The liquidity crisis has been cutting deep for almost nine months (much longer than expected) and now debilitating the financial system. A hard look at trends suggests:
1) Overall borrowings by non-bank lenders have gone up marginally but a clear divergence in their borrowing instruments has emerged; investors too are differentiating between weaker and stronger players.
2) Liquidity is easing marginally; however, more direct intervention is needed for effective resolution.
3) Systemic risk-aversion persists with corporate spreads ruling high and spreads between AAA and A rated corporates not narrowing.
4) Pockets of the real sector, namely real estate and auto, have suffered the most.
We also uncover: a) the recovery will be slow and extended; b) market risk appetite remains slack; c) consolidation is quite probable – as the crisis would separate the men from boys. We continue to favour banks, namely ICICI, HDFC, SBI and AU Small Finance Bank; among NBFCs, we prefer HDFC and Mahindra Finance due to their stronger balance sheets, vintage parentage and better ALMs.
Investors extremely selective; divergence in market instruments
Investors have shied away from investing in short-term paper. Outstanding commercial papers (CPs) are down 14% from peak (in July 2018) and monthly CP issuances have halved. We found more acute risk aversion towards HFCs with MFs’ investments in CPs of HFCs halving to INR482bn over Sep. 2018 to May 2019. Markets are also differentiating amongst players. Players with steady balance sheets or better credit ratings or strong parentage (Bajaj, Kotak, Tata, Aditya Birla, L&T etc.) have easier and cheaper access to CPs (at the cost of players such as DHFL, IHFL, JM, IIFL and Piramal, etc.).
Weak asset cycle; pockets of real sectors impacted
Systemic risk aversion persists—corporate spreads have risen by 40–60bps since August 2018 and spreads between AAA and A rated paper have not yet widened. With non-bank lenders readjusting business models, pockets of the real sector are being adversely impacted. The real estate segment has borne the brunt and the stress thereof cannot be overlooked. Vehicle financing is another segment to watch out amid bleak outlook.
Heading to resolution but recovery is slow
To deal with the situation, stressed entities are evaluating asset monetisation, portfolio sell-downs and stake sales but progress is far from satisfactory. More active participation by private players is needed, and regulators/policy makers too should intervene directly (government in budget has offered some support through partial credit guarantee but more needs to be done) to expedite the process of resolution and prevent the contagion from engulfing the real sector at large. That said, we believe market risk appetite remains slack and the focus is on risk and efficiency than growth. In this fragile environment, we favour banks – namely ICICI, HDFC, SBI and AU SFB – as asset quality and earnings tailwinds are around the corner. Among NBFCs, we like HDFC and MMFS due to their robust balance sheets, well-matched ALMs, and strong parentage.