IL&FS row should not be a contagion, depends on how it is handled: Experts

Non-banking finance companies are also walking the extra mile to assure investors that they are in the pink of health

The IL&FS default has created its own kind of risk-averse environment, with investors trying to offload bonds in a market without ample buyers. 

Non-banking finance companies (NBFCs) are also walking the extra mile to assure investors that they are in the pink of health. A few of them are issuing mundane press releases such as successful repayment of bonds due in September, and commitment to pay full amount of their bond liabilities. 

Some have also started terming IL&FS as India’s own Lehman moment, a claim State Bank of India Chairman Rajnish Kumar termed as “unwarranted mayhem”. 

Experts are also of the opinion that there was no point adding to the hyperbole. But that doesn’t mean that there was no vulnerability. 

“Ideally, it should not be a contagion, but it depends how authorities handle it,” said Ananth Narayan, Associate Professor (Finance) at SP Jain Institute of Management & Research. 

“There is an immediate problem, the problem is that of liquidity in the market. Bond investors want to get out, but there is no liquidity. But that liquidity can be provided as was done in 2008,” Narayan said. 

In 2008, liquidity was created by reducing banks’ mandatory bond holding limit and allowing the lenders to buy NBFC papers from the mutual funds. Similar collateral can be created now with papers of reputed name companies, both from the government and the private space. 

And frankly, nobody is expecting the NBFC sector to collapse under defaults. 

“Market sentiments are not in line with the performance of NBFCs, these companies are fundamentally strong, their books have been growing and they have free cash flow to help them sustain. The market is reacting too negatively with a lot of speculation going around,” said Rachit Chawla, CEO of Finway, an NBFC.

“If you look at the size of the top NBFCs like Indiabulls or Bajaj Finance, their Assets under Management are substantial. These NBFCs have become so large in nature and in size that any hit in terms of interest rates will hamper their customers and ultimately, retail investors,” Chawla said, adding the market is misinterpreting the health of these large NBFCs.

Large brokerage houses also agree with this assessment. 

“NBFC stocks, especially of Housing Finance Companies (HFCs), came under significant pressure on Friday – but default risk is very low,” wrote Morgan Stanley. However, credit cost will remain elevated in the coming days, the brokerage said.

Bond dealers say even as the rating agency gave their highest credit rating to IL&FS, the bond market knew for some time that their subsidiary businesses were in trouble. The group companies were not getting loans easily, and they were struggling to issue bonds as well. 

Mutual funds were gradually cutting down their exposure in IL&FS too. But the markets cannot completely ignore the rating too. The transition of rating from the highest (AAA) to the lowest (D – default) will have its ramification.

“There will be some lasting impact. There will be nervousness. We don’t know really if the present market reaction is all knee-jerk, but the market would be suspicious giving money to NBFCs. Liquidity will dry up for a vast majority of them, and the cost will increase,” said the head of treasury of a large private sector bank.

Sure enough, the yields on the commercial paper of an NBFC spiked 175 basis points when IL&FS was on the verge of default. Mutual funds are the major investors of commercial papers of NBFCs, holding 60 per cent of those short term papers issued by the sector, according to Credit Suisse.  They will now try to reduce their exposures even when the ratings are maintained, the brokerage said.

Another treasurer of a bank said the IL&FS issue was a “localized air turbulence” and not interlinked much with others in the financial system. 

“We should not jump to a conclusion. Contagion is too extreme a scenario to presume,” the treasurer said.