Crisis in Yes Bank has zero impact on NBFCs – AT1 Bonds for NBFCs irrelevant: The recent crisis in Yes Bank has impacted most NBFC stocks under our coverage. Irrespective of other aspects, there are two main concerns that need to be clarified for NBFCs. First, a complete write-down of Additional Tier-1 (AT1) bonds of Yes Bank. Second, the exposure of NBFCs within Yes Bank. Our discussions with managements of various banks and NBFCs over the past two days suggest that the decision of complete write-down of AT1 bonds would have a major impact on banks with weaker adequacy rather than NBFCs as there would be a clear reluctance over investments in AT1 bonds going forward. In addition, most NBFC managements have confirmed Zero exposure to Yes Bank’s bond portfolio, apart from SHTF which has Rs0.5bn exposure to Tier-2 bonds of Yes Bank. Some NBFCs do have deposits with Yes Bank which are linked to their securitization portfolio; however, they are fully covered against recoveries from the securitized portfolio.
Impact of Covid-19 is not visible yet; sluggish economic activity remains the key concern: Our discussions with various managements also suggest that the impact of Covid-19 in India is fairly insignificant and none of the NBFCs have witnessed weaker trends in disbursements and collections due to the spread of the virus in the country. Rather, the worry still remains about weak trends in economic activity in India. Domestic infrastructure and construction activity remained indolent; however, agri-activity has seen some momentum, helped by better water availability. Overall, the demand environment in the country has continued to remain sluggish.
Most NBFCs are better-placed on the adequacy front; dependence of Tier-II bonds negligible: NBFCs under our coverage universe are better-placed on adequacy, with the major contribution coming from direct equity rather than Tier-2 bonds. With recent capital infusion undertaken by large NBFCs such as Bajaj Finance (BAF) and Cholamandalam Finance (CIFC), overall adequacy trends for high-growth NBFCs are even better-placed in comparison with weak names such as Edelweiss Financial. The overall dependence on Tier-II bonds for NBFCs had been negligible, providing us further comfort.
Overall liability franchise improving; margin trend expected to surprise positively: The recent liquidity measures from the Reserve Bank have improved the overall liability franchise of NBFCs. Relatively large and better-placed NBFCs are gradually returning to the capital markets (incl. CPs) to raise money at lower rates. In addition, banks’ exposure to NBFCs has also been improving as confidence has been rebuilding on the business model of these NBFCs. We believe that a continued decline in overall cost of funds, coupled with steady trends in yields, will finally result in an improvement in the margin profile of NBFCs – at least on a sequential basis. Asset-quality trends are expected to remain subdued amid weak economic trends and rising risk from the developer portfolio. However, the risk of elevated defaults is subsiding with improving economic scenario.
Stick to high-quality names; reiterate Buy on CIFC, SHTF, BAF and HDFC: Although we remain positive on high-quality NBFCs with decent promoter backing and superior asset-liability management profiles, we also believe that demand recovery will be a gradual process. We prefer Bajaj Finance (Buy; TP: Rs4,900), HDFC Limited (Buy; TP: Rs2,846) and MMFS (Buy; TP: Rs394). We have recently upgraded SHTF to Buy with a TP of Rs1,459, factoring in the favorable risk-reward it offers.
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