What could have been the best year in terms of performance for non-banking financial companies (NBFCs) quickly turned sour in just a few weeks in September. As 2018 draws to a close, NBFCs are yet to come out of the woods after infrastructure behemoth Infrastructure Leasing and Financial Services (IL&FS) defaulted on its loan obligations.

The defaults laid bare the mismatches between assets and liabilities of some non-bank lenders, and the risks to liquidity that everyone faces. The last six months have seen valuations of NBFCs erode, reflecting the liquidity concerns. At one point in October, an index of 20 NBFC stocks had fallen almost 30% from end-August levels. While they have since recovered, they are still down about 15%.

Investors have taken note of the impact on business growth and most NBFCs are likely to see modest credit growth, lower than previous expectations, as conserving liquidity and capital will take priority. Housing finance companies could also witness some stress from their developer loans book, growth in loans to infrastructure would slow, but, in contrast, retail-focused non-banks will perform well. “While the liquidity situation has been improving over the past two months, higher cost of funds and slowdown in growth will impact the sector as a whole. We believe the impact will be particularly pronounced for wholesale financiers," said analysts at Motilal Oswal Securities in a note. Incidentally, wholesale financiers have been the worst hit in terms of funding and financing costs since the liquidity

The focus of NBFCs will be their cost of borrowing, and, therefore, spreads that they earn over loans. Here, the outlook is not sanguine. “The incremental cost of borrowings for NBFCs and HFCs will go up by as much as 50-150 basis points. Companies that have a big fixed-interest asset book or don’t have the pricing power would find it difficult to pass on the incremental cost of funds to customers," said ICICI Securities in a note. The increase of over 100 basis points in commercial paper rates between September and November is a reflection of this. Funding woes may continue for some of them even in 2019.

Nevertheless, NBFCs have put the fear of liquidity crunch behind them, thanks to some measures by the Reserve Bank of India, and banks such as State Bank of India (SBI), which agreed to provide liquidity to finance companies by buying their loan portfolios through securitization. SBI, India’s largest lender, bought 5,250 crore worth of loans from NBFCs in October and is targeting more purchases.

Investors seem to have taken note of this, which reflects in the recovery of NBFC stocks. That said, most of these shares are still sharply below their peak in 2018, which shows that investors are still wary of how much impact would be seen in earnings in the second half of FY19. Hence, NBFC valuations are unlikely to be revised in a hurry.