The non-banking financial company (NBFC) sector has been under pressure due to rising cost of funds, which have gone up for most and that is one of the reasons why these stocks have been under pressure. In the past 12 months, major NBFCs have cracked 40-50 per cent under pressure. With interest rates expected to peak over the next few months, analysts say that it’s time to look at fundamentally stronger players.

Over the past few months, NBFCs have had to accept stricter rules and appear to be on even keel with banks on how they classify assets and bad loans. The double whammy has come in the form of the nervous macro environment in India where sustained tightening and rise of rates by the Reserve Bank of India (RBI) stymied credit growth. This has also expanded the risk of bad loans, especially, for those NBFCs that have concentrated portfolios in the areas of power, construction or even infrastructure.

Spotlight on infra NBFCs: According to Dinesh Shukla, research analyst (banking) at Sharekhan, as interest rates have gone up significantly, the cost of funds have shot up leading to margins pressures. In addition, the limited ability to pass on rates to borrowers (especially vehicle fin­ance companies) and growing asset quality risks have slowed down business gro­wth. The fund-raising process for fresh ca­pital has also become difficult for NBFCs due to extremely tight liquidity that has pushed costs to unreasonable levels.

Earlier, RBI had raised concerns on strong growth in banks’ exposure to the NBFC sector, which has impacted bank funding to NBFCs. Further, the fresh set of regulations by RBI on capital adequacy, securitisation and asset classification, among others, will impact the performance of NBFCs.

“The mortgage finance companies have done relatively better, but rising reality prices and National Housing Bank’s recent circular could impact the earnings outlook. On the other hand, infra NBFCs (REC, PFC, IDFC) are plagued by asset quality concerns due to ongoing issues in infra projects (power sector),” said Shukla. The recent trend in results shows the strain among strong NBFCs that were hit by forex losses. Rural Electrification Corporation (REC) reported a Q2FY12 net profit of Rs 620 crore, which was flat in year-on-year (y-o-y) terms. Owing to adverse currency movement, REC booked foreign exchange losses of Rs 120 crore during the quarter, dragging down the bottom line. PFC’s net profit fell by 40 per cent y-o-y to Rs 420 crore, in line with estimates and also due to forex losses on unhedged forex loans. While its loan growth picked up by 26 per cent, top line growth lagged behind due to compression in margins. Only IDFC (Infrastructure Development Finance Company) 2QFY12 profit rose by 55 per cent y-o-y to Rs 524 crore, led by higher profit from sale of investments worth Rs 260 crore. Being largely wholesale-funded makes IDFC’s funding costs very sensitive to rate cycles. However, infrastructure NBFC s’ status has provided some buffer in terms of increasing the mix of cheaper overseas borrowing and picking up of tax-free retail bonds from the market, analysts said.

Housing finance NBFCs: In this segment, after HDFC, the second largest firm is LIC Housing Finance. However, analysts feel its prospects are quite dull. Pankaj Agarwal of Ambit has initiated coverage on this stock with a sell and estimates an over 15 per cent downside.

“While we continue to believe that LIC Housing Finance is a robust franchise given the competitive advantages on both sides of the balance sheet, its present valuation appears to more than factor in these strengths, even as cyclical pressures impacting growth and margins, coupled with regulatory changes, could lead to muted 8 per cent earnings CAGR over FY11-FY13,” said Agarwal.

Margins of housing finance NBFCs appear to be under threat for those with falling incremental spreads. In addition, a bigger fixed rate portfolio in a high interest rate environment, lower proportion of high-yield developer portfolio, coupled with increased borrowings are challenges.

Hire purchase and lease NBFCs appear weak: Shriram Transport (SHTF) recorded a muted performance for 2QFY12, which was well below market consensus. Higher provisions for NPAs dragged down performance. The management has attributed the sharp increase in provisions to the sudden deterioration in the performance of assets that were deployed in Karnataka for transporting iron ore. But, most importantly, the company’s management lowered the guidance for disbursement volumes sharply.

Mohan Swamy, head of research at RBS Equities, believes that financing de­mand in the auto sector is headed for cy­clical moderation driven by high interest rates, fuel costs and a weak economic outlook. That said, RBS has recently initiated coverage on another auto financier Ma­hindra Finance on the back of continued demand buoyancy in its core rural market, diversified loan book and low regulatory risks compared with other NBFC peers.

With more than 30 per cent correction since its October 2010 peak, Shriram Transport Finance’s regulatory risk appears to be priced in, but could remain an overhang over the near term, RBS added. While both NBFCs are strong candidates for a bank licence, Mahindra Finance’s M&M parentage and predominantly rural and semi-urban focus (in sync with RBI’s financial inclusion focus) makes it a stronger contender for an eventual licence.

Investment-oriented NBFCs: Bajaj Finserv is the financial services arm of the Bajaj group with business interests in “protection”, “lending”, and “financial advisory and wealth management” through its subsidiary companies, such as Bajaj Finance, Bajaj Allianz General Insurance and Bajaj Allianz Life Insurance. The company in July-September quarter reported 129 per cent growth in profits on the back of better-than-expected performance across life, general and finance businesses. However, the life insurance business showed moderation in line with the industry as the management works on rationalising cost structures as per the new regulatory environment. The management expects the life insurance business to start witnessing revenue growth from Q3FY2012 onwards, because by then, the company wouldn’t face a higher base of the previous year.

Another major company is this space is Reliance Capital. According to experts tracking the company, the September quarter was another dull quarter with individual subsidiaries like its asset management company and consumer finance division reporting strong numbers. But, the company as a whole, continued with its lower profitability trend in consolidated profits after taxes, declining 70 per cent y-o-y. General insurance as incurred losses with Q2FY12 loss at Rs 28 crore. The commercial finance portfolio reported lower profits before taxes of Rs 54.7 crore this quarter. ICICIdirect’s Kajal Gandhi said the management expects about Rs 2,700 crore of high cost funds to mature, helping cost of funds to decline. “We expect loan growth to be around 30 per cent for FY12E to Rs 15,990 crore (for commercial finance portfolio),” said Gandhi. zz