We could be at the beginning of a multi-year credit cycle: Vinay Sharma

“We are getting more bullish on some of the smaller private banks as well as some of the medium sized public sector banks along with some of the niche plays in the NBFC sector as well. It has become a very difficult choice now unlike what it was in the past few years,” says Vinay Sharma, Fund Manager, Nippon India MF.

I want to start with a big trigger for the as well as Limited stock. HDFC historically has given fantastic returns but negligible if we look at the last couple of years. But with the proposed merger being cleared, it is time for this counter to get back the returns that investors have been used to historically. Your view?
We cannot talk about individual companies but what we would like to say is that the large brunt of foreign selling has been borne by two sectors – financial services and IT, especially because of the over ownership of the large counters in financial services. They have taken a majority of the FII selling pressure over the past couple of quarters or probably a year and more. Therefore one of the important triggers for some of these large financial counters to perform would be the reversal of FII flows. As and when the overall macros improve – not just in India but in emerging markets and the US – FIIs flows will again reverse because India remains an attractive destination. There are very few emerging economies which are in such good fundamentals from a medium and long term perspective as India is. So as and when that reverses, some of these large financial counters would start performing.

The credit offtake data seems to be picking up and I wonder why that is happening? Is it because of a high working capital requirement because inflation has gone higher or has the new capex cycle that we have been waiting for started?
There are several reasons for that. It is difficult to pinpoint what is the exact reason for credit pickup. One, easy optical reason is obviously that the base effect last year at this point of time offtake was very poor. Optically it looks much better.

But having said that, we have been on credit growth for quite some time and it looks like pieces of the puzzle are now falling into place. For example, inflation benefits credit growth to a certain extent because working capital requirements go higher.

Similarly, retail credit in India has always been growing in mid-teens plus/minus here and there depending on the subsectors you are talking about. Retail credit seems to have come in full force and the Covid effect is behind us. Some of the smaller industries and SME, MSMEs took the brunt of GST and demonetisation from 2017-18 onwards. We think that effect is behind us and now they are also back to their normal self and large industries are showing signs of recovery after a long time.

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We think these large Indian corporates were practically in a deleveraging phase from 2015 to 2020. There are signs that that phase is now behind us and green shoots for private capex are emerging and the large corporates have started to conceptualise projects and maybe started working on some of them. It is a mix of all of these that is leading to credit growth. But we believe this might just be starting. Credit cycles generally go for multi-years and therefore this could be beginning of a multi-year cycle.

So what is the best way to maximise assuming that the points which you have just flagged off all come true? Should one just stick to four of the largest banks in India and keep it safe and simple because they have size, scale, capital, balance sheet, talent and also technology?
I would agree with you and for the most part of last few years, that is what we have been saying that one should stick to large banks both private and public. The reasons were as you said, they have easy access to capital, markets are always there to support them, they have the wherewithal to invest in technology and they have been investing quite a lot over the last few years. Also, a lot of these large private banks are not really banks. They are financial conglomerates amd so maybe 50-60% of their valuations come from banking entities but the rest, depending on each entity, comes from insurance, asset management, general insurance and all of that.

Therefore, these were a good diversified, slightly less risky way to play the financial sector but now we are beginning to believe that maybe it is time to take a little bit more risk and valuations in the small and midcap space are now very attractive. Some of these banks are available at less than book today and the credit cycle is just starting to pick up. The rising tide lifts all the boats and therefore maybe it is time to add a little bit more risk.

We are getting more bullish on some of the smaller private banks as well as some of the medium sized public sector banks along with some of the niche plays in the NBFC sector as well. It has become a very difficult choice now unlike what it was in the past few years it has become a difficult choice now because the para-banking sectors have also corrected. Insurance has corrected a lot, some of the capital market plays have also corrected and the small and midcap banks from a cycle perspective are starting to look good. The next three-four years could be good from a cycle perspective. So it is a more difficult choice.

Now large banks remain a bigger part of the portfolio because of their market caps and liquidity and all those criteria but financial services from a space perspective now look much better than what it was two-three years back. The way to play it has become much more diversified than what it was a few years back.

Where do NBFCs come in because they have lost market share? They do have a large issue in terms of where the fintech and the plans have moved. What happens to the entire NBFC space which in a sense was sold on the premise that India will need more credit and India can have not one, not two but at least 1,000 NBFCs?
We have frankly never believed in this proposition. We have always been a believer that NBFCs need to have a niche business model and as long as that niche moat is strong, those are the NBFCs we tend to look at.

Therefore if you look at spaces like housing finance, gold finance, SME credit, affordable housing, in some of these subsectors, NBFCs have a very big role to play because some of these private sectors banks do not cater to that and India being such a large country, there is always space for more.

We tend to be selective in NBFCs as that approach continues. Along with that, there is the rising interest rate cycle, where the cost of funds generally tend to go up a lot more for NBFCs than with large banks because banks have that cushion of CASA with them that makes generally in a rising interest rate cycle that makes banks quite more dependable from risk perspective than NBFCs.

Therefore our answer to that would be we continue to be selective in NBFCs. There are some spaces which look quite attractive either due to valuations or because longer term growth could be higher than general credited for in those subsectors. From an overall perspective, in a rising rate scenario, banks are probably positioned better than NBFCs.

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