem is unlikely to be resolved immediately as developers are sitting on large unsold inventory. This may trigger consolidation among developers and NBFCs who lend to them. But as investors, we are aware of the proportion of construction finance in individual NBFC books and can take a nuanced view.
WHAT MARKETS SAY
Finally, as someone who has had over two and half decades of experience in financial markets, I have great respect for Mr. Market. Today, stock and bond prices for NBFCs or banks don’t indicate a systemic issue. They are instead saying that there are clear winners and losers from this crisis. Between January 2019 and June 10, 2019, while 11 NBFC stocks have on an average lost 16 per cent there are 8 other NBFC stocks which have gained 23 per cent. Gold loan NBFCs have made sharp gains, while vulnerable NBFCs in housing finance, large SME finance (LAP) and wholesale financing, which operate on thin margins and depend on short term funding have been most affected. In our view, irrational pessimism often creates great investing opportunities. NBFCs or banks who have a strong liability franchise today have a one-off opportunity to create profitable assets. Mutual funds like us can now earn attractive yields on highquality paper, something which was relatively difficult, just one year ago.
- "We live in a time of radical counter-enlightenment" : Indybay
- Microsoft Teams Up with Walgreens, Countering Amazon
- Anushka Sharma spotted with Virat Kohli after ODI series win
- What evidence? BuzzFeed fuels ‘Russiagate’ with bombshell report on Trump and Cohen
- Zimbabwe's biggest mobile operator Econet says ordered to shut down internet
- Klopp: Liverpool contracts mean Anfield progress can continue for years
- Rossi a no-go for Tottenham as Pochettino rules out panic buys
- NJ Transit needs to improve Atlantic City Rail Line in South Jersey