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* Covid-19: Companies remained in denial mode but lenders are the most vulnerable: Our previous discussions (during early March) with various NBFC managements suggested that the impact of Covid-19 in India is fairly insignificant and NBFCs have not witnessed any weaker trends due to the threat of the virus. Now, after two weeks and a series of lockdowns and shutdowns, we are of the view that the financial sector would be the most impacted across parameters - slowing demand, rising yields and increasing delinquencies. Though the impact of the epidemic would be partial during Q4FY20 earnings (limited to the month of March), the full impact stemming from Covid-19 on growth and delinquencies would be visible from Q1FY21.
* Economic impact from social distancing inevitable: The uncertainty about the spread of Covid-19 and its impact on global demand should keep the market nervous. And, virus spread containment measures like social distancing is new for India, which has grown on the basis of community model. With further extension of this scenario (even for a month or so), we may probably face a rise in unemployment levels (due to global/domestic meltdown) and dip in business revenues, resulting in slow growth and spike in delinquencies. From this point of view, we believe that all lenders - whether good or bad, risk-taker or risk averse - are facing the same odds now. Hence, the justification of premium valuations on the quality of the portfolio (retail/secured lender, etc.) becomes fragile.
* NBFCs with shorter asset maturity and higher cash collections remain more vulnerable: On the demand front, NBFCs with relatively lower asset maturities remain more prone to AUM slowdown in the case of weak disbursements (especially during lock downs). Bond yields have already started inching up amid drying system liquidity which should cause margin pressure for NBFCs. With city lockdowns and mall shutdowns, safehaven products like lease rental discounting (LRDs), consumer durable loans and credit cards have already come under the distressed scanner. The current pandemic has also raised concerns about recovery mechanism of all lenders, especially cash recoveries for microfinance, gold and auto financiers. Such situations do ask for special measures such as loan dispensation and the extension of NPA recognition which the industry is expecting from the Reserve Bank.
* Sensitivity check; HDFC remains the preferred choice; we also like CIFC and BAF but caution stays; avoid MMFS: To assess the probable and possible impact of such lock-downs and shutdowns, we have built a framework to compare and contrast NBFCs under our coverage based on various parameters including asset composition, liability mix, maturity duration, capital adequacy, geographical penetration etc. HDFC Ltd. remains our preferred pick with safer asset composition (salaried mortgages), longer maturity duration (72 months) and superior collection efficiency (99% digital). CIFC has high preference followed by BAF; however, elevated discretionary exposure (including auto) and shorter maturity duration keep us cautious. We would avoid MMFS due to rising delinquencies and low coverage. We are turning Neutral toward LICHF on the back of longer asset duration and relatively low probability of default on home loans. We are upgrading LICHF to HOLD from SELL earlier whereas downgrading MMFS to HOLD from BUY earlier.
* Introducing scenario analysis: In order to avoid current volatility and uncertainty, we have built in three scenarios – Base-case, Best-case and Worst-case. The base-case scenario assumes that the impact of Covid-19 will stay for two quarters (until Q1FY21) and the situation will normalize thereon, while the worst-case scenario assumes disruption will continue until Q3FY21. Accordingly, we have adjusted our estimates for growth, margin (amid tightening liquidity) and credit costs.
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