What ails the NBFC sector? Nirmal Jain explains
Nobody knows the NBFC sector better that Nirmal Jain, the Billionaire visionary founder of IIFL.
In his latest article, the Billionaire has provided a masterful explanation of the crisis and offered suggestions on how it can be resolved.
He has explained that the IL&FS default, the systemic tight liquidity and the ALM (asset liability management) are the three root causes of the precarious position that the NBFCs currently find themselves.
Apparently, NBFCs were merrily borrowing short-term funds from mutual funds through commercial paper (CPs) and lending for longer-tenure assets.
This was done because short-term interest rates are lower than long-term ones and led to hefty gains.
However, when the IL&FS crisis erupted, panic-stricken lenders rushed to the NBFCs to withdraw their funds.
The NBFCs could not honour the withdrawal demands because the funds were stuck in high-end realty projects, for which there are no takers owing to the slowdown in the realty sector.
The end result is that stocks of all NBFCs like DHFL, IndiaBulls Housing Finance, Repco etc came crashing down like a ton of bricks.
All housing finance companies crack!
DHFL now down 25%
Indiabulls Housing down 10%
Repco down 5%
Can Fin down 5%
— Mubina Kapasi (@MubinaKapasi) September 21, 2018
Collateral damage was suffered by investors in NCDs and debt mutual funds. They had invested in the mutual funds in the fond hope that it is risk-free. However, they had to suffer a haircut of as much as 50% of their capital.
How much is the MAXIMUM a debt fund (and I repeat DEBT FUND) NAV fall in a SINGLE day?
Option 1: 4% (~ 6 mths interest)
Option 2: 8% (~ 1 yrs interest)
Option 3: 25% (~3 yrs interest)
Option 4: 50% (~ 5 yrs interest)
Here's the fall in debt fund NAVs yesterday of some funds pic.twitter.com/UZhETPGlbu
— Nagpal Manoj (@NagpalManoj) June 5, 2019
Thankfully, the Government rushed to the rescue of the NBFCs and salvaged the situation to some extent by injecting liquidity into the system.
However, the crisis is looming upon us and we are still not out of the woods.
“All the measures announced till date do not reach out to the epicentre of the earthquake, which is big-ticket real estate loans in large metros, chiefly for high-end customers. As people see a few cracks on the surface and feel some jitters, the panic of a full-blown quake starts to spread,” Nirmal Jain has stated.
He has also warned that similar circumstances were the root cause of the Lehman Brothers default which led to the global financial crisis of 2008.
My piece in The Fortune on NBFC Sector: Road Ahead- the Achilles' heel is exposure of wholesale NBFCs to real estate developers in high priced segment in Mumbai/ Delhi https://t.co/776AkkJi9H
— Nirmal Jain (@JainNirmal) November 1, 2019
Govt should buy high-value, luxury apartments and bail out developers
Nirmal Jain has offered a suggestion that he knows will be met with vehement opposition from the intellectuals.
“Nobody would like to support the real estate developers building high-value, luxury apartments with funds from the exchequer or through policies,” he has observed, tongue-in-cheek.
He has suggested that the Government should consider setting up a fund like the “Troubled Asset Relief Program (TARP) fund” and buy stressed real estate projects at fair valuation and ensure their completion.
He has assured that this step will not only bail out the developers and the NBFCs but will also allow the Government to make “significant profits”.
It is worth noting that a similar proposal was also made by Raghuram Rajan, the former Governor of the RBI.
For me, big takeaway was also Rajan saying: 1.troubled NBFCsneed to be taken into receivership & 2. troubled real estate needs to be bought over by a govt holding co & the flats sold when prices stabilize. I think,these 2 pieces of advice need quick thot & action @DasShaktikanta https://t.co/i9TYQkk3XB
— Latha Venkatesh (@latha_venkatesh) October 13, 2019
The suggestion was vehemently opposed.
So you support "Profits are Private and Losses are Social" Theory.
— Er Advait Chothave ईं. अद्वैत चोथवे (@AdvaitChothave) October 13, 2019
No way government should buy troubled real estate, these guys bought properties at dirt cheap prices, now pleading for government. Their profits were private, don’t make their losses public. This suggestion enables their bailout with taxpayers money.
— Yogesh I. Satpute, FCA PhD?? (@yogesh007pute) October 14, 2019
Oh please!! Why in world should govt. buy troubled real estate projects? is tax payer money meant for this? never thought that you would make such a suggestion. RR needs to answer for his acts of omission & prevented from making such suggestions
— Vijay Kumar Sharma (@ervijaysharma) October 13, 2019
Saurabh Mukherjea had predicted the NBFC crisis in June 2018
Saurabh Mukherjea has demonstrated amazing clairvoyance of thinking.
As far back as in June 2018, he had sounded the grim warning that the practice of the NBFCs of borrowing in the short-term market to lend in the long-term market is a recipe for disaster.
“I cannot but help feel that a major correction in financials is overdue. I am talking about the wholesale market dependent financial companies who borrow money in the wholesale market and lend to the retail customers.
The wholesale market rates have tightened by 125-130 bps in the last six months. There is further tightening in rates coming in the wholesale market and I cannot feel that a major correction in NBFCs and HFCs is also around the corner,” he had said in a grim tone.
One man’s poison is another man’s food: Ongoing crisis is a boon for the lenders in our portfolio
Now, Saurabh has written an article in which he has argued with conviction why the three finance stocks in his portfolio will be big beneficiaries of the NBFC crisis.
The three finance stocks are HDFC Bank, Kotak Bank and Bajaj Finance.
Saurabh has explained that the three stocks have not only their own individual strengths but the commonalities that differentiate them from their competitors are the following:
i. Good corporate governance;
ii. Focus on consistent and sustainable long-term growth across market cycles;
iii. Prudent credit underwriting; and
iv. Management teams with an innate sense of capital allocation.
He has opined that the said three stocks will benefit because:
(a) When the competition struggles to raise funds during & after a crisis, great lenders have access to adequate liquidity; and
(b) As competition’s ability to lend reduces, great lenders can pick and choose quality borrowers, leading to better net interest margins (NIMs), higher loan book growth, lower NPAs and hence better RoEs.
He has also pointed out that one can gauge the resilience of the three stocks from the fact that each emerged largely unscathed from the IL&FS debacle.
The only impact they suffered was a short-term de-rating of multiples while business continued as usual.
At the end, Saurabh has concluded that the ongoing financial crisis will turn out to be a big positive for the said three stocks.
He has advised us also to stay away from poor quality lenders and to keep focusing on high quality players which have stability on both the liability as well as asset side of their balance sheet!