RBI allows banks to provide credit enhancement to NBFC
Another step to improve liquidity
* In a circular on 2nd November, RBI allowed banks to provide Partial Credit Enhancement (PCE) to bonds issued by NBFCs and HFCs, subject to certain conditions.
* The conditions are as follows – a) It is for systematically important non-deposit taking NBFCs/HFCs b) The tenor of the bonds for which the PCE is provided will be at least three years c) The proceeds from these bonds will be used only to refinance existing debt d) The exposure of a bank by way of PCEs to these bonds issued by each entity shall be restricted to one percent of capital funds of the bank e) The exposure of banks to these NBFCs/HFCs shall be within the aggregate PCE exposure limit of 20%
* We await clarity on whether this rule applies to only non-deposit taking HFCs as well.
* We believe this is a step in the right direction for providing support to certain NBFCs. In our view, this norm will be most beneficial to wholesale financiers who are finding it difficult to tap the bond markets. This would also be useful to some HFCs too. For most other NBFCs, this rule is inconsequential because most NBFCs raise bonds of less than years’ maturity.
Liquidity for bonds to improve but need to wait to see actual impact on COF
PCE helps to provide additional guarantee for bonds of NBFCs. This in turn will help to increase the demand especially from long term institutions like Insurance companies and provident funds for NBFC ND SI/HFC paper in the three year+ segment. One will also have to analyse the landed cost of funds after taking into account the cost associated with receiving PCE. We believe most players who will utilize this facility will do it primarily to raise funds for maintaining liquidity, rather than for business growth. Also, we would have to look at this from banks’ point of view – would they rather give term loans or do portfolio buyouts or earn fee income through PCE?
Wholesale financiers to benefit in this stressed liquidity scenario
In our view, this norm will be most beneficial to wholesale/Infrastructure financiers who are finding it difficult to tap the bond markets. This would also be useful to some HFCs too. For most other NBFCs, this rule is not meaningful as most NBFCs raise bonds of less than years’ maturity as asset side has average duration of 3-4 years.
Reiterate HDFC, LICHF, STF and MMFS as top bets in the sector
Our interaction at the industry level suggests that the market is gradually normalizing from the liquidity freeze post the IL&FS crisis. Most players have been able to raise debt capital to manage liquidity. However, cost of funding remains elevated for all players - 20-30bp higher for some AAA-rated players like HDFC, BAF and 50-100p higher for others. We remain constructive on selective players. Our top picks are HDFC, LICHF, STF and MMFS.
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