NBFC chats ..

Non- Banking Financial Companies  are financial institutions which do not hold a banking license but partake in lending financial services. 

Intention here is not to provide an explanation on NBFCs rather it is to evaluate the opportunities to invest in NBFC sector. There are close to 190 odd NBFC listed in Indian Stock Exchanges . NBFCs are present in competing fields like housing loans , auto loans, power financier, infrastructure loans. With easier loan sanction procedures , low operating cost NBFCs have a stronger footing in the market , added to this they are not constrained by CRR ( Cash Reserve Ratio ) , SLR ( Statutory Liquidity Ratio), and priority sector lending norm ( 40%) . 

Major constraints faced by NBFCs are they do not have access to low-cost deposits, high loan to value ratio (LTV) , high rate of delinquencies. Subdued economic activity , high fuel rates, decelerating auto segment are all added concerns. But the bright side is there is a huge potential in the housing finance sector , and if the new government moves its infrastructure plans into execution the NBFC sector should definitely be in the investor radar. Another trigger is also the fact that RBI has announced, they would fine tune the process of granting new banking licenses.

Recently NBFCs have been in news as RBI has granted permission to NBFCs to act as Business Correspondents (BCs) [Retail agents providing banking services in locations other than banks/ATMs] to the banks. The move is to expand the process of financial inclusion, and of course some of the NBFCs are indeed well positioned to be bank correspondents in inaccessible areas where banks and banking services remain remote possibilities Central bank has issued some basic guidelines to  this newly introduced rule

• There should not be intermingling of bank and NBFC  funds when NBFC function as BCs

• Scope of activities which the NBFCs as BCs are expected to do are
• Identification of potential borrowers
• Pre-processing loans - Collecting applications , data verification 
• Promoting self-help groups
• Post loan disbursal monitoring 
• Recovery follow-up
• Creating awareness on savings products and money management
• small value money remittance

Advantage for NBFCs  is the commission from the banks for loan disbursal which is pretty much close to the margins they make by lending small loans.Operational expenses for the banks are also reduced as they can leverage the existing NBFC infrastructure, manpower, knowledge and skill. There is no major conflict of interest in functioning of NBFCs as BCs as currently they are not permitted to undertake such business.

Conflict of interest comes in for NBFCs which are currently allowed to take small deposits and for NBFC- MFIs  which currently lend loans at the rate of 20% - 35%, which is more than what banks charge for small loans.

The other issue that could probably be raised as a concern is if the same NBFC is allowed to partner with multiple banks. Solution would be to restrict one NBFC - one bank symbiosis in a territory.

Factors to look for in NBFCs

Whenever an investor is looking for Financial institution as prospective investment opportunities key points to keep in mind are

• Sound Valuation ratios ( P/E, P/B, EV/EBITDA etc  basic filter for stocks)
• Capital Adequacy Ratio which is measure of bank's capital as percentage of bank's risk weighted credit exposure 
• Net Interest Income = Interest on loans lent - Interest expenses on borrowed money
• Asset quality ( prime importance) has NBFCs have had high rate of delinquencies . 
• Operating income 
• Extra vigilance required if they are into gold financing business, government import/export curb on gold could impact NBFCs as well

      NBFCs is definitely a sector to look out for if the reader is keenly interested in investing in small and mid-cap stocks. With economy providing positive signals ( of course with inclination towards sloth) , there is a huge potential for long term investment in NBFC stocks. If claims of financial inclusion were to be taken seriously  then  NBFC is definitely some value investing .





Fyi..

How different is NBFC from MFI ?

NBFCs can do all the banking activities like lending, advances to businesses and farmers investing in equity market etc, but they cannot accept saving deposits ( of course there are some exceptions to this called NBFC- D, which accept public deposits) , even if they accept saving deposits there is no guarantee for these deposits like banks. They cannot engage in agricultural or industrial activities , cannot issue checks drawn on themselves.

But NBFCs do come under the supervision of banking regulations .

For more details on RBI guidelines refer to the below link

http://rbidocs.rbi.org.in/rdocs/notification/PDFs/46344MN010713.pdf

MFI( Micro Financial Institutions ) run at a much smaller scale , opened with the intention of catering to the poor and underprivileged. ( Read about : Muhammad Yunus who founded Grameen bank ,pioneering concepts of micro-finance and micro-credits)    

Breaking down REIT

REITs stands for Real Estate and Infrastructure Investment Trusts. The to-be introduced instruments have the potential to attract investors to  the cash starved real estate sector.

History 

In 1960, President Eisenhower signed legislation that allowed both equity and real estate  investors to purchase and sell liquid real estate equities. People got access to huge returns  from commercial real estate which was initially open only to wealthy individuals

REITs looked inviting because trusts bought income -producing property and avoided paying taxes as they passed the bulk of their gains as dividends to the shareholders

Purpose

Infrastructure demands for the 12th Five -Year plan is around INR65 lakh crore 

• Additional window of funding for infra and real estate sector
• Reduces the exposure limit of public sector banks
• Saves many despondent developers from huge interest rates that they sign up for as part of financing their projects. Many real estate developers in spite of taking advances for their project end up cash-strapped.

What does it mean to retail investors ?

• Minimum investment amount has been fixed at INR 2 lakhs for REIT and  INR10 lakhs for InvITs 
• Retail investor could trade in units of REITs and InvITs like any other security in stock exchange
• Returns from REITs have been less correlated with the performance of the broader market. 
• Returns have hugely outpaced the inflation numbers as the investment of REIT has normally been in diversified assets
• Investors can reduce their portfolio volatility by allocating funds as per their risk appetite in REIT units
• Low entry level investment, high liquidity, high probability of capital appreciation
• Long term income generating instruments

 Infrastructure which remains a major bottleneck to the development of our country can be eased through new capital inflow.  Many infrastructure projects which are stalled due to capital crunch can get a lifeline with this investment instrument.New guidelines expected are inlines with that of developed countries like US , UK, Singapore, Hong Kong etc

How to choose your REIT ?

Apart from the history of dividend yield which the investor has to keep tracking, investor have to maintain prudence , do their homework on checking the underlying property , and check if the REIT is heavily invested in any particular area. Over concentration in certain markets , deteriorating tenant quality should be checkpoints for the investors.

Because property owners should deduct non-cash depreciation expenses when calculating earnings, even if the property is, in fact, appreciating in value, reported income is reduced unrealistically. REITs mandate 90% distribution of cash flow to investors non cash expenses  reduce dividend yield drastically. For that reason, the REIT trade association created a measure called “funds from operations” (FFO), which reflects the actual cash profits generated by a REIT’s operations.

Growing FFO would be one of primary numbers to be verified before investing in REIT. Having major shareholders to participate in reinvestment decisions can prevent managers from squandering wealth generated.

Word of caution would be that there is huge market risk  plus known unsystematic  risk as real estate has been notorious for its significant contribution to multiple bubbles in financial history

For the financial technicalities of REITS

• Indian REITs are allowed to invest only in commercial properties
• REITs are allowed to raise funds from foreign investors. 
• REITs must distribute 90% of its cash flows to its investors
• Tax treatment is pass through for REITs
• Minimum size of REIT asset has been lowered to INR500 crore from INR1000 crore. Multiple sponsors with minimum 5% holdings is permitted. 
• Up to 20% of investment can be in under construction assets,shares/debts of real estate companies, and mortgage backed securities
• Minimum initial offer size would be around INR250 crore with a minimum public float of 25 %
• Sponsors would need to have mandatory holding of 25% for 3 years and then continuous 15 %  thereafter  
• Minimum net worth of manager would be raised to INR 10 crore 

P.S.   Blog has been written as per the current draft guidelines issued by SEBI and is subjected to change with time. The purpose of the blog is to introduce the reader to a new plausible financial investment instrument . But the readers should use their own wise discretion to make investment decisions

Understanding the Business model

First step any fundamental analyst would vouch for  in stock picking is : " Pick a stock only if we understand  the business model ".

 Lets learn the business model  through a series of questions ,  and here I have focused  mainly on the Qualitative aspects of questioning . Sector wise we can fine tune these questions and in my future blogs I'll endeavor to do it , but for now lets get into generic mode of understanding the business model 

First one that we would intuitively ask is  : 

• What is a business model ?  Simply put : it is the way in which company makes money . 
• What does the company manufacture  or provide as a service ?
• Who are the customers ? How often would the consumer need to buy/use this product ? Is the product readily available in the stores nearby?
• What are the core products , if any ?
• What are the various sources of revenue ?   Is the core product alone generating revenue ?                   For example ,
• We have to look at the after sale service model for certain products 
• Information about the input to the product ? For example a complete ban on plastic will close the shutters of many company mainly dependent on  plastic as its raw material . Ban on tobacco has considerably reduced revenues for cigarette manufacturing companies etc . Price fluctuation of input materials also needs to be considered
• Does the service/product of the company have any competitive advantage ? Moat around the business model is extremely important .  Customer recall factor matters the most . Eg. First word anybody would associate with an adhesive in India is Fevicol ( manufactured by Pidilite Industries )
• How has the product innovation been ? Is major chunk of revenue getting generated from the recent product morphs or is it from the basic version of the product 
•  Distribution & Supply chain management : Are franchises generating revenue ? Is it real estate , rather leasing of  brick & mortar locations , leasing of machines / other infrastructure ? 
• Revenue generated via e-commerce ( which encapsulates app version revenue)
• Export revenue : Which countries are major consumers ? In general , what is the political condition of the major revenue generators ?  How strong is our currency vs currency of those countries ?
• Has the company been recently trying to divert from their main business model?
• Is the company enjoying any tax rebates due to government policy , if yes how long would the company have such an advantage?

 When we venture to buy stocks , its extremely important to understand the business model. To understand the business model in detail , we have to refer to company website , quarterly/annual reports ( especially the Management Discussion & Analysis portion ) , conference calls transcripts  with the company management . 

Understanding the business model is like grammar to a language and it is the foundation for sound and market agnostic investment.

Thought process that leads to the scrips I own

Many people have tread this path , and I am only following the path they have laid , with the dream that I can make significant inroads in this path. 

The aim is to build a safe stock picking strategy and the caveat at this point is , I have laid out the steps I have followed so far to pick my stocks , and the purpose is to fine tune the strategy via multiple iterations 

• First step in my safe mode strategy is to pick up the stocks that is part of Sensex or Nifty. Why so? 
• Scrip selection criteria is based on the  free float methodology, the index reflects the market trends and takes into consideration only those shares available for  trading in the market (i.e. floats are stocks which are not held by promoters and associated companies )

• For stocks to be included in benchmark index the impact cost of trading the scrip must be on an average 0.50% or less during last six months of trading.
• Index constituents are chosen in such a way that there is no heavy concentration on any particular sector.
• Float-adjusted market capitalization: ensures companies eligible for inclusion have at least twice the market cap of the current smallest index constituent
• Index is reviewed semi-annually to ensure the above-mentioned criteria is met by scrips 
• Next step  is to read the company description - what it deals with, where all the company has presence etc. Most of the time with our experience we can identify whether the company has any competitive advantage over it peers or not and in some instance we need to do more comprehensive reading to find out how the company would stand out . For beginners the red herring prospectus can be the first step to begin.
• The third step is to do a basic sanity check. What I follow is to check the Net Income for past 3 years. Scrips go out of my list if they don't have a decent history to boast about. Parameters which I use as general indicators for this are 
• P/E ratio 
• P/B ratio: Intuitively we know we can start off with scrips that have low P/B values. How do we know what this "low" means? I use the industry benchmark, check for the number of years the company has been functional  and  then decide my threshold.
• Debt to Equity ratio 
• Return on average equity
• Beta

 Technical Indicators  I follow:

• Bollinger Bands 
• According to some studies, Bollinger bands must contain 88-89% of the price movements which makes the move outside the band significant. 
• Prices are relatively high if it's above the upper band and relatively low if it is below the lower band. But again the decision would require certain discretion like looking at the past patterns and observing the movements outside the band.
• Relative Strength Indicator 
• Shows how strongly a stock is moving in its current direction. 
• Above 70 levels indicate overbought and below 30 levels indicate oversell in scrips 
• Put-Call Ratio can be used to gauge market sentiments about the scrip.
• Volume traded
• FII shareholdings 

 In Outliers , Malcolm Gladwell points out that to master any art and to attain world class status in it ; minimum 10,000 hours of consistent effort would be required. The pursuit of my passion has begun , and this means there is still a long way to that mastery.
From all the money masters I have read about, what I have understood is : Investing is going to be a fun journey provided we treat it as a science experiment with some pre-determined sanity steps and logic to follow rather than tossing the coin , and waiting for the lady luck to shine.  The purpose of my journey would be to collate , consolidate , use various permutations and combinations to really become that -" The Intelligent Investor".