Is this India's Sub-prime moment?
Ever since the IL&FS crisis hit the Indian markets in Sep'18, several things have changed for the NBFCs (Non-Banking Finance Companies), Banks and investors in debt mutual funds. This blog looks at the core problem and resulting implications for retail investors!
Background
NBFCs are non-deposit taking organizations that are known to reach channels not easily accessible by banks for lending. NBFCs primarily takes loans from banks and instituitional investors such as Mutual Funds & Insurance companies at say 10% and lends it to businesses such as MSMEs, Real estate builders etc at say 14%. They make 4% (14% - 10%) of the entire loan disbursed, provided such loan gets repaid. Similar to banks, unpaid loans get classified as NPAs (Non-Performing Asset). NBFCs must also set aside money from their profits to cater to such NPAs (called Provisioning).
The Stats
Per RBI, as of Mar'18, total bank deposits in the country stood at Rs.117Tn (Lac crores), with NPAs of Rs.10Tn. In comparison, NBFCs are small, with total (payables) of Rs.7.17Tn, which they borrowed from Banks (44%), Mutual Funds (33%) and Insurance companies (19%).
When the bank NPAs started bloating in India in 2013, banks curtailed their direct lending to MSMEs and real estate builders. Borrowers who were turned down by banks went to NBFCs for funds. As a result, NBFCs, which had a total payables of Rs.3600 cr (2014-15) grew 20 times to Rs.74000 cr in 1 year (2015-16) and 10 times to Rs.7.17 Lac cr in 2018. This led to a boom in the NBFC sector in India from 2015-2018.
India's sub-prime moment?
Banks are in the business of lending, so when an NBFC approaches them for funds, they have a stipulated process of due diligence (at least on paper) prior to lending. On the other hand, Mutual Funds are not in the business of lending - they are in the business of buying/selling bonds and CPs (Commercial Papers with short 90 days maturity) on behalf of the debt/liquid funds in their portfolio.
But as MFs got easy money (after demonetization), they lent rampantly to many businesses without adequate checks/due-diligence on the borrower. Only when the first of such borrowers (IL&FS) defaulted on its interest & principal repayment, everyone woke up. Reminds us of a stricking similarity with the US sub-prime phenomena!
Implications for Retail Investors!
Savers and investors put their money in banks, mutual funds and insurance policies. These instituitions lend our money to NBFCs, which in turn lends it to Realty developers (10,000 developers in the country, only 35 are listed). NBFCs funding to realty developers now stands at Rs.4Tn (out of their total Rs.7.17Tn). These realty companies are unwilling to reduce the home price to market equilibrium and clear their inventory. Current unsold home inventory across 8 major cities in the country is estimated to be Rs.7.7Tn. As a result, projects are delayed and these companies end up defaulting on both the interest & principal.
In turn NBFCs work out "no-repayment" deals with banks and MFs. After 6 months, if the builder goes bust, banks will classify the loan as NPAs & MFs will write off such debts. In turn government ends up capitalizing the banks with tax payers money, investors in MFs settle for lower returns on their funds and insurance policy holders will not even know whatz happening until their policies mature after 10-20 years!
Solution
Lets face it, this is a systemic risk, that cannot be avoided or eliminated by shunning a class of products such as bank deposits or debt MFs. As prudent investors, staying with short duration, high quality funds would help mitigate your risk(s). Also, periodically monitor if your fund invests in any one company in a concentrated manner (not more than 5% in one company's papers). By following such practices, you may be able to provide downside protection to your portfolio!
Background
NBFCs are non-deposit taking organizations that are known to reach channels not easily accessible by banks for lending. NBFCs primarily takes loans from banks and instituitional investors such as Mutual Funds & Insurance companies at say 10% and lends it to businesses such as MSMEs, Real estate builders etc at say 14%. They make 4% (14% - 10%) of the entire loan disbursed, provided such loan gets repaid. Similar to banks, unpaid loans get classified as NPAs (Non-Performing Asset). NBFCs must also set aside money from their profits to cater to such NPAs (called Provisioning).
The Stats
Per RBI, as of Mar'18, total bank deposits in the country stood at Rs.117Tn (Lac crores), with NPAs of Rs.10Tn. In comparison, NBFCs are small, with total (payables) of Rs.7.17Tn, which they borrowed from Banks (44%), Mutual Funds (33%) and Insurance companies (19%).
When the bank NPAs started bloating in India in 2013, banks curtailed their direct lending to MSMEs and real estate builders. Borrowers who were turned down by banks went to NBFCs for funds. As a result, NBFCs, which had a total payables of Rs.3600 cr (2014-15) grew 20 times to Rs.74000 cr in 1 year (2015-16) and 10 times to Rs.7.17 Lac cr in 2018. This led to a boom in the NBFC sector in India from 2015-2018.
India's sub-prime moment?
Banks are in the business of lending, so when an NBFC approaches them for funds, they have a stipulated process of due diligence (at least on paper) prior to lending. On the other hand, Mutual Funds are not in the business of lending - they are in the business of buying/selling bonds and CPs (Commercial Papers with short 90 days maturity) on behalf of the debt/liquid funds in their portfolio.
But as MFs got easy money (after demonetization), they lent rampantly to many businesses without adequate checks/due-diligence on the borrower. Only when the first of such borrowers (IL&FS) defaulted on its interest & principal repayment, everyone woke up. Reminds us of a stricking similarity with the US sub-prime phenomena!
Implications for Retail Investors!
Savers and investors put their money in banks, mutual funds and insurance policies. These instituitions lend our money to NBFCs, which in turn lends it to Realty developers (10,000 developers in the country, only 35 are listed). NBFCs funding to realty developers now stands at Rs.4Tn (out of their total Rs.7.17Tn). These realty companies are unwilling to reduce the home price to market equilibrium and clear their inventory. Current unsold home inventory across 8 major cities in the country is estimated to be Rs.7.7Tn. As a result, projects are delayed and these companies end up defaulting on both the interest & principal.
In turn NBFCs work out "no-repayment" deals with banks and MFs. After 6 months, if the builder goes bust, banks will classify the loan as NPAs & MFs will write off such debts. In turn government ends up capitalizing the banks with tax payers money, investors in MFs settle for lower returns on their funds and insurance policy holders will not even know whatz happening until their policies mature after 10-20 years!
Solution
Lets face it, this is a systemic risk, that cannot be avoided or eliminated by shunning a class of products such as bank deposits or debt MFs. As prudent investors, staying with short duration, high quality funds would help mitigate your risk(s). Also, periodically monitor if your fund invests in any one company in a concentrated manner (not more than 5% in one company's papers). By following such practices, you may be able to provide downside protection to your portfolio!
Nice article on nice topic.
ReplyDeleteIf any one want to apply for quick business loans with us and get them from top business loan providers, and use the funds for overall growth & development of your business? Contact Finfree
Thanks for such a useful content, it is useful for many traders Forex trading tips
ReplyDeleteHi Ms. Lalitha, your insight is apt and the article touches a chord in me because I also was worrying on the same lines. What exactly are the solutions to ordinary investors? Liquid funds?
ReplyDeleteThank you Mam. Liquid or Ultra-Short or Short Term bond funds with high quality and low concentration (<5% in a single company) could be used as low risk avenues. Of course, monthly fact sheets of funds needs to be closely monitored!
Delete