NBFCs Tank 5-10% on Tighter AIF Norms

RBI’s Tighter Alternative Investment Fund Rules Lead to Sell-off in NBFC and Bank Stocks

Overview

The Reserve Bank of India (RBI), India’s central bank, has released new rules that restrict non-banking financial companies (NBFCs) and banks from investing in certain types of alternative investment funds (AIFs). AIFs are privately pooled investment funds in India that invest in areas like real estate and infrastructure.

Key Changes

The key change is that NBFCs and banks can no longer invest in AIFs that have exposure to “debtor” companies – companies that owe money. If an NBFC or bank has already invested in such an AIF, they need to either sell their stake within 30 days or set aside 100% of the investment amount as a financial provision or reserve.

Impact on Retail Investors

Short-Term Impact

The new RBI rules on AIF investments will negatively impact retail investors in NBFCs and banks in both the short and long term. In the short term, stock prices have already declined significantly – dragging down overall portfolio values.

The rules can lead to NPAs being recognized faster – resulting in higher credit costs and provisioning expenses. This will hurt profitability and lead to poor quarterly results in the coming months. Valuation multiples can contract further if the market assumes asset quality issues are more pervasive than previously thought.

Long-Term Impact

In the long run, NBFCs and banks will need to reassess funding channels to weaker companies. Earlier debt funding was being masked under complicated structures like AIF investments. With that route shut, overall credit availability may reduce. This means future earnings growth could be lower than expected – further impacting stock price upside.

Overall, retail investors should avoid buying into the sell-off indiscriminately. Carefully evaluate balance sheet strength before investing more into companies directly impacted by this change. Closely track upcoming quarterly results and guidance as the true impact will become clearer over the next few quarters.

Impact on Industries

Short-Term Impact on Industries

The tightened AIF investment norms can negatively impact short-term funding availability for certain industries more reliant on NBFC and bank debt like real estate, infrastructure and structured credit providers.

With NBFCs forced to liquidate holdings in AIFs with exposure to debtor companies, overall funding to already stressed sectors may decline further. Banks could also turn more risk-averse in lending if uncertainty rises over the true asset quality of existing loans and potential NPAs.

Industries Most Affected

Industries anticipated to be more severely impacted include:

Commercial Real Estate

Builders and developers will face higher borrowing rates due to perceived higher risk. Slowing construction can negatively impact employment and growth in ancillary sectors.

NBFCs

Structuring arms like Edelweiss, IIFL which pool credit assets into funds will need new operating models. They also face mark-to-market losses in existing holdings.

Infrastructure & Structured Debt Financing

A vital sector but often has higher leverage and uncertainty in project cash flows/repayments. Banks were lending via AIF structures which get choked.

However, more transparent recognition of bad loans will benefit the industry ecosystem in the long run. Capital can get redeployed more efficiently once weak balance sheet issues are tackled upfront. Stronger companies may gain market share. Overall lending discipline is also enhanced.

Long-Term Benefits & Negatives

Potential Long-Term Benefits

1. More prudent lending standards as risk management frameworks in banks/NBFCs are shored up to better flag vulnerable loans. Will reduce system-wide risk from over-leverage or funding misuse.
2. Build confidence in credit culture as debtor loans recognized more accurately as NPAs instead of being hidden under complicated structures enabling evergreening.
3. Market leader banks/NBFCs will emerge stronger once sector consolidation happens across next 3-5 years due to tighter norms.
4. Redirect capital from over-heated sectors like real estate to more productive uses which support the real economy over the long term.

Potential Long-Term Negatives

1. Sustained higher provisioning costs as banks/NBFCs recognize more NPAs already hidden under restructured AIF investments gradually over several quarters. Will negatively impact earnings and thus valuations until issues are fully accounted for.
2. NBFC funding channels get permanently choked for some sectors like structured credit, hurting their access to capital for business growth. Will negatively impact India’s aim to fund infrastructure growth.
3. If unchecked, credit availability may get impaired for an extended period until trust is rebuilt between lenders, regulators and industry. Can reduce GDP growth estimates until balance is restored.

Short-Term Benefits & Negatives

Short-Term Benefits

1. Proactive financial provisioning for potential asset quality issues yet to manifest into NPAs for loans underlying AIF exposure being asked to be marked down or sold off immediately.
2. Create urgency for banks with weaker underwriting standards to strengthen risk frameworks, preventing bigger issues further down the line.

Short-Term Negatives

1. Share prices and market values for NBFCs and banks have already declined 5-10% within a day of the news on panic selling over earnings hit fears. Retail investors suffer portfolio losses.
2. Will sharply increase cost of capital in the next 6 months for vulnerable sectors like real estate, infrastructure where funding channels now choked. Companies already facing cash flow issues will get into further difficulties to refinance existing obligations.
3. Until clarity emerges on the extent of money already deployed via AIF structures to evergreen loans, overall lending appetite will remain subdued given questions over unaccounted asset quality issues in the system.

NBFCs Impacted by Tighter AIF Norms: Potential Winners and Losers

Indian Companies Potentially Losing:

• NBFCs with high AIF exposure and builder loan exposure:
  • Piramal Enterprises: Mentioned in the article with a 5-10% stock drop, likely due to significant AIF investments and potential builder loan issues.
  • Indiabulls Housing Finance: Similar concerns about AIF exposure and potential stress in their builder loan portfolio, leading to a 5-10% stock decline.
  • Edelweiss Financial Services: Another mention in the article with a 5-10% drop. AIF exposure and possible builder loan problems could be impacting sentiment.
  • Other similar NBFCs: Smaller names with significant AIF and builder loan exposure might face even greater scrutiny and potential losses, leading to negative market sentiment.
• Small Banks with AIF exposure:
  • While large banks are less likely to be heavily invested in AIFs, smaller banks might face challenges liquidating existing investments or making provisions, potentially impacting their financial performance and stock prices.

Indian Companies Potentially Gaining:

• NBFCs with strong fundamentals and limited AIF exposure:
  • Companies like HDFC Ltd., Bajaj Finance, and Cholamandalam Financial Holdings Ltd. have minimal AIF exposure and strong risk management practices, positioning them as potential beneficiaries of increased focus on financial stability.
  • Their stocks could be seen as safer havens by investors seeking refuge from the uncertainties surrounding AIF-exposed NBFCs.
• Other Banks with limited AIF exposure:
  • Larger banks with strong financial positions and minimal AIF involvement might benefit from investor concerns shifting towards safer options in the banking sector.

Global Companies:

• Limited impact: This regulatory change mainly affects domestic NBFCs and banks. However, global investors with holdings in Indian equities might be cautious towards AIF-exposed companies, potentially impacting overall market sentiment.

Remember, this analysis is based on the available information and the actual impact on individual companies can vary depending on factors like their specific AIF exposure, financial performance, and management response to the new regulations.

Investors should carefully assess individual company fundamentals before making any investment decisions based on this news. Consulting a financial advisor for personalized advice is always recommended.

I hope this analysis is helpful! Let me know if you have any other questions.

Proper citation: ET Bureau (2023, December 21). NBFCs Tank 5-10% on Tighter AIF Norms. The Economic Times.