September 2018 saw the Indian stock market rocked by volatility triggered by IL&FS, an infrastructure development and finance company, defaulting on its short term debt. The Nifty fell 6.4% in the month, the Nifty Midcap 100 index fell 13.9% and the Nifty Small Cap 100 index fell 19.8%. Such steep falls, particularly the quantum in the mid and small cap indices are unusual, to say the least.
IL&FS is a large wholesale funded company with approx. Rs. 1 lakh crore balance sheet. It is predominantly funded by PSU banks and through some exposure to the bond market. It was a AAA rated company till a few months back and the default took the market by surprise. The IL&FS board did meet last week and put in place a plan to manage the crisis. This includes raising equity funds through a rights issue, plan for sale of some of its assets and some short term infusion of liquidity to tide over the short term debt repayment. The firm is backed by some large shareholders including Orix Japan, LIC, SBI, Abu Dhabi Investment Authority and HDFC Ltd. Despite these steps, given the severity of the problem, it is unclear if this will address the issues at hand.
IL&FS’s default on its debt sent shockwaves across the NBFC space as liquidity has been hit for some of these companies with cost of borrowing going up sharply in many cases too. Some of this has been reflected in sharp price corrections in many of the NBFCs, some to the tune of as much as 50% in one month. Similarly, RBI and market participants sending worrisome signals over Yes Bank has caused a more than 50% fall in the share price of the bank over the past few weeks. On the whole, there is some concern over quality of accounting and funding availability for the companies in the financial sector – especially some NBFCs and HFCs.
Part of the reason for this crisis to emerge now is the rising interest rate scenario, led by risks of increased inflation, weaker rupee, concerns over fiscal deficit and tight liquidity. As expected, the month also saw large withdrawals from the debt market to pay for advance taxes. We need to watch this space closely and see if the liquidity strain eases over the coming weeks. The regulators and policy makers are taking measures to handle the situation. It is also important to note that the current regulatory framework allows for a time bound program for sale of assets and therefore work towards solving challenges like these. Till a few years back, we did not have such time bound remedial measures.
These are testing time for equity markets. From our portfolio perspective, we don’t have much direct exposure to the problem at hand, as we predominantly invest in debt free companies or businesses that can grow without borrowing or taking outside capital. Economic recovery can get affected, if the higher interest rate regime continues and if there are restrictions for Banks and NBFCs to lend. Our portfolio exposure to banks and NBFCs are primarily companies which are untouched by large NPAs or accounting issues. There are virtues in investing in safe companies – companies where there are no excessive borrowings and have clean balance sheets. We strongly believe these companies will withstand challenging times, such as the one we are witnessing now and perhaps even benefit from them in contrast to their weaker peers.