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Event update: Financials - Liquidity frameworks for NBFCs

The government has announced a 6 months partial credit guarantee  to PSU banks equal to first loss of 10% for buying out pools of NBFCs (including HFCs) of upto Rs1 trillion. To facilitate the buy-outs, RBI has offered a liquidity window of 1% of deposits (NDTL) amounting to Rs1.3 trn to all banks (PSU and private). The liquidity facility will be available only for incremental lending to NBFCs and HFCs.

Key points:

• PSU banks will get a guarantee in the form of credit enhancement of 10% for buying pools from NBFCs upto Rs1 triliion. Total assets of NBFCs and HFCs put together amount to Rs37 trn. This guarantee will be available for 1) highly rated pools of 2) financially sound NBFCs
• There is some confusion on the interpretation of the credit enhancement clause in the budget. The wordings suggest that the government will provide credit enhancement / guarantee for pool buy- outs to state owned banks for 6 months which makes the whole transaction meaningless because most of the retail pools are long dated if the credit enhancement goes away in six months there will be a sharp downward migration in the rating of the pools. This concern will prevent banks from buying these pools in the first place. So it is more likely that that six months refers to the window for which banks can buy these pools to qualify for the government’s enhancement. The government needs to clarify if six months relates to the time frame for which banks can buy pools or it is the period for which the government will provide enhancement.
• Assuming that six months relates to the time window during which banks can buy pools, banks are likely to buy only retail (not wholesale pools) because 1) 10% credit enhancement is too low for wholesale pools and 2) it is difficult for a wholesale pool of under construction property loans to be highly rated.
• To facilitate this purchase of pools, the RBI has provided a liquidity line of Rs1.3 trn. RBI will give banks backstop liquidity of 1% of their NDTL (by buying government securities / HTM from them) at the repo rate of 5.75% provided the amount is used for incremental funding for NBFCs/HFCs.
• The RBI’s liquidity window comes as a support to banks who have high LDRs or are struggling with their LCR requirements and did not have enough to lend to NBFCs.
• There were three key constraints for NBFC fund raising 1) Banks unwilling to lend to NBFCs because of higher risks 2) Lack of availability of good pools. 3) No liquidity lines for NBFCs from RBI. While the budget and RBI cannot address the first two constraints, the liquidity window by RBI does provide a cheap source of funds available at repo rate to banks which is attractive enough for banks to buy some good  NBFC pools and make a good spread.
• Highly rated NBFCs that have retail pools to securitize include SHTF, Indiabulls, L&T Finance. NBFCs with wholesale portfolios such as Piramal, wholesale loans of Indiabulls do not benefit from this facility. This facility will not help low rated NBFCs like DHFL, Reliance Home Finance or Reliance Commercial credit.
• SBI and BoB have said that they are already lending to NBFCs based on their internal risk benchmarks and are unlikely to pick up any significant portion of retail pools incrementally. So according to them their contribution to the retail pool buyouts under the government’s credit enhancement will be minimal. We note that though RBI has relaxed seasoning norms for banks investments in securitized pools, SBI has with the old tighter seasoning norm. So it is not as if state owned banks are taking up every relaxation offered to them.

·      Key gainers: SHTF.