India's Cash-for-Gold Shadow Lenders May Be Headed for Shakeout

Aug 2016
India, August, 10 2016 - A shakeout may be looming for investors in India’s enormous cash-for-gold and personal finance shadow-lending firms.

Three of the largest, trading with market values of more than $1.5 billion, may be facing an imminent plunge in their share prices after becoming overvalued, according to IIFL Asset Management Co., whose investments in the firms helped make its fund the country’s best performer, and analysts at Credit Suisse Group AG.

With Indian banks cutting back on their lending to consumers due to tighter regulation and their highest rates of bad loans in 16 years, people have instead turned to non-bank financial institutions, or shadow banks -- often taking out loans using their gold jewelry as collateral. That’s helped drive their share prices to record highs.

These lenders “were filling up the space left vacant by the banks,” said Prashasta Seth, chief executive officer at IIFL Asset Management, which has $890 million of assets. Valuations of big shadow lenders have risen to expensive enough levels that IIFL might pare its holdings, he said. “Incrementally, no fresh exposure will be taken.”

Shares of Muthoot Finance Ltd., India’s largest provider of loans backed by gold jewelry, have more than doubled this year. Consumer-lending firm Bajaj Finserv Ltd. has seen its stock price rise 37 percent this year, and its Bajaj Finance Ltd. unit is up 67 percent. Spokesmen for the three companies didn’t respond to e-mails seeking comment.
Muthoot sank 4.2 percent on Thursday as of 11:46 a.m. Mumbai time. Bajaj Finserv rose 1.4 percent, while Bajaj Finance added 0.4 percent.

The IIFL India Growth Fund is the best performer this year among 195 open-ended funds that track the country’s broader markets, data compiled by Bloomberg show. The fund holds 20 percent of its assets in shadow financiers including Bajaj Finance, Muthoot Finance, and Bajaj Finserv. When it pares down those holdings, it will increase stakes in technology, pharmaceutical and utility companies, Seth said.

Non-banking finance companies had an average 11 percent weighting in the fund over the past year, or almost 10 percentage points more than their representation in the S&P BSE 500 Index, data compiled by Bloomberg show. The big bet was responsible for the fund beating the gauge by 7.9 percentage points since Dec. 31, the data show.

Credit Suisse analysts led by Ashish Gupta recommended selling Bajaj Finance in an Aug. 2 note, saying that the market capitalization of the non-bank lenders had exceeded the size of their loan books. At the beginning of this month, the company’s market value was at least 120 percent the size of its loan book, the note said. By comparison, the market value of ICICI Bank Ltd., India’s biggest private-sector lender, is equal to about 30 percent of its outstanding loans.

The Credit Suisse analysts also recommended selling Bharat Financial Inclusion Ltd., a microfinance firm that extends loans to the poor at an interest rate of about 20 percent and has seen its share price climb 61 percent this year. Analysts’ recommendations to sell Bharat Financial are the highest since 2012, data compiled by Bloomberg show.

Shares of the firm, formerly known as SKS Microfinance Ltd., lost 12 percent of their value this month after financial-crimes investigators arrested its President S Dilli Raj in relation to an ongoing investigation of his former employer. J.S. Sai, a Hyderabad-based spokesman for Bharat Financial, declined to comment on the arrest or the impact on company operations.

Record Holdings
India’s money managers had raised holdings of non-bank finance companies in June to a record 6.84 percent of the combined $69 billion they owned in local equities, up about a percentage point from the beginning of the year, data from market regulator Securities and Exchange Board of India show.

“If you are already heavily invested in NBFCs, it may be wise not to keep adding up at this point of time,” said Ajay Srivastava, New Delhi-based managing director at Dimensions Consulting Pvt. “If the stocks correct by more than 10 percent, we will be back in the market to start nibbling.”

Some non-bank financial companies are still relatively cheaper than India’s non-state-owned lenders, he said.
Earlier this year, the non-bank lenders “were at a deep discount” to other companies growing at the same pace, IIFL’s Seth said. “It is no longer the case.”

Hindered Lending
Non-bank finance companies displayed double-digit asset growth in 2014, compared with an average 2 percent growth by such firms in 26 major economies, according to the latest Financial Stability Report. Surging delinquent loans and inadequate risk buffers at India’s government-controlled lenders, which account for more than 70 percent of loans in the nation’s banking system, have been hindering the banks’ ability to make new loans.

The stressed-loan ratio for state banks climbed to a 16-year high of 14.34 percent in the year through March, Ministry of Finance data show. Rules requiring government stakes of at least 51 percent have curtailed state banks’ ability to sell shares, while an audit of loan books by the Reserve Bank of India uncovered more bad debt since October, making them less capitalized than many non-bank finance companies.

“What happens when you put pressure on one side of balloon?” Raghuram Rajan, the RBI’s outgoing governor, said in a speech in May. “It balloons out on the other side. So is there a danger that by regulating the banks so strongly, we have shifted activity -- not just risky activity but human capital -- to the shadow-banking system.”

Source : Bloomberg

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