Non-banking finance companies' mess: Cash-strapped firms haven't seen the worst of liquidity crisis yet

There is no non-banking finance companies (NBFC) crisis, but we should be worried. It may be just around the corner and we cannot afford one. Is there going to be a liquidity crisis in the debt markets this week on in the next? Many analysts have suggested that non-bank finance companies as a group are on the cusp of a series of defaults that could send all other markets – including equity markets – into a tailspin. The reason? A lot of short-term NBFC debt is falling due, analysts say that will not be rolled over, and NBFCs don’t have the cash to meet repayment obligations. The data suggests a system-destabilising crisis is unlikely: At least in the immediate future. This is not to say that all is well in the NBFC universe. Far from it. There will be entities that face a severe liquidity crisis, and regulators may have to step in to maintain market confidence in the viability of NBFCs as integral parts of the financial system. Like other parts of the financial system, NBFCs are not homogenous, but exist in a variety of forms: Asset financing, core investment, housing finance, retail/consumer, microfinance, vehicle finance and last but not least, infrastructure finance companies. Each type is structurally different, on both the asset and liability sides.

Separating the vulnerable from the solid requires looking at the two sides separately; a company vulnerable on the asset side may not be vulnerable on the liability side. The current nervousness in financial markets is focused more on the liabilities side of the balance sheet, on asset-liability mismatches, and sources of funds.

To understand that better, a brief review of the landscape is in order. [caption id=“attachment_5502681” align=“alignleft” width=“380”]  Representational image. Reuters[/caption] At the end of March 2017, there were over 11,400 NBFCs; but in reality, only about 220 matter (that number is now 249). These are what the Reserve Bank of India (RBI) classifies as systemically important, non-deposit taking (SI-ND) companies. Of these 15 are government-owned companies; think Power Finance Corporation, Rural Electrification Corporation, Indian Railway Finance Corporation, IFCI, India Infrastructure Finance Corporation, among others. Of the remaining number, 100 are private limited companies that aren’t listed on the stock exchanges; the rest are, and their stock prices have been behaving like yo-yos. These 220 companies accounted for over 86 percent of the total assets held by all NBFCs. The Reserve Bank of India (RBI)’s Trends and Progress in Indian Banking Report 2016-17 shows that at end March 2017, NBFC assets were about Rs 16.92 lakh crore. The number for end-March 2018 is estimated at Rs 22.1 lakh crore. Let’s parse the data a little further: In FY17, the 15 government companies accounted for 37 percent of total assets or roughly Rs. 6.28 lakh crore. The 100 private limited or unlisted companies accounted for Rs. 2.37 lakh crore, leaving about Rs. 8.27 lakh crore on the books of listed companies. Lastly, who did they lend to? Industry accounted for 60 percent, vehicles and retail lending amounted to another 23 percent. Asset financing, microfinance etc accounted for the remainder. The RBI report also show that gross NPAs among NBFCs were 5.8 percent or half that of the banking system. On the asset side, at least, things seem stable.

On the flip side, where do NBFCs get their funds from? Three main sources: debentures and bond issues, bank borrowing and commercial paper. That’s a mix of long-term money, working capital and short-term money for managing liquidity. The other ways NBFCs replenish their finances is through repayments and securitising payables like vehicle loans and consumer loans, even housing loans, and selling those in the money markets.

In 2017-18, NBFCs were the largest net borrowers from the financial system; they received about Rs 7.17 lakh crore – a third of that from mutual funds, about 44 percent from banks and 19 percent from insurance companies. Roughly Rs 1.57 lakh crore of that was short-term, or payable within a year. Commercial paper, or CPs, accounted for half of that or roughly Rs 78,000 crore. Mutual funds have been a particularly good source of finance for NBFCs. Sadly, NBFCs they may not have reckoned with the structure of mutual fund/asset management company liquidity. Here’s why it matters. At end-March 2018, on an assets-under-management (AUM) basis, corporates and HNI’s account for 74 percent (43 and 31, respectively) of mutual fund assets, with 25 percent held by retail investors. 80 percent of corporate investments is in debt and liquid schemes, and about 44 percent of HNI money is also in debt/liquid funds. Retail investors hold 72 percent of their investments in equity schemes, thanks to the burst in SIPs. The problem: When AMS/MF investors face redemption increases that outpace new inflows, they don’t roll-over their investments (mostly CPs) which puts a large number of NBFCs at the mercy of a slightly toxic combination of interest rate and liquidity risk. The CP market – a perennial favourite with AMC/MFs – is also a proxy for NBFC liquidity. From 1 April to 30 September 2018, CP issuances on a net basis amounted to about Rs. 1.75 lakh crore (issuances of Rs. 13.6 lakh crore, repayments Rs. 11.8 lakh crore). In April, yields ranged from 6.5 percent to 14 percent; at end-September the range narrowed, but the lower end went up to 6.84 percent. which means they just got expensive. All of this has been building up over the last 6-12 months; plus, banks have rediscovered their appetite for lending directly to industry rather than through NBFCs. Add the fact that Infrastructure is plagued with delays, and that there is no great appetite for long-term corporate bonds. So could we have predicted this earlier? Perhaps, particularly if we looked at returns that NBFCs are expected to file with the RBI. Of particular interest is one specific set of returns: The statement of structural liquidity, in particular the statement of short-term dynamic structural liquidity. This return requires asks NBFCs to list their receivables and payables by periods of less than 30 days, monthly, quarterly and half-yearly. That tells us the asset-liability gap, and the sources of funds will help assess the ability to manage that gap effectively and well. Perhaps they may have even warned the markets about the storm clouds that were building. But too many believed that NBFCs could solve the credit flow problem to industry better than banks. They didn’t see any NPA problem, and missed the liability gap problem. The bad news may not be over yet. There is one other factor that may change the NBFC picture a little more: The new accounting standard Ind AS, that became effective on 1 April 2018. The new standard replaces a system based on guidelines and rules to one based on principle. But as the central bank itself has pointed out, it is too early to arrive at any conclusion on its impact on balance sheets. It is, however, one more complication that the NBFCs and markets have to deal with. The timing is not great either. It comes at an unstable time, and stretches from outside our borders (felt through the exchange rate), through the heartland of India (beset by political uncertainty) and within tense policymaker relationships (disagreement on ways and means).  As the Chinese proverb has it, NBFCs are living in interesting times. (The author is a senior journalist and communications consultant)