Analysts are positive on the non-banking financial company (NBFC) segment in the long-term, even as their net interest margins are seen compressing in the next few quarters due to a rise in borrowing costs.
“We may see a compression in NBFC margins in the first half of FY24, but that may stabilise or improve in the second half as new loans will be priced at a higher rate than existing ones and this will lift yields higher,” Bunty Chawla, assistant vice president, IDBI Capital Markets and Securities, said.
Additionally, a sustained credit growth will aid the net interest income of non-bank lenders in the long-term, say analysts.
To put things in perspective, stocks of some large NBFCs have underperformed the broader market in the past three months. For instance, shares of marquee Bajaj Finance and Cholamandalam Investment and Finance Co have fallen nearly 18% and 6%, respectively, in the last three months, when the Nifty 50 has risen 5%.
This underperformance is largely due to steep valuations of these lenders, say experts. “Large private banks would look reasonably priced at a price to book of 3 and below if credit growth tracks 15% per annum. Some NBFCs still trade above 4 times price to book and hence look relatively expensive even if growth from here is healthy,” Kedar B, founder, Congruence Advisers, said.
“In an environment where fixed income instruments offer a return of 8% per annum and beyond, investors tend to demand an equity return much higher than 12%. Growth would need to be much higher at good credit quality to meet investors’ expectations on return. We sense that the market is starting to make a distinction between a good business and a good investment,” he said.
During a liquidity crunch, banks are better placed than NBFCs as they tend to have a wider branch network, and this allows them to mobilise low-cost deposits at a fast pace. NBFCs are at a disadvantage because their ability to raise deposits is limited. Also, these non-bank lenders are hamstrung as unlike banks, they do not earn from cross-selling activities, say analysts.
With interest rates rising, NBFCs are expected to see a rise in borrowing costs and this will likely dent their margins. Nevertheless, the potential bottoming of margins by July-September 2023 can be a re-rating trigger for NBFC stocks, said brokerage firm Jefferies.
“It is possible that by the end of 2023, we might see some kind of rate cut happening from the RBI. When that happens, it is going to help NBFCs as well. Currently, the cost of funds is going up and that is why, the margin compression is there. But how I read this is that all this is transient in nature because the system credit growth is very good,” Sanjeev Hota, vice president – head of research, Sharekhan, said. “When system credit is good, growth prospect is good and valuations are reasonable, definitely the NBFC segment will do well in the next 2-3 years. But if growth is lower and valuation is rich, then we might definitely see some correction.”
Specifically, analysts are positive on Cholamandalam Investment and Finance Co, Aavas Financiers, Mahindra and Mahindra Financial Services, and Can Fin Homes.