After the IL&FS crisis happened, everyone started questioning the business model of NBFCs; they are now aware of this word called risk, says Srini Sriniwasan, managing director of Kotak Investment Advisors. Photo: Aniruddha Chowdhury/Mint
After the IL&FS crisis happened, everyone started questioning the business model of NBFCs; they are now aware of this word called risk, says Srini Sriniwasan, managing director of Kotak Investment Advisors. Photo: Aniruddha Chowdhury/Mint

Brace yourself for more NPA declarations from NBFCs

The fancy valuations at which NBFCs were raising money or were trading will come down to earth, says Srini Sriniwasan of Kotak Investment Advisors

Mumbai: In a video interview with Mint for the Mint Insights series, Srini Sriniwasan, managing director at Kotak Investment Advisors, said valuations of non-banking finance companies (NBFCs) in India will witness a correction against the backdrop of a liquidity crunch due to the crisis at Infrastructure Leasing & Financial Services Ltd (IL&FS) and the likelihood of tighter regulations.

Edited excerpts:

The NBFC sector is facing a liquidity crisis, particularly post the IL&FS defaults. What does this mean for retail investors considering the high exposure of mutual funds in NBFCs?

The theme in India in the last few years has been financialization of savings. Retail investors have moved away from real estate to putting their money in financial savings which includes investing in mutual funds. They thought they were diversifying by investing in mutual funds. But mutual funds got so much of retail investors’ money that they went ahead and gave a lot of that money, at least 40% of it, to NBFCs. These NBFCs in turn thought real estate was the best place to put that money. So, indirectly the retail investor is still playing the real estate market. One big difference is that earlier if their investment didn’t appreciate, they had only themselves to blame and would have said: “Oh, it is a long term holding". But today they have someone else to blame if things go wrong.

While Sebi allowed MFs to have a maximum exposure of 40% to NBFCs, most of them reached that limit. Should they have been reaching that or been more cautious?

But NBFCs were a constant funding source for real estate developers. With the funding drying up due to the liquidity crunch, what are the likely consequences? Most of the investments by mutual funds into NBFCs were by way of short-term paper. These NBFCs have gone and lent money to real estate which has a long gestation period. There is bound to be a (asset-liability) mismatch. If you borrow at a cheap rate for the short term and lend at a high rate for the long term, your profits look very good. So there was temptation to continue that. But after IL&FS crisis happened, everyone started questioning the business model of NBFCs. Suddenly people started becoming aware of this word called risk.

The first reaction of lenders, mutual funds and banks who lend to NBFCs is: “Let us stop for a minute and relook what we are getting into." As a consequence, the capital available for NBFCs has shrunk. Bigger firms will continue to get capital but marginal ones will have to struggle. Real estate had the lowest entry barrier, but that will change now.

What do you think about the under-construction segment?

Under-construction projects were being funded by advances from customers. Now customers are already twice shy. They are not paying money upfront to finance projects. So if neither customers nor lenders are lending, how will you finish the project?

A lot of private capital is flowing into NBFCs. What are the likely implications on NBFC valuations?

Where there are concentrated bets of lending by large NBFCs, and if those projects are not performing or coming through, they will have to call that an NPA. And remember, NBFCs had more lenient provisioning norms than banks. RBI is relooking it. You will see more delinquencies and declaration of NPAs from NBFCs which I do believe will happen. The fancy valuations at which NBFCs were raising money or were trading will come down to earth.

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