Why Citigroup thinks NBFCs are attractively valued and what is its outlook

An increase in interest rates and continuous improvement in India’s macroeconomic growth are key factors that will support rich valuations of India’s shadow banks, or non-banking financial companies, which have been hit by the IL&FS crisis, stress in the real estate market and the coronavirus pandemic in the past three years.

In its 2022 outlook, US diversified financial services conglomerate Citigroup said that calendar 2021 prepared India’s NBFCs for strong growth by strengthening their balance sheet.

It said that strong demand for the housing sector bodes well for housing finance companies and rates Housing Development Finance Corporation (HDFC) as its top pick among the listed NBFCs with a target price of Rs 3,300 per share. Here’s what Citigroup said to its clients

AUM growth

Better affordability, targeted product launches, lower competitive push from banks and a lagged pick-up in construction finance should drive growth for housing finance companies, foresees Citigroup analyst Aditya Jain.

The investment advisory firm expects housing finance companies’ assets under management (AUM) to grow 12% by the end of March 2022, followed by a growth of 14% for the year ended March 2023.

Citigroup notes that AUM growth hovered over 15% before the liquidity crises triggered by IL&FS in late-2018. 

“For overall NBFCs, we expect a 11% and 16% AUM growth in fiscal 2022 and fiscal 2023, respectively, as we build a delayed pick-up in vehicle finance due to supply constraints,” Jain said in a note to clients.

Interest rates

Citigroup observed past cycles and said that a rising interest rate augurs well for the sector as it normalises liquidity and boosts net interest margins (NIMs) of NBFCs.

While growth clearly improves in such periods, NIM response to rising rates has been mixed in the past and is a function of ALM-matching, interest rate hedges and pricing power.

“The relative timing of rise in bond yields versus repo rate hikes will be key given repo-linking in home loans,” Jain said.

Citigroup sees a 9 basis points (bps) rise in NIM for fiscal 2022 followed by a five-bps expansion in fiscal 2023, but said that underlying trends will be different from segment to segment, with the housing finance companies likely to see a neutral-to-slight negative impact.

Asset quality

Total stress increased 2.9 percentage points between December 2019 and September 2021, while total provisions increased 1.1 percentage points.

The increase in provisions is ample in aggregate at about 40% of the increase in stress, though some NBFCs have lagged.

The net impact of recoveries after the second Covid-19 wave and daily NPA tagging are key parameters to watch out for in the third quarter (October-December) earnings.

Valuations

Most NBFCs are at or near their five-year average price-to-book (P/B) ratio. Given that the market is well-above its average valuation, this is attractive.

However, the impact of daily NPA tagging and stricter NPA upgrade norms in December earnings will be key to build conviction, Citigroup said.