NBFCs overtake bank stocks in FY24. Here’s why

economictimes.indiatimes.com:

NBFCs barring the giant HDFC have generated returns greater than 20%. NBFC Stocks which underperformed the banks in FY2023 have started to outperform them now. So what has changed in this short span of time? What has led to this increased optimism in NBFC Stocks? A significant reason has been the anticipation of interest rates peaking out and potential cuts in the near future.

But how do we quantify the market’s expectations of interest rates peaking out? By looking at the government bond yields. As can be seen from the below chart after a long rise, the government yields peaked out and are on a downward trend now. Simply speaking a falling yield indicates a market’s expectations of a dovish stance by RBI and vice versa.

Okay so we now understand that the market does not expect the repo rates to go higher but why is this good for the NBFCs? An NBFC borrows money majorly from four sources ~ banks, non-convertible debenture (NCDs), commercial papers and deposits. Out of these four — bank borrowings and NCDs are the two biggest sources. Smaller-sized NBFCs typically rely more on bank borrowings and the bigger NBFCs with better credit ratings diversify into NCDs.

Mahindra and Mahindra Financial Services, one of the biggest NBFCs, borrows 40% from banks and 32% from NCDs. Whereas Fusion Micro Finance, a smaller NBFC, borrows 94% from banks and 7% from NCDs. NBFCs borrow money from banks either on a fixed rate or floating rate.

A fixed rate as the name suggests will have fixed interest payments till the end of the loan tenure. A floating rate on the other hand is typically linked to MCLR and Repo rates. Thus in changing rate environment, the floating rates would also change.