Non-Banking Financial Company

Non-banking financial services

Non-banking financial services companies (NBFCs) may have smaller scale of operations, but when it comes to building investors’ wealth, they are way ahead of large public sector banks and as good as some of the private ones. The market capitalisation of NBFCs in India, which was just 50 per cent of the public sector banks’ on March 31, 2006, is now nearly twice that of the latter at the end of FY 2016.

Since the ‘90s crisis the market has seen explosive growth, and as per a Fitch Report, the compounded annual growth rate of NBFCs was 40 per cent in comparison to the CAGR of banks being 22 per cent only. Therefore, NBFCs have turned out to be the engines of growth and are an integral part of the Indian financial system, enhancing competition and diversification in the financial sector, spreading risks specifically at times of financial distress and have been increasingly recognised as complementary to the banking system at competitive prices. The banking sector has always been highly regulated, however, simplified sanction procedures, flexibility and timeliness in meeting the credit needs and low cost operations has resulted in the NBFCs getting an edge over banks in providing funding.

NBFCs vs Public Sector Banks

With public sector banks battling the mounting non-performing assets and losing risk appetite, non-banking financial companies have a big opportunity knocking at their doors. There is a large opportunity out there, but PSU banks can’t meet the demand, thanks to their legacy of bad loans and poor profitability. NBFCs are taking full advantage of the situation.

Stressed assets of the banks, mostly in public sector, have touched Rs 10 lakh crore at the end of fourth quarter of 2015-16. In the backdrop of large exposure of banks to sectors suffering the most, such as steel, infrastructure and power, their risk aversion is understandable, the report noted.

So far, NBFCs have scripted a great success story. Their contribution to the economy has grown leaps and bounds from 8.4 per cent in 2006 to above 14 per cent in March last year. In terms of financial assets, NBFCs have recorded a healthy compounded annual growth rate (CAGR) of 19 per cent over the past few years, comprising 13 per cent of financial assets and is expected to reach nearly 18 per cent by 2018-19, as per recent reports.

The reports have attributed the success of NBFCs to their better product lines, lower cost, wider and effective reach, strong risk management capabilities to check and control bad debts and for better understanding of their customer segments. Most NBFCs are focused on a particular niche. It allows them to offer customised solutions and a faster turnaround.

Going forward, the latent credit demand of an emerging India will allow NBFCs to fill the gap, especially where traditional banks have been wary to serve. NBFCs also operate in customer segments which are not served by the PSUs banks such as small & medium enterprises and self-employed entities. These segments offer higher yields allowing NBFCs to earn superior profit margins, which they can leverage to grow even faster.

India Ratings expects NBFC to account for 17.1 per cent of the total credit in the system by FY20, up from 13.8 per cent at the end of FY15 and 9.4 per cent in FY06.

NBFC size is substantially lower as compared to other economies

Credit penetration in India is low as compared to other economies. On similar benchmarks, the non bank finance penetration in India is even lower. Indian economy has a huge latent credit demand fuelled by a massive self employed population that is underserved by banks due to inadequate income proof.

According to a report by BCG, India’s credit-to-GDP ratio stands at 97 per cent as of FY15 as against 165 per cent in China, 149 per cent in Germany, 244 per cent in the US and 447 per cent in the UK. This implies growth opportunity for the credit market in India as a whole. Interestingly, for the same year, the NBFC-credit-to-GDP ratio in India was just 13 per cent, versus 33 per cent in China, 29 per cent in Germany, 130 per cent in the US and 264 per cent in the UK. If one overlays on this the fact that the largest segment in the banking sector is facing some challenges, then the opportunities to grow should be even higher.

New RBI Norms for NBFCs

The Reserve Bank of India (RBI) has introduced a slew of changes in regulations related to NBFCs due to requirement for capital adequacy, NPA recognition and provisioning and tightening rules in a phased manner over the next four years.

Key changes to NBFC regulations:

Transition from 180 days to 90 days NPA recognition: The RBI wants NBFCs to migrate to 150 days by Mar-16, 120 days by Mar-17 and 90 days by Mar-18. The RBI has given a 3.5-year transition period, which is higher than expected, and thus the change will be less disruptive for NBFCs.

Leeway to restructure once: The RBI has allowed NBFCs a one-time adjustment to the repayment schedule. This provides NBFCs some leeway to adjust overdue to reduce the potential impact on migration.

Other changes: 1) Tier-1 capital requirement has increased to 10 per cent - Most of the large NBFCs are already at over 10 per cent and the impact of this will be limited. 2) Standard provisioning raised to 40bp from 25bp - This has to be done over the next three years and impact on P&L will be miniscule. 3) Reduce limit on raising public deposits to 1.5x of net worth. 4) Corporate governance changes: The RBI has bridged the gap on disclosures by NBFCs with banks.

At housing finance companies front: 1) HFCs such as LIC Housing Finance and HDFC are already at 90-day NPA recognition. 2) LICHF/HDFC have Tier-1 capital levels, well in excess of 10 per cent and that will also not impact HFCs in case the NHB (National Housing Board) decides to apply the same regulations. Hence, we don't see any large issue in housing finance companies.

While on power finance companies’ front, the regulation will negatively impact PFC and REC as they follow 180-day NPA recognition. Therefore, it seems to have been hit by the need for higher provisioning on these in last two quarters.

Financial Performance:

Most NBFCs have delivered 10-30 per cent Y-o-Y growth in PBT during the Q4FY16. Both the retail segments – CV and rural auto segments have reported strong collections. While higher collections imply first signs of demand recovery, growth trends during the quarter were sluggish with maximum weakness in housing finance. Housing finance companies across the board have shown signs of weakness. DHFL, the fastest growing housing finance company under the housing finance space has reported 15 per cent loan growth, whereas home loan growth of LIC Housing Finance was down to 10 per cent.

Talking of loan growth on the CV finance front, Shriram Transport Finance has reported 20 per cent loan growth (excluding the impact of the merger with the equipment finance business). Vehicle finance growth at Chola was 14 per cent as compared to 5 per cent a year back. While growth in rural finance businesses of M&M Finance, L&T Finance and Magma was weak. Q3FY16 was a strong quarter due to the festive season and slowdown in Q4 was likely its after-effect. The management was focused on collections.

Microfinance and consumer loans were strong. Consumer finance and microfinance segments continue to drive strong growth. Bajaj has reported 44 per cent loan growth in the consumer segment; its loan growth at 36 per cent was pulled down by 20 per cent growth in business loans. SKS has reported 84 per cent loan growth and 63 per cent disbursements growth. Outstanding active borrowers were up 26 per cent; while average loan/ borrower was up 46 per cent Y-o-Y, and this was due to elongation of the loan tenure. Ticket size on disbursements was up 27 per cent Y-o-Y. Around 15 per cent gold price rise boosted the gold loan business.

Now talking of net interest margin front, strong collections boosted NIM of rural plays like Mahindra Finance and CV finance companies like Chola; the extent of improvement was much higher than expected this time.
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Commercial vehicle (CV) loans

It is expected that the revival in industrial and infrastructure activity will reflect in the higher utilisation of commercial vehicles in 2016. The likelihood of a normal monsoon in 2016 will also improve the economies of rural assets in second half of Fiscal 2017. Moreover, an improvement in operator cash flows is expected by virtue of a benign interest rate scenario, a fall in fuel price, and stable freight rates over the last nine months. Rationalising of manufacturers’ discounts on new vehicles is expected to boost the resale value of vehicles, which should minimise the credit losses on repossessed assets.

HFCs are gaining mortgage market share

Competition between banks and housing finance companies (“HFCs”) is intensifying in the housing finance landscape in the low ticket loan segment of Rs 10 lacs to Rs 25 lacs. The very low ticket loan segment of less than Rs 10 lacs has been vacated by banks, thereby opening up space for HFCs. Such a penetration would drive growth, help control operational expenses and credit cost.

However, HFCs with their reach and/or specialisation will continue to safeguard their market share despite increased competition from banks. As per India Ratings & Research Report, it is expected that HFCs will grow at 13-15 per cent; while mid-sized and regional HFCs will continue to grow at 8-10 per cent, higher than the system average.

Gold Loan Finance

The Gold loan market in India is the biggest market in the world, probably due to large demand for gold by the Indians. Every year India imports around 900 tonnes of gold for consumption and it has the largest gold stock of 22000 tonnes, which is privately held by domestic households and temples. The low income groups in India are the major customers of gold loan. Century's old practice of lending money against security of gold has been continuing in India in an unorganised manner. Farmers and peasants buy gold during the months of prosperity and stock it in the form of jewelleries and ornaments and then pledge it to the local money lender or pawn brokers during tough times to meet their financial requirements. This peculiar phenomenon in India has given rise to the gold loan market.

Organised segment is fast catching up. It grew around 60 per cent in FY12 and then 45 per cent in FY13, but the growth has reduced in year FY14 due to decline in the international gold prices. The market is expected to grow at a rate of CAGR 15 per cent YoY during next 5 years as per Gold Loan Market in India 2016 – 2020 report.

CONCLUSION

NBFCs have been playing a crucial role in terms of the macroeconomic perspective as well as strengthening the structure of the Indian monetary system. NBFCs have to focus more on their core strengths and must constantly endeavour to search for new products and services in order to survive and grow constantly while improving on weaknesses. We are still bullish on this sector.
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NBFCs glitter on Dalal Street; It is not too late to pick few of those

Equity markets in the country are witnessing a topsy-turvy ride, since the past one year, but stocks of non-banking financial companies or NBFCs are only shining during the period under consideration. Companies like Bajaj Finance, Manappuram Finance, SREI Infrastructure Finance, Capital First and SKS Microfinance have handsomely rewarded their investors during last 12 months. The phenomenal performance by the IPOs that recently hit the markets talk about the growth prospects of the sector. Mahalakshmi Hariharan explores the sector for its investors.

NBFCs are rocking it on the Dalal Street. The ‘Make in India’ and ‘Start Up’ programmes are offering fresh opportunities to NBFCs for further growth. This has truly resulted in a sense of confidence amongst NBFCs who are charged up and raring to scale to greater heights. The regulator is working hard to bring NBFCs at par with banks in terms of regulations. With a renewed sense of optimism, several companies have hit primary markets to raise capital through an initial public offering (IPO). NBFC stocks have grown to become investors’ favourite in the last few months now.

Says Abhimanyu Sofat, a co-founder of AdviseSure, an investment advisory, “Despite not having the advantages of being a bank, the sector has still had a relatively decent net interest margin, return on assets and lower NPAs than banks. We believe that due to better process, product focus and distribution network they have been able to outperform.” 

Companies like Bajaj Finance, Manappuram Finance and SREI Infrastructure have handsomely rewarded their investors in the last one year. (Refer Table).

Company	Share Price as on 6/16/2015	Share Price as on 6/14/2016	Return (%)
Manappuram Fin.	28	57.45	105.2
SREI Infra. Fin.	32.3	59.4	83.9
Bajaj Fin.	4697.65	7488	59.4
Cholaman.Inv.&Fn	596.15	946.5	58.8
SKS Microfinance	437.5	669.6	53.1
Capital First	370.5	557.9	50.6

 

According to Payal Pandya, Research Analyst (Wealth) at Centrum Broking Ltd, a sample data of 16 listed NBFCs show that on an average, NBFCs have given a return of 43 percent over a three-year period. The same set of companies have given a return of 30 percent over one year, 21 percent over six months, 14 percent year-to-date and 23 percent in three months ending 15 June 2016. Top five companies that have distinctly outperformed in last three years are Can Fin Homes at 111 percent, SKS Microfinance at 83 percent, Bajaj Finance at 76 percent, Cholamandalam Investment and Finance at 55 percent and Repco Home Finance at 51 percent.

Increasing interest in the NBFC sector

Since the last two years, Indian banks are going through a rough patch owing to a rise in NPAs, which has largely resulted in the overall slowdown in the economy across sectors thereby leading to lower advances. As a result, investors’ interest towards the NBFC sector has only grown.

Says Prem Rajani, Managing Partner, Rajani Associates, “With growing NPAs and tightening of policies for banks in disbursing loans, in particular to large corporate and manufacturing sectors and to other sensitive sectors like infrastructure, power and real estate; the only other option available for corporates is to look at NBFCs for availing loan facilities. Unlike banks, most NBFCs are still closely controlled and monitored by a dedicated team and some NBFCs are promoter driven. To that extent, proper scrutiny measures and documentation are being undertaken by the NBFC before disbursing loans to the corporates.”

He adds, “With all the precautions in place, the default rate of NBFCs is significantly lower than the default rates of the banks in recovering loans. Further, NBFCs are able to charge higher rate of interest as opposed to banks. With good recovery of loans, high rate of interest and comparatively lower cost of operations, NBFCs are able to generate better cash profits and distribute good returns to investors.”

Pandya notes, “In the last two years, NBFCs present in the auto financing and equipment financing sector also faced pressure in terms of loan growth and asset quality. Shriram Transport Finance’s gross NPA stood over six percent while that for M&M Financial Services at 8 percent, in FY 2016. Microfinance and housing finance companies grew at a healthy pace, during the period, with loan growth ranging from 35-75 percent over financial year 2014-16.”

Regulator’s role

The overall functioning and growth of NBFCs has been supported by the RBI’s renewed guidelines of migration to 90 dpd NPA recognition and encouraging infrastructure financing, which should help in better asset quality control and loan growth.

Points out Pandya, unlike banks, NBFCs were earlier reporting NPAs on 180 dpd (days past due) basis until FY 15, when RBI revised the guidelines saying they would have to migrate to recognising the NPA on a 90 dpd basis, like banks, gradually by the end of FY 18 (120 dpd by end of FY17, 150 dpd by end of FY16). “Most of the companies in the sector have already started reporting NPAs on 120 dpd basis. Despite, the migration from 180 dpd to 90 dpd, the asset quality of NBFCs has largely remained healthy. Gross NPAsof SKS Microfinance, Can Fin Homes, Repco Home, L&T Finance Holdings and PTC Indian Financial Services have stood at 0.1 percent, 0.2 percent, 1.3 percent, 3.1 percent and 3.4 percent, respectively.”

“With stricter norms on NPAs and recognising stressed assets at an early stage, the asset quality for the sector is all set to improve going ahead. While the robust loan growth may result in an increase in the NPAs in absolute terms, the same is expected to remain well in control considering the close-connect and regular customer interactions, relatively smaller ticket size and focus on recovery,” Pandya notes.

In order to encourage infrastructure financing, RBI recently eased refinancing norms for NBFCs. The RBI, in its notification, said any infrastructure loans refinanced by NBFCs by way of take-out financing, without a pre-determined agreement with other lenders and having longer repayment tenure; would not be treated as restructured asset, if the loan was a standard account in the books of the previous lender and had it not been restructured in the past.

“With the Government’s increased focus on improving infrastructure like building new national highway corridors, targeting to more than double the roads and highway network to 9.6 lakh km by 2020, increase railway lines and so on, the loan growth for NBFCs is expected to stay robust. The sector would reap further benefits from the Government’s focus on housing development across country through ‘Housing for All by 2020’ and support to MSME sector through the ‘Make in India’ and start-up financing,” says Pandya.

Israni says, “Previously, the sector did face certain challenges, especially after certain chit-fund and ponzi-scheme companies mopped up funds from the market and vanished. However, with the recent success of branded NBFCs and successful IPOs by a few, various regulations in place and monitoring by the RBI and SEBI, this sector is now attracting bankers and investors.”

He adds, “The RBI has already put in place various directions to govern the NBFC sector and with passage of the Insolvency and Bankruptcy Code, hopefully, the recovery process also would expedite. In my view, there is enough regulation in place to regulate NBFCs including, entry level barriers and prudential norms governing their operations.”

Here, Sofat believes considering the soft real estate and infra segment, it will be challenging to manage growth as the regulations tighten in short term.

“We believe sharing of information using platforms like CIBIL needs to be strengthened to ensure lower slippages. Project report for disbursement of loans should be shared. The RBI needs to closely watch the sector so that frauds such as ‘First Leasing scam’ do not happen,” he adds.

NBFC IPOs

Recent IPOs from Ujjivan Financial Services and Equitas Holding were oversubscribed by 41 times and 16 times, respectively.

Sofat says, “The growth rate of these NBFCs has been quite attractive coupled by reasonable valuations. Despite the strong growth, NPAs of the company are in check. This is why the issues have outperformed.”

                                                                                                                                            

Company                           Price Band (Rs)   Listed Price (Rs)     CMP  

Ujjivan Financial Services 207- 210              231.90 (up 10.4%)   379

Equitas Holdings                109- 110               146 (up 33%)          171

Source: AdviseSure.com

As the market sentiment for the sector is increasing, experts believe more IPOs will come in.

“PNB Housing is likely to come up with an issue of about $300mn. Considering the strong growth exhibited by the company over last five years, we are quite bullish on the prospect of the company. We believe that microfinance, gold lending, two wheeler loans and HF companies will continue to do well,” says Sofat.

Israni points out, “Most of the NBFC that go public are from the space of ‘housing finance’ or ‘investment companies’ or ‘deposit-accepting loan companies’. They do have specific guidelines and one needs to adhere to the prudential norms and strict reporting and compliance provisions set. Most NBFCs also have special tax and audit and accounting standards, which the company needs to strictly adhere to.”

Pandya explains that the primary reason for NBFCs to reach out to equity markets are the new shareholding norms for all NBFCs aspiring to get a small finance/payment bank license and the need for raising growth capital. “Considering an average of over 30 percent loan growth across the sector, companies are required to reach out to the capital markets for raising their Tier-I capital, in order to maintain the regulatory requirement of 15 percent CAR. Also, as per RBI guidelines, for setting up a small finance/ payment bank, the FII holding in the company should be less than 49 percent.”

What lies ahead?

“New initiatives such as P2P lending will bring in more opportunities for the NBFC to target. Cross selling of products is likely to further enhance ROEs for NBFCs. As the turmoil in PSU banks are on, NBFCs are likely to be major gainers in different segments like lower and middle customer segment, gold loan, HF and microfinance,” says Sofat