Investing in stock markets now? Go with large banks, well governed NBFCs

It has been a nervous few days for investors exposed to banks and non-banking finance companies (NBFCs). The Nifty witnessed 6.4% fall in September lead by fear of liquidity squeeze and events like IL&FS defaults and downgrade, Reserve Bank of India’s denial on tenure extension to Yes Bank’s Rana Kapoor, and a sharp correction in NBFC stocks basket after reports of a DHFL commercial paper sale by a fund house at a steep discount.

Stocks of Bandhan Bank were beaten down after RBI decided to freeze the remuneration of its MD & CEO, and curb branch expansion, as the bank could not bring down the promoter’s stake to meet regulatory norms.

While the mood is not upbeat, it’s not the end of the world, either. DNA Money tells investors what they should do if they have banks and NBFC stocks in their portfolio.

Performance of banking and finance sector

A lot of investor money is riding on the banking and finance sector. In the Sensex the market cap of banking and finance stocks is almost 38%. That’s more than twice of the next important sector, that is, IT (15.5%). In fact, finance as a sector has an equivalent weight in the index as the combined trio of IT, oil & gas and FMCG.

You might not directly invest in stocks, but your market-linked equity investments in mutual funds and unit linked investment plans (Ulips) are exposed to the finance sector. In MF’s equity assets, banking stocks have a 20% weight, while finance has another 10%. Both diversified equity funds and banking & finance sector-specific funds have bet big on this sector.

“Some months backs, PSU banks were in a bad shape. At that time, NBFCs and private sector banks were doing well. There will always be some event or the other. After the correction, some of the best private sector banks are attractively poised, even though there was no issue with them specifically in this round,” said a mutual fund manager.

High beta plays

A high beta stock or sector typically does better than the market when there is an upswing. They also perform worse than the market when there is a slide. For example, the Sensex and the Nifty fell over 6% in September, but the finance sector indices declined about 13%.

Banking and finance stocks are high beta plays because they offer high growth, so they are more volatile than the market. Or because finance firms are preferred by momentum chasers, the stocks display the behaviour exhibited by investors.

Earnings wise, banks are not badly placed. PSU banks look like they are out of the woods. PNB, hit by the Nirav Modi and Mehul Choksi scam, is expecting a turnaround. Corporate banks are also getting their act together. Retail focussed banks should report healthy teen earnings growth in the upcoming earnings season, said Pankaj Murarka, founder, Renaissance Investment Managers. “Corporate banks will continue to witness sequential improvement in earnings driven by lower provisioning costs,” he pointed out.

RBI rate hike risk

Private sector banks and NBFC stocks have done well because of retail credit growth, which was fuelled by benign interest rates. But NBFC stocks have dual challenges facing them now. Firstly, banks are understood to be reluctant about lending to NBFCs, which means NBFCs will need to tap other sources and thereby see higher fund-raising costs. Two, the RBI is anticipated to hike interest rates in its October 5 monetary policy. If rates inch up again, retail loan demand will be hit. Consequently, finance sector earnings will be under the cloud.

What should you do

The financial services sector has entered turbulent times after a phase of strong lending growth, particularly in NBFCs and housing finance companies (HFCs). Hence, experts are advising investors to play it safe with direct equity investments. Stick to large banks is the advice. “Improving competitive edge, owing to rising interest rates and tighter liquidity, is seen tilting the tide towards large banks with high CASA (savings and current accounts). Overall, the banking sector seems to be near the peak of asset quality woes, with a gradual recovery seen ahead. Hence, we prefer businesses with a robust operating model, strong and stable franchise, and strong management,” said a report by ICICI Securities - retail equity research.

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“We prefer NBFCs with strong corporate-promoter backing (to garner confidence among lenders) and superior ALM profiles,” said Dhananjay Sinha, Head, Institutional Research, Economist and Strategist, Emkay Global Financial Services.

Source: DNA Money