Coronavirus impact: Bet on top-tier names in banking sector, avoid NBFCs

Avoid banks and NBFCs with a high proportion of unsecured and small, medium enterprises loans

The banking and financial sector is among the worst hit in the current downturn. While the Nifty50 has declined 27.7 per cent, the Nifty Bank index has nosedived 40.1 per cent over the past three months. 

In a report issued on April 15, Macquarie Research cut its earnings per share estimates for private banks by 35-40 per cent and reduced its target prices for private banks by 45 per cent and for public-sector banks by 47 per cent. 

With economic growth poised to slow down — the International Monetary Fund has cut India’s GDP growth estimate to 1.9 per cent for 2020-21 — the banking and financial sector, whose prospects are tied closely to the economy’s, is bound to bear the brunt. 

There could be a spike in bad loans. “The slowdown could lead to potential job losses, which could cause stress in banks’ retail loan books. 

Similarly, loss in production could lead to stress in corporate, small and medium enterprises (SMEs), and some the other sectors impacted by this slowdown,” says Vinay Sharma, fund manager, Nippon India Mutual Fund. 

Adds Nitin Aggarwal, vice-president, research-banking sector, Motilal Oswal Institutional Equities, “With discretionary consumption likely to get affected, loan growth could slow down across segments.” 
 

Many private banks were trading at rich valuations prior to the downturn. “Since credit growth is likely to slow down and gross non-performing assets could spike, investors are unwilling to accord rich valuations to them,” says Jaikishan Parmar, senior equity analyst-BFSI, Angel Broking. This sector, which tends to be heavily owned by foreign institutional investors, has also been hit by their pull-out.  

 

The downturn, however, offers longer-term investors an opportunity to pick quality stocks, which, in calmer times, trade at exorbitant valuations. 

“Indian banks have cleaned up their asset quality over the past few years. Lending standards have become more stringent. While there could be slippages in asset quality and moderation in credit growth, these concerns are adequately reflected in current prices,” says Aggarwal.

The sector’s longer-term prospects remain bright. The penetration of financial products is low in India, which provides ample runway for growth. 

In the past few years, new opportunities have arisen, such as life insurance, general insurance, and asset management companies. Fintech companies could get listed soon. 

However, do not enter expecting a quick turnaround. “Asset quality issues could emerge on loans given in the past.  These could affect earnings for at least three-four quarters,” says Parmar.   

Investors should focus on top-tier banks. “Deposit outflows have been reported from mid-cap banks. This money will flow to larger banks, reducing their cost of funds,” says Aggarwal. 

Insurers may also be considered, as the fear generated by the pandemic could lead to people purchasing more policies. 

Asset management companies may be bought, provided they have not faced issues in their debt funds recently. Be cautious about investing in non-banking financial companies (NBFCs). “Due to the moratorium allowed by the Reserve Bank of India, customers have a choice not to make payments. But these NBFCs still have to pay interest on their own market borrowings. This could create a cash-flow mismatch for them,” says Ankur Kapur, managing partner, Plutus Capital. 

Those with higher risk appetite may opt for NBFCs reliant on gold loans since the price of their main collateral is on the upswing. “Avoid both banks and NBFCs with a higher proportion of unsecured loans and SME loans,” says Parmar.

Investors with at least a seven-year horizon may invest in a banking and financial sector fund having a consistent track record. Avoid those with exposure to the more vulnerable segments mentioned above. Allocation to a sector fund should not exceed 5 per cent of the equity portfolio.