It has been a nervous few days for investors exposed to banks and non-banking finance companies (NBFCs). The Nifty witnessed 6.4% fall in September lead by fear of liquidity squeeze and events like IL&FS defaults and downgrade, Reserve Bank of India's denial on tenure extension to Yes Bank's Rana Kapoor, and a sharp correction in NBFC stocks basket after reports of a DHFL commercial paper sale by a fund house at a steep discount.
Even stocks of new lenders like Bandhan Bank were beaten down after the banking regulator decided to freeze the remuneration of its MD & CEO, besides curbing branch expansion, after the lender was unable to meet licencing norms on bringing down promoter's stake.
In short, banking and finance sector shares have seen the perfect storm come out of nowhere as Murphy's law played out. The mood is not upbeat. But it's not the end of the world, either. DNA Money tells investors what they should do, if they have banks and NBFC stocks in their portfolio.
A lot riding on banking and finance sector
A lot of investor money is riding on the banking and finance sector. In the benchmark index, Sensex, the market cap of banking and finance stocks is almost 38%. That's more than twice of the next important sector, that is, IT (15.5%). In fact, finance as a sector has an equivalent weight in the index as the combined trio of IT, oil & gas and FMCG.
You might not directly invest in stocks, but your market-linked equity investments in mutual funds and unit linked investment plans (Ulips) are exposed to the finance sector. In MF's equity assets, banking stocks have a 20% weight, while finance has another 10%. Both diversified equity funds and banking & finance sector-specific funds have bet big on this sector.
"It can be a phase. Even some months backs, PSU banks were in a bad shape. At that time, NBFCs and private sector banks were doing really well. There will always be some event or the other. If you trust the conviction of your fund manager, then you don't need to worry too much. After the correction, some of the best private sector banks are attractively poised, even though there was no issue with them specifically in this round," said a fund manager managing one of the biggest banking-focused schemes.
High beta plays
A high beta stock or sector typically does better than the market when there is an upswing. They also perform worse than the market when there is a slide. For example, the Sensex and the Nifty fell over 6% in September, but the finance sector indices declined about 13% in the same period.
But why are banking and finance stocks high beta plays? Some say finance firms offer high growth, so they are more volatile than the market. Others say that finance firms are preferred by momentum chasers, so the stocks display the behaviour exhibited by investors.
The equity market view is not bullish by any standards, especially for the near-term. According to a report by Edelweiss Private Wealth Management, although some healthy growth in earnings was seen last quarter, earnings downgrades still abound. A sustained recovery in earnings is needed to support the high valuation of Indian equities, which remain overvalued compared to their peers in the emerging markets. "We expect headline indices to face increasing odds of a deep correction of 10% or more or be range bound at best. We revise our Nifty target range to 11,500-12,000 for December 2019," the report said.
Earnings wise, banks are not badly placed. PSU banks look like they are out of the woods. PNB, hit by the Nirav Modi and Mehul Choksi scam, is expecting a turnaround. Corporate banks are also getting their act together. For instance, Axis Bank will see HDFC Life Insurance's chief executive officer Amitabh Chaudhry assuming charge as MD&CEO for a three-year term starting January 1, 2019. Retail focussed banks should report healthy teen earnings growth in the upcoming earnings season, said Pankaj Murarka, founder, Renaissance Investment Managers. "Corporate banks will continue to witness sequential improvement in earnings driven by lower provisioning cost," he pointed out.
RBI rate hike risk
Private sector banks and NBFC stocks have done well because of two factors. One is retail credit growth. Two, especially pertaining to NBFCs, is liquidity, due to which many have borrowed in the short-term to lend in the long-term.
NBFC stocks have dual challenges facing them now. Firstly, generally, banks are understood to be getting reluctant about lending to NBFCs, which means the NBFC sector will need to tap other sources and thereby see higher fund-raising costs. Two, the RBI is anticipated to come out with an interest rate hike after its October 4 monetary policy meeting. The rupee has been extremely weak (it's among the worst-performing currencies globally) and the rising crude oil prices are heightening inflation risk. Benign interest rates have fuelled credit growth and retail loan demand.
If the rates inch up again, that demand will be hit. Consequently, finance sector earnings will be under the cloud. Many fund managers are hoping against hope. "Raising rates, in a domestic liquidity freeze, is counter-productive when the financial system is under stress. To design policy around global flows is a massive risk, particularly when the flows are really driven by factors outside domestic control, that is, U.S. strength and Fed liquidity withdrawal. We hope the RBI will focus on the needs of the domestic market. FI flows will return when the economy demonstrates stability, growth and attractive investment opportunity. Raising rates will exact a toll on domestic consumers, businesses and banks, something we can ill afford at this juncture," said Sunil Sharma, chief investment officer, Sanctum Wealth Management.
What should investors do
The financial services sector has entered turbulent times after a phase of strong lending growth, particularly in NBFCs and housing finance companies (HFCs). Given this situation, experts are advising investors to play it safe with direct equity investments. Stick to large banks is the advice. "Improving competitive edge, owing to rising interest rates and tighter liquidity, is seen tilting the tide towards large banks with high CASA (low cost deposits such as savings and current accounts). Overall, the banking sector seems to be near the peak of asset quality woes, with a gradual recovery seen ahead. Hence, we prefer businesses with a robust operating model, strong and stable franchise, both on the asset as well liability side, and strong management. We recommend avoiding smaller HFCs having large loan against property (LAP) exposure, along with ALM (asset liability) mismatches and weak pricing power," said a report by ICICI Securities - retail equity research.
Apart from being under-weight on PSU banks, Emkay is also cautious on NBFCs. "We also retain our cautious stance on NBFCs as the prevailing liquidity crisis is expected to continue. As a result of the hardening in market yields and the widening in credit spreads, NBFCs' margins and their growth prospects are likely to remain under pressure. We prefer NBFCs with strong corporate-promoter backing (to garner confidence among lenders) and superior ALM profiles," said Dhananjay Sinha, Head, Institutional Research, Economist and Strategist, Emkay Global Financial Services.
RISK OR HIGH GROWTH?
- 38% - Market cap of banking, finances stocks in Sensex
- 13% - Fall in finance sector indices in September
- 6% - Fall in Sensex, Nifty in September
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