MUMBAI: Private equity (PE) investments into non-banking financial companies (NBFCs) in India are most likely to increase in 2020, even as the sector faces high chances of slipping into distress in the future.

“Traditional sources of funding, such as bank lending and mutual funds, have become constrained over the last two years. So, for Indian NBFCs, the major source of money today is a private equity and that is going to continue,” said Gopal Agrawal, co-head, investment banking, Edelweiss Securities.

The trend can be seen in data from the past two years, which were marked by a severe liquidity crisis. In 2019, 37 non-bank lenders raised private equity funding worth $2.2 billion, slightly lower than the $2.7 billion that flowed into 44 such firms in the previous year, according to private company data tracker Venture Intelligence. That is despite the credit crunch that has hit NBFCs in Asia’s third-largest economy since the collapse of Infrastructure Leasing and Financial Services (IL&FS) Ltd in September 2018.

The credit crisis hit NBFCs and housing finance companies (HFCs) the most as bank lending, which was their primary source of capital, dried up sharply during the period. Pulled down by a lack of capital and poor sentiment, it became difficult for many non-bank lenders to raise funds from alternative sources, creating a domino effect that resulted in a further liquidity squeeze and fresh defaults by the otherwise healthy NBFCs. 2019 also saw defaults at other large NBFCs, including Dewan Housing Finance Corp. Ltd. (DHFL), and Reliance Home and Commercial Finance.

The investments by PE firms are likely to remain robust despite the ongoing liquidity squeeze in the market, according to Ajay Saraf, executive director and head of corporate finance and institutional equities, ICICI Securities. “Despite all these issues, the inflows in 2019 have been pretty healthy, specifically to the retail-focused NBFCs and HFCs. Going forward, well-governed and well-capitalized firms will continue to attract PE investments, and there will be higher control deals in the sector,” he said.

The focus may also shift from growth-led transactions to deals triggered by stress in the sector. “While most investments in the last two years have been growth-led, the focus is expected to shift more towards stress-related transactions and recapitalization required by the NBFCs. In 2020, I expect that a lot of PE investments will typically be directed to stress-related situations,” said Sanjeev Krishan, partner and deals leader, PwC India.

A December report by restructuring and turnaround consulting firm Alvarez and Marsal reaffirms this view. The liquidity crisis in the NBFC sector, it said, throws open opportunities for investors to acquire NBFC assets fully or in part, and rectify the asset-liability mismatch issues.

The best resolution outcomes for stressed NBFCs would involve finding a new owner or investor with a strong balance sheet that can allow new loans to take place, according to the report.

The new owners, said Agrawal, could be large PE-backed NBFCs that are looking to consolidate in the market. “Some of the small firms that are not being able to raise funds will see interest from larger NBFCs, which either have to expand regionally or from a product offering perspective. Therefore, the pace of investments in 2020 should continue at the same rate as the last two years, as there will be consolidation in the market and private equity investors will see an opportunity, even as they remain selective,” he said.

According to Krishan, the deal valuations would soften, even if the pace of investments remains unchanged.

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