Amid underlying asset quality concerns and risk aversion due to a spate of high-profile defaults, mutual funds are cutting down their exposure to debt instruments of non-banking financial companies (NBFCs).
According to SEBI data, total exposure of mutual funds to the NBFC sector fell to ₹1.38-lakh crore as on July 2020 from ₹2.04-lakh crore for the same period last year. The exposure was ₹2.65-lakh crore in July 2018.
“The last one to two years has seen heightened risk aversion among both AMCs and debt mutual fund investors on the back of defaults by a few NBFCs such as IL&FS, DHFL, Altico Capital, Reliance Home & Commercial Finance, Reliance Capital, and Morgan Credit,” Sachin Jain, MF Analyst at ICICI Direct, said, adding, “Many top NFBCs also saw rating downgrades. This is one of the major reasons why mutual funds are shying away from lending to lower-rated NBFCs.”
But the exodus of investment seems to be for good.
“NBFCs have a model of raising money through commercial papers (CPs) on shorter tenure at cheaper rates and then lend it for longer tenures at higher rates,” an analyst at Emkay Global Financial Services said, adding : “These are at superior spreads. So, they kept accelerating the loans on the assumption that they will continue to get short-term money consistently from all the mutual funds.”
Consequently, mutual funds’ exposure in CPs of non-banking lenders fell by 68 per cent to ₹51,268 crore as of July 2020 from a high of ₹1.58-lakh crore in July 2018.
“All this got completely busted the moment IL&FS defaulted. The risk profile of most NBFCs started increasing So, mutual funds turned cautious, not (wanting) to lend to them, specifically those below AA rating,” the analyst added.
As mutual funds continued to tighten their purse strings, many NBFCs also diversified their borrowing portfolio and to bridge their asset-liability mismatch more efficiently with long-term borrowings from banks and overseas borrowings in the form of external commercial borrowings (ECBs) or by issuing foreign currency convertible bonds (FCCBs) in the international capital markets.
For instance, bonds, as a percentage of total borrowings of Shriram Transport Finance Company (STFC) fell from 31.72 per cent in June 2018 to 22.03 per cent as of June 2020, while the share of CPs fell more sharply to 0.21 per cent from 6.09 per cent during the same period. On the other hand, foreign currency borrowing of STFC swelled from a mere 0.71 per cent in Q1FY19 to 17.77 per cent in Q1FY21.
Take the case of vehicle financing NBFC Magma Fincorp. The company’s source of liability between banks and debt capital market stood at 82-18 ratio in Q1FY21, compared to 68-32 ratio in Q1FY20.
“Most of the NBFCs’ borrowing profiles are shifting to relatively more secured and longer-tenure borrowings, such as bank borrowings, against shorter-tenure CPs and NCDs,” the Emkay Global analyst said, adding, “Because of the certainty of longer-tenure borrowing, the risk of defaults has largely come down but the cost of funds will be higher and most of the NBFCs’ margins are squeezed in the last 12 months.