NBFC - Safety in quality - Navigating uncertain interest rate cycle - Antique

In response to the recent currency depreciation and the subsequent liquidity tightening measures taken by RBI, the short term rates in money markets have spiked 100-150bps. These developments jeopardize the expected reversal of interest rates over FY14 and increase the risk of an elevated interest rate regime continuing through FY14. Given the wholesale funded nature, NBFCs with ALM mismatches in the near term could face margin pressures. NBFCs with strong capital position, minimal ALM mismatch in the near term and some degree of pricing power on the asset side remain well placed to navigate such an environment.

Within the asset finance NBFCs, Bajaj Finance is our preferred pick given strong capital position and relatively better pricing power in its consumer business. In the small HFC space, Repco Home Finance & Gruh Finance are well positioned given the strong capital position, relatively better pricing power on the asset side and large contribution from NHB.

Near term ALM mismatches to weigh on margins, asset pricing power key to margin stability

NBFCs running near term ALM mismatches could witness some pressure on their margins as they will have to re-finance maturing liabilities at current elevated rates. Among asset financiers, Mahindra Finance & Bajaj Finance have a relatively well matched ALM profile for the next twelve months. All housing finance companies run a positive ALM mismatch due to the inherent nature of their business. However, availability of NHB re-financing limits the risk non-availability of funds for small HFCs. On the asset side, only the asset financiers and small HFCs have reasonable pricing power to pass on the increased borrowing costs and protect their long term margins.

Pressure on repayment capacity of underlying assets for infra financiers

Currency depreciation and resultant increase in interest rates is bound to impact the power sector in form of higher fuel costs and increased debt servicing costs. Revival of capex demand looks even more distant and financial stress for SEBs as well as private power developers could culminate into fresh asset quality trouble form PFC, REC and to a lesser extent for IDFC.

Capital position key to minimize risk perception, defensive positioning warranted

With an exception of Cholamandalam, Dewan Housing, LIC Housing and Muthoot Finance, other NBFCs have comfortable capital position. In the wake of recent developments, we shift our preference to NBFCs with strong capital position, minimal ALM mismatches in the short term and pricing power on the asset side. Bajaj Finance, Repco Home Finance & Gruh Finance are our top picks in the NBFC space. Mahindra Finance also fits the bill but rich valuations leave little upside while Shriram Transport is available at attractive valuations but asset side slowdown and regulatory risks on securitization / NPA recognition front poses downside risk to earnings.

Source : Equity Bulls

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