The financial sector has massively underperformed the broader
markets in past three months. A number of experts have called for increasing
exposure to this sector in view of this underperformance. They have argued that
valuations are now discounting the worst in terms of COVID-19 related
delinquencies and the economic activity shall normalize in next 2-3 quarters.
The consensus amongst experts is veering towards outperformance of the sector
in next 12-15 months. It appears that many non institutional investors are in
agreement with the experts' opinion and have increased their exposure to the
banks and NBFCs, especially the low priced ones.
I would like these investors take note of the following data
points while increasing their exposure to the financial sector in India.
(a) The capacity
utilization of Indian enterprises peaked at 83% in 2011 and has ranged between
70-75% since then. It declined to below 70% in 2QFY20, much before the COVID-19
induced lockdown took place. The business sentiment is at multi year low,
indicating that businesses do not see any sustainable rise in capacity
utilization and need for capacity addition in short term.
Consequently, the project announcement has declined in past five
years, from 17% of GDP in 1QFY16 to about 5% of GDP in past 4 quarters. The
project completion rate has also declined materially.
This does not augur well for credit growth in the short term.
Any growth in credit demand will come from mostly from consumption and working
capital requirement. The quality of credit shall therefore remain under
pressure, and ALM issues will persist.
(b) Consumer confidence is
at lowest since 2013, and the employment outlook has worsened materially. This
shall keep the fastest growing credit category (personal loans) under check as
the borrowers' credit profile deteriorates.
(c) The liquidity in the
system is surplus, and it is likely to remain so in the short term. The call
money rates are now closer to reverse repo rate, rendering overnight market
competing with RBI.
Besides, the bond yields are now below bank lending rates, even
though the benchmark G-Sec yields are well above the policy repo rate. This
shall pressurize banks to liquidate some of their excess SLR portfolios and
lend aggressively in the market. The pressure on return ratio may increase
while the credit quality remains under pressure.
(d) MF as source of
corporate funding (especially working capital and promoter equity) has come
under pressure due to a spate of defaults in past one year. This could bring
some short term financing business back to banks. But the events of moratorium
in case of Yes Bank and PMC Bank have left scare in the memories of depositors.
They are increasingly veering towards larger banks, especially large PSBs. The
cost of funds for smaller private banks may therefore rise in the short term.
(e) The mutual funds and
banks are wary of lending to non AAA rated borrowers, especially NBFCs. The
cost of funds and availability of growth capital may remain a major constraints
for these NBFCs, at a time when the delinquencies are expected to rise once the
loan moratorium ends in August.
Personally, I would exercise little extra caution in making
fresh investment in any financial stock. For asset allocation discipline, I
shall stick to top 4 banks and top 4 NBFCs.
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