Analysts bullish on NBFCs despite RBI's PCA framework

The Reserve Bank of India's (RBI's) diktat to bring non-banking finance companies (NBFCs) under its Prompt Corrective Action (PCA) framework will be largely neutral for the sector, said analysts, who believe the companies covered under the ambit are already complying with the norms.

"Since most of the listed NBFCs are in compliance with the regulatory provisions mentioned by the RBI in the framework, the move will be neutral for the sector," said Kajal Gandhi, BFSI analyst at ICICI Direct.

The move, she added, was to make NBFCs more vigilant going-forward, and to avoid a repeat of a DHFL or an ILFS-episode. "The RBI wants NBFCs to be alert and not come under the scanner after a default has happened," she said.  

Despite this, shares of NBFCs including HDFC, Bajaj Finance and Finserv, Cholamandalam Finance and Investment, M&M Finance, Muthoot Finance, and Shriram Transport Finance slipped between 1 and 3 per cent intra-day on the National Stock Exchange (NSE) on Wednesday.

The RBI on Tuesday introduced a PCA framework for large NBFCs, putting restrictions on para-banks whenever vital financial metrics dip below the prescribed threshold.

The main parameters would be Capital to Risk weighted Asset Ratio (CRAR), Tier I ratio and Net NPAs including non performing Investments. As per the new guidelines, the PCA will be triggered if CRAR falls 300 bps below the regulatory requirement and Tier I capital falls below 200 bps below the regulatory requirement and Net NPAs go beyond 6 per cent. READ MORE HERE

The framework will come into effect on October 1 2022, on the basis of the financial position on or after March 31. It will be applicable for all deposit-taking NBFCs and other large ones that sit in the middle, upper, and top layers of the central bank's scale-based regulation for the sector.

However, those not taking deposits and with an asset size of less than Rs 1,000 crore, primary dealers, government-owned NBFCs, and housing finance companies are exempt from this framework.

Currently, M&M Financial Services (MMFS) is the only listed NBFC that has net non-performing assets (NNPA) in excess of 6 per cent. Overall, among large NBFCs with asset size more than Rs 25,000 crore, about three entities are in breach of the NPA criterion. However, all these entities have an established parentage, according to an analysis by ICRA.

Deepak Jasani, head of retail research at HDFC Securities, meanwhile, opined that the regulations will be a mixed bag for the sector as it will benefit larger NBFCs.

"The restrictions, if imposed on any smaller player, will weed out competition for bigger NBFCs. Hence, highly capitalized NBFCs, with a good NPA-check mechanism in place, need not worry, while smaller financiers will have to tread carefully from now on," he said.

For G Chokkalingam, founder and chief investment officer at Equinomics Research, RBI's move will hit the NBFCs that are struggling to compete with banks and do not have access to easy funding.

"Further, the return ratios, such as return on equity or return on investment, may decline going ahead if NBFCs decide to raise buffer capital as a precautionary measure," said Kajal Gandhi of ICICI Direct.

From a long-term perspective, however, analysts remain bullish on the sector.

"The PCA being extended to NBFCs may prove to be a good decision for the long-term as it will encourage good practises and is also expected to improve governance. Investors must be careful and must include parameters like NPAs and capital adequacy ratios in their screening criteria and not compromise with any breach in these parameters. Asset quality of an NBFC must be carefully monitored before making investment in it," suggested Vishal Balabhadruni, senior research analyst at CapitalVia Global Research.

Those at Morgan Stanley, too, expect the sector to re-rate in the long-term as NBFCs are carrying excess liquidity on their balance sheets with a balanced asset-liability management (ALM) and conservative borrowings.

"Fixed income markets' exposures to NBFCs have been stagnant in recent years and down significantly from the 2018 peak. There is still significant scope for back borrowing books to reprice lower. Besides, valuations across most NBFCs are below or around average levels which makes them ripe to re-leverage, helped by economic and asset up-cycles," they said in a recent report.