Investors are concerned about the risk of higher loan defaults at MFIs and NBFCs with rural exposure owing to recent farm loan waivers and demand for waivers in more states. The state government of Uttar Pradesh announced a farm loan waiver in April and the Maharashtra government has announced one in June. These loan waivers apply only to loans by banks which in due course will get compensated by the respective state governments. However, the concern is risk of ‘moral hazard’ i.e., willful defaults by borrowers.
Investor concerns are reflected in the stock underperformance of BHAFIN and MMFS in our coverage, since the Maharashtra announcement. We agree with the moral hazard risk from rural lending for lenders and will need to wait and see how it impacts second order NPL formation. However, in our view, the impact is likely to be greater for banks with large unsecured farm loans and less for secured loans or Joint Liability Group Lending.
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With newsflow on farm loan waiver likely to continue, stocks will be volatile. Then why remain OW these stocks, especially BHAFIN given unsecured nature of the product? We will know the exact impact of farm loan waivers on these businesses only with a lag. But management commentary and initial data points suggest no material impact. Feedback from these companies suggests that historically there has been little negative impact of such waivers: Per BHAFIN, its collections continued to improve even following the UP announcement. Per our discussions with MMFS management also, MMFS saw no meaningful impact from 2009 farm loan waiver. Management attributes this to awareness among borrowers regarding applicability of farm loan waivers and option with MMFS to repossess vehicle in case of default.