NBFCs To Unleash Its Potential

NBFC sector has grown consistently and has undergone tremendous transformation over the past few years. Yogesh Supekar and Nikita Singh explain why the sector is on a growth trajectory and here to stay for good.

Amidst all the chaos and the uncertainty on the macroeconomic front in India, and especially in the banking sector, the non-banking finance company (NBFC) sector is one sector that has managed to deliver consistent growth year-on-year.

If one considers the current government's goal of rapidly improving financial inclusion in India, one will immediately realise the importance of NBFC sector and the crucial role it plays in complementing the banking sector in reaching out credit to the un-banked sections of society.

Indeed, NBFCs form an integral part of not only Indian financial system, but also the Indian economy.

The NBFC sector in India has undergone tremendous transformation over the past few years and has been able to deliver consistent year-on-year growth. NBFCs have played an important role in infrastructure development in India and has provided support for the economically weaker sections.

NBFCs have especially contributed handsomely to the growth in advances in micro, small and medium enterprises (MSMEs), which has by far been the biggest achievement of the sector.

NBFCs recently have improved their performance on several metrics, even as the banking sector struggled owing to the issue of non-performing assets.

Based on the financial stability report (FSR) of the Reserve Bank of India (RBI), the NBFC loans expanded 16.6 per cent in FY16, reflecting a growth twice as fast as the 8.8 per cent credit growth logged by the banking sector at the aggregate level.

The sector has grown at a compounded annual growth of almost 18 per cent over the last few years and is expected to maintain similar growth momentum in the coming years.

"A non-banking finance company (NBFC) is a company engaged in the business of loans and advances, acquisition of shares/stocks/ bonds/debentures/securities issued by the government or local authority"
- Reserve Bank of India's definition of NBFC.

The NBFC sector continued to raise funds mainly through debentures, borrowings from banks and commercial papers. In a welcome move the Reserve Bank has eased the norms for external commercial borrowings (ECBs) for NBFCs that lend to the infrastructure sector. In addition, the Reserve Bank also allowed NBFCs to raise funds through rupee denominated bonds overseas. - RBI Publication

Multiple factors are playing in favour of the NBFC sector, including their focus on the retail segment. The retail-heavy portfolio of NBFCs has helped the players to maintain steady growth. Several NBFCs are also seen expanding beyond their traditional lending business to offer working capital loans for corporate entities.

A plethora of strategies is being adopted by the tech-savvy NBFC players, however, the ones that have catered to niche segments have benefited immensely.

NBFC Classification

KEY ADVANTAGES :

NBFCs' understanding of their customer's profile and their credit needs is one of the key advantages enjoyed by the NBFC players. The ability to innovate and customise products as per the client's needs allows NBFCs to deliver credit to MSMEs, which have hitherto been rejected by the traditional banking sector.

When compared with the banks, NBFCs do not enjoy a level playing field, especially on the liability side. Once this issue is addressed, it will help NBFCs to realise their full potential. However, with deepening bond markets in India, NBFCs do have an opportunity to bring down their cost of borrowing funds.

The ongoing stress in the banking sector, especially the public sector banks, presents an opportunity for the NBFC players to improve their market share by lending more to the unattended customer base.

Owing to the NPA problems faced by the banking sector, certain PSU banks such as Dena Bank have been placed under prompt corrective action (PCA) under which there are limitation on providing new loans. One can expect NBFCs to encash such situations profitably.

Ability to tap the unbanked customer base has proven to be the key reason behind the growth story of NBFCs. Majority of credit seekers in India do not have income proofs or IT returns owing to temporary employment or selfemployment and this is one of the primary reasons for the tepid credit penetration in India.

This is exactly where the NBFCs have an edge. Adoption of digitisation and acceptance of digital data and social media data comes into play when data set in traditional manner is not available.

The digital disruption will facilitate new ways for NBFCs to tap markets, even as acceptance of alternative data from social media is expected to be on the rise.

Better product lines, lower operational costs, wider reach, effective risk management capabilities leading to lower bad debts have all led to better performance by NBFC players when compared to banks. Even in personal loans and housing finance segments, which have been the bastion of private sector banks, NBFCs have improved their penetration.

The ever-increasing credit demand in India will drive growth for the sector. With improving macroeconomic indicators, the credit penetration will only improve from hereon.

NBFCs have, over the years, monopolised number of product segments, such as consumer durables, new car segment in small town and truck finance. It is also observed that NBFCs have disproportionate share in the niche segments, which helps NBFC players to remain profitable.

DIFFERENT GROWTH DRIVERS FOR DIFFERENT COMPANIES

Certain NBFCs that transformed themselves from being a wholesale focused lender to a retail-centric business such as Capital First have been on a faster growth trajectory. The switch for Capital First worked wonders and its retail loan book grew nearly 40 per cent on an annualised basis since 2011-12.

The focus on retail segment allows NBFCs to focus on high growth, high yield segments, such as consumer durables and two-wheeler loans. These segments are high margin segments for NBFC players.

Then there are certain NBFC players such as Motilal Oswal, IIFL and Edelweiss that have a different growth story. While Motilal Oswal banks on a quality asset management company and runs a decent (growth) housing finance company, IIFL is making all the right moves in the wealth management business and is now focusing on building its credit businesses. IIFL & Edelweiss have a healthy product mix and have diversified income streams.

The beauty of investing in NBFC sector is that you will invest in businesses with unique business models operating in high yield, high growth, high margin businesses which are also agile. Agile structures and set-ups of most of the NBFCs allows these companies to quickly spot growth opportunities in new related areas. You may well be buying a different NBFC stock for an altogether different reason. The IT infrastructure is in place for most of the players and the technology is leveraged optimally by the NBFC players to reach out to their prospective consumers.

Consolidation within the NBFC sector continued during 2015- 16, resulting in a reduction in the number of both NBFCs-D and NBFCs-ND-SI. Their assets continued to register substantial growth. The accelerated growth in credit deployment by NBFCs was due to their ability to contain risks and tap demand in niche markets. The profitability of NBFCs was significantly higher as compared to commercial banks.
- RBI Publication

CONCLUSION :
Looking at the NBFC sector's competitive nature, it will be important for investors to identify those NBFCs which have hit the right customer segments and right product mix. Right product mix is extremely crucial for NBFCs to maintain high growth rates without sacrificing profitability.

Those NBFCs which have got the customer segmentation right along with the right product mix and enjoy wide geographical spread are the ones that may keep investors delighted going forward. However, the checklist on NBFCs should also include their digital capabilities. NBFCs that have embraced digitisation will have a definite edge over their competitors. Also, investors looking at NBFCs for investing should not forget that NBFCs are proxy plays on infra-affordable housing segment, which is the growth engine for many of the real estate players.

The growth in middle class and improvement in per capita income will spur demand for consumption and commercial finance. This segment will drive credit demand. Those NBFCs that are focused on this segment can expect to benefit from the development of this huge market over the coming years.

NBFCs have outperformed banks on ‘Return on Equity (RoE)' parameter over the past several years, despite the perception of being at a disadvantage due to higher cost of funds.

It is by now clear that NBFCs are able to create massive value owing to higher profitability and higher growth. The unique business model of NBFCs help them deliver consistently. Higher yield, operational efficiency and credit cost allows NBFCs to deliver higher RoA. The business model that allows NBFCs to focus on customer-oriented product segments proves to be an asset in the long run and hence makes a strong case for investors to include and hold on to quality NBFC stocks in their portfolios.

George Alexander 
Muthoot Managing Director, Muthoot Finance

How is GST expected to affect the pricing of your services and how do you see demand for your services getting impacted?
Our pricing will be based on the stipulations of GST rules. Considering the market conditions, demand for gold loans will continue to rise. Proposed tax rate under GST for gold is 3 per cent as against 5 per cent VAT in Kerala and 1 per cent VAT in other states. For gold ornaments, most of the jewellers in Kerala are paying VAT at 1.50 per cent under compounding system. Hence, the price of gold ornaments is poised for an increase throughout the country.

How is Muthoot embracing digitisation? 
The transformation to digitisation started a few years back and the pace has increased drastically in the last two years. As a result, every aspect of our business functions and operations is now almost completely digitised. An enhancement to this is a continuous process.

Customer-focused digitisation was the company's motto from Day-1 and, as a result, we have a complete web and mobile solution for our customers' convenience, which is enhanced almost on a daily basis. Hence, we are able to communicate and connect effectively with our customers and this digital strategy is enabling us to bridge the gap in reaching out to new target segments faster than ever before.

Spend on digitisation is need-based, which is current and future envisaged. We leave no stone unturned to ensure the best possible user experience to maintain and increase our high level of customer satisfaction.

What trend do you see in Gross NPAs and Net NPAs for Muthoot Finance in the upcoming quarters? 
Asset quality has never been a concern for the company as the loans have 100 per cent collateral in the form of gold. Thus, the company always has the technical NPA, which is currently about 2 per cent. We anticipate the NPA for June will be lower than March 2017. With gold price expected to improve post-GST, gross NPA will be kept below 2 per cent.

Since last year, we have initiated steps to derisk against gold prices. We have started collecting interest periodically and incentivised the customers to pay the interest monthly, quarterly and half yearly. The customers paying interest monthly or quarterly are eligible for concessions in the interest rates, thus assisting the company to have the interest collections that are much better.

Gold loans remain the core focus for Muthoot. What are your internal growth targets and how are other services growing?
Gold loan sector is poised for a growth of 10 per cent to 20 per cent during the year, Gold price is also expected to remain steady in the short term.

During FY17, the company witnessed 46 per cent growth in net profit at Rs.1180 crore, as against Rs.810 crore in FY16. Retail loan AUM stood at Rs.27,278 crore, registering 12 per cent growth in FY17.

During FY17, Muthoot Finance acquired 64.60 per cent in equity share capital of Belstar Investment and Finance Pvt Ltd (BIFPL), an RBI registered micro finance NBFC. Its loan portfolio grew by 114 per cent at Rs.567 crore in FY17 with profit after tax of Rs.10 crore as against PAT of Rs.6 crore. Its gross and net NPAs stood at 0.09 per cent and 0.02 per cent, respectively. The company also acquired 100 per cent stake in Muthoot Insurance Brokers Pvt Limited, an IRDA registered direct broker in insurance products. It generated a first year premium collection amounting to Rs.70 crore during FY17, as against Rs.48 crore in the previous year During FY17, the company increased its shareholding in the housing finance company Muthoot Homefin (India) Ltd from 79 per cent to 88.27 per cent. Its loan portfolio increased by Rs.409 crore at Rs.441 crore. Total revenue for FY17 stood at Rs.24 crore as against Rs.2 crore in FY16. It achieved a profit after tax of Rs.2.87 crore during the FY17, as against Rs.1.36 lakh.

During the year, the company increased its shareholding in the Sri Lankan subsidiary Asia Asset Finance PLC. It increased its loan portfolio by 26 per cent at LKR 866 crore in FY17. Total revenue for FY17 stood at LKR 213 crore as against LKR 139 crore in FY16. It generated a profit after tax of LKR 28 crore during the year as against previous year profit after tax of LKR 18 crore.

The subsidiaries today contribute about 5 per cent to the group's assets. The company is looking at increasing the share of subsidiaries to about 10 per cent of the group's assets in the coming year.

Ashutosh Khajuria
Executive Director & CFO, Federal Bank

What is your outlook on NBFC sector in India? 
With the regulatory supervision over NBFCs and their reach in the nooks and corners of the country, NBFCs bring diversity to the financial sector. They have already become an integral part of the economy and have ample scope for further growth in the coming years, provided a robust and well-supervised credit risk management policy is put in place.

In your view NBFCs are grabbing market share from traditional banks like yours? 
Yes, banks have an edge in terms of their ability to raise CASA and comparatively lower cost retail term deposits from the public additionally, but it comes with regulatory costs in the form of Cash Reserve Ratio, Statutory Liquidity Ratio and the directed lending to priority sector, agriculture, micro and weaker sections at regulated rates. There is no question of grabbing of market share by NBFCs. They function on a relatively different platform and we would like to see them as agents complementing our efforts. NBFCs would, in fact, aid in initiation of these un-banked or under-banked population to formal banking system.

What is the outlook on vehicle finance and LAP products at Federal bank? Which segment is growing the fastest for you?
LAP has traditionally been our strong area. We continue to focus on it considering the opportunity available in the market. We have tailor-made and well-priced products both in SME and retail sectors in LAP. There are some sectors like vehicle finance where NBFCs are gaining share from commercial banks, but we are seeing our share quite stable. We have got into agreements with a number of dealers for inventory financing and retail business, which is why we have not only stood our ground but have grown significantly too in this sector.

Rajashree Nambiar
CEO, IIFL

For FY18 what is the outlook for NBFCs and what are the growth expectation at IIFL for its NBFC business? 
We are operating in exciting times and the country is well-poised for long term economic growth. When compared to other economies, we are still at a low penetration of credit, and NBFCs have a large role to play in credit growth on the back of their widespread distribution reach in sub Tier I locations and contemporary solution offering.

The outlook is to sustain the pace of growth through FY18 and beyond. Our key volume drivers would be affordable housing, CV and SME - these products will enable us to participate in the most promising growth areas of the economy. At the same time, initiatives on digitisation and technology will reduce opex and drive profitability.

What is the outlook for SME, gold finance and housing finance business at IIFL? Can you let us know the growth rates you have witnessed in each of these individual segments?
We witnessed strong growth in our SME loans segment in FY17, while mortgages grew at ~42 per cent.

The outlook fore various segments are as follows: 
SME Loans — Riding on the favourable macro environmental conditions and in-house digitisation initiatives — SME lending at IIFL is poised for exponential growth. Recent government reforms will further aid the lending industry: 
1.Due to demonetisation, adoption of the digital payment system has shown significant improvement by MSMEs, which opens up lending opportunity.

2.Implementation of GST bill is expected to benefit MSMEs not only with simpler tax structure but also with aspects such as improved technology adoption in order to comply with GST system and provide lender access to the transaction data through GST portal.

SME loans aim at digitising the processes to ensure seamless processing of files with minimum manual intervention and meeting the customers' financial requirements. 100 per cent of the retail MSME loans will be sourced digitally, ensuring faster delivery.

Housing Finance — The market potential of affordable housing projects in the country is expected to touch Rs.6.25 trillion by 2022 (source — ICRA) due to demand emanating from a growing population and the disparity that exists in household income and high real estate prices. In addition, the government has provided various incentives to home buyers, targeted at the affordable housing segment, which is expected to further augment the demand.

How is digitisation shaping your strategy? What is your annual digital spend? 
1.We are focussed on implementing end-to-end digitised products and processes. We have been able to enhance our processes and improve our services based on the digital initiatives across all products and customer life cycle.

2.We are now digitally on-boarding customers through web and TABbased services across all our products. Backed by eKYC, eSign and robust real time appraisal process, we are now able to disburse loan in seamless and almost paperless manner. With eNACH being implemented, we are geared up to disburse our loans in completely digital and paperless mode.

3.We continue to invest disproportionately in building our digital platforms and capabilities. As regards marketing spend, our conscious aim is to spend on both online and offline platforms, as appropriate.

Shrey Loonker
Fund Manager, Reliance Mutual Fund.

What is your house view on the NBFC sector?
NBFC market share is relatively smaller in the entire financial landscape, and thus the growth opportunity remains strong. Also, post-demonetisation, surplus liquidity in the system makes banks more aggressive on the pricing front. However, select NBFCs with their distribution moat can flex their muscles to counter this competition. On the valuation front, the NBFCs are not cheap, but with growth availability and distribution moat can offer a good longer term opportunity.

Compared to the banks, have NBFCs proven to be more profitable?
Both banks and NBFCs are cyclical businesses, and thus NPAs are a function of the cycle and underwriting mechanism. Also, NBFC business is more retail in nature vis-a-vis banks, which are more wholesale focused. The wholesale businesses have undergone a prolonged slowdown in the macro environment, thus resulting into higher NPAs. However, on the retail business, banks have performed relatively better versus their NBFC counterparts — mainly due to the difference in customer segment. On profitability, return ratios have been higher for the NBFCs as banks have been saddled with NPA issues on the wholesale side. Thus, certain niche NBFCs like housing finance, gold finance, insurance companies have opened new avenues and provided superior returns in the financial space.

As of May 31, Reliance Banking Fund has given 22.22 per cent returns on an annualised basis. What is the underlying growth assumption for the fund to do well?
In the past, banking credit growth has been approximately 1.5x nominal GDP. As India is a growing economy, we expect this to happen for the coming years. Thus, we believe there is a huge opportunity to invest in the India's financial savings as well as disintermediation story via niche NBFCs, insurance companies and banks.

Umesh Revankar
MD and CEO, Shriram Transport Finance Ltd 

What will be the growth outlook like for coming two to three years? 
We are looking at 12-15 per cent growth in our AUM for FY18. The first half will witness slower growth due to implementation of GST, as the whole system down the value chain needs to adopt and absorb the same. We expect good monsoon to result in demand pick-up by rural India and growth outlook of 15 per cent. Also, if our economy is growing very healthy, STFC could grow beyond 15 per cent over the two -three years.

Going forward, do you see the NPA problem subsiding for the NBFC industry as a whole? 
Earlier, the NPA recognition for NBFCs stood at 180 days. As the entire industry must move to 90 days by FY18, we have well equipped ourselves to manage the same. The whole process will aid in making the customers more disciplined, leading to reduction in delinquencies over the period.

How is pre-owned CV segment performing for STFC? What are the major issues faced by STFC in pre-owned CV market? 
Commercial and passenger vehicle industry witnessed strong recovery in FY2015-16 due to replacement demand. The CV industry continued the momentum in FY17 as well. However, after witnessing healthy growth of 13 per cent in Q1, M&HCV truck underwent sudden contraction period, resulting in the growth momentum taking a break. The key factors for the same were decreasing replacement demand, impact of demonetisation and the uncertainty related to the impact of GST on vehicle prices and the expectation on the prices to decrease post the implementation of GST.

Post the GST and BS-IV implementation, long term certainty will set in the overall business environment that would result long-term positive credit demand.

Kaustubh Belapurkar
Director - Fund Research, Morningstar Investment Adviser

Have MFs been piling up NBFC stocks? 

Financial stocks are typically the largest sector exposure in a manager's portfolio, by the virtue of these stocks having the largest weightage in the indices. But, over the past few years, fund managers have turned even more bullish towards financial stocks and have been steadily increasing exposure on an aggregate basis. While banks constitute a large allocation in fund's portfolios, the allocation towards NBFCs stocks has also significantly shot up. In May 2014, investment in banks constituted 21.1 per cent of the overall equity portfolios and NBFCs constituted 5.5 per cent. This allocation now stands at 22 per cent in banks and 7.8 per cent NBFCs as of May 2017. Manager's top NBFC holdings include stocks like HDFC, Bajaj Finance, Max Financial Services, Bajaj Finserv and Cholamandalam Investment and Finance.

How much money have NBFCs attracted in the past one year as compared to banks (both private and PSBs)?

Over the last year, managers have been increasingly investing in financial stocks. While banking stocks have been witnessing large buying, there has been ever increasing focus towards NBFC stocks, especially in the housing finance space. The aggregate investments in banks has gone up from Rs.89,000 crore to Rs.144,000 crore. At the same time, manager investments in NBFC stocks have gone up from Rs.28,000 crore to Rs.51,000 crore.

Is there any thematic mutual fund scheme that invests primarily in NBFC stocks?

Investors who are looking to take NBFC exposure can look at investing in banking and financial services funds. While there is a larger allocation in these funds towards banking stocks, many funds also take a sizeable NBFC exposure in these funds, with the typical exposure in NBFC stocks ranging from 10-40 per cent.

MUTHOOT FINANCE

BSE Code: 533398 FV: 10 CMP: 456
Market Cap (F.F.): Rs.4,557.21 Crore

Muthoot Finance Ltd is India's largest gold financing company in terms of loan portfolio. Muthoot Finance, with over 4,250 branches across India, is engaged in providing loans against collateral of gold jewellery.

On the financial front, Muthoot Finance's revenue increased 17.47 per cent to Rs.5,639.55 crore in FY17 as compared to the previous fiscal. The company's operating profit rose 17.38 per cent to Rs.4,263.04 crore in FY17 on a yearly basis. Its profit after tax also increased 45.78 per cent to Rs.1,179.83 crore in FY17 as compared to previous financial year.

On a segmental basis, the company derives about 52 per cent of its loan portfolios from the southern India, followed by northern India contributing about 23 per cent. The eastern India operations of the company has the least involvement in gold financing with only 7 per cent contribution.

The favourable regulatory environment for the company coupled with the rising gold prices is expected to boost the growth of the company and result in the growth of AUM. A trend of increasing recoveries and auctions is further likely to boost the financial performance of the company. The company is also likely to witness a substantial hike in its NIM on the increasing yield and an optimised infrastructure.

BAJAJ FINSERV

BSE Code: 532978 FV: 5 CMP: 4134 
Market Cap (F.F.): Rs.23,683.20 Crore

Bajaj Finserv, a part of the Bajaj Holdings & Investments Ltd, is a prominent financial services company engaged in lending, asset management, wealth management and insurance. On the financial front, Bajaj Finserv's revenue decreased 36.49 per cent in FY17 as compared to the previous fiscal, yet its revenue remained positive at Rs.153.90 crore. The company's operating profit also declined 46.25 per cent to Rs.105.46 crore in FY17 on a yearly basis. Its profit after tax decreased 57.08 per cent to Rs.70.02 crore in FY17 as compared to the previous financial year.

Despite a negative undertone in financial performance, the company is expected to extensively recover in the current fiscal with the growth in CD financing resulting in a consecutive growth in the CF segment.

The expected growth in life insurance segment is also likely to enhance the performance of the company. The markets have witnessed a consistent growth in the performance of Bajaj Allianz General Insurance Company, which is a joint venture of Bajaj Finserv and Allianz SE, a German financial services company. Moreover, the reduction in cost to income ratio as well as credit cost will cut the operational costs for the company, and thereby reap financial benefits. 

EDELWEISS FINANCIAL SERVICES

BSE Code: 532922 FV: 1 CMP: 191 
Market Cap (F.F.): Rs.7,972.33 Crore

Edelweiss Financial Services Limited, the holding company of India's diversified financial services major, Edelweiss Group, provides investment banking and advisory services, besides offering agency services and life insurance. On the financial front, Edelweiss Financial Services revenue increased 33.91 per cent to Rs.423.53 crore in FY17 as compared to the previous fiscal. The company's operating profit rose 36.14 per cent to Rs.286.94 crore in FY17 on a yearly basis, although the company's profit after tax witnessed a decline of 17.08 per cent to Rs.129.01 crore in FY17 as compared to previous financial year.

On a segmental basis, the company posted a good growth of nearly 117 per cent in the income from the life Insurance segment, growing from Rs.110.96 crore in the third quarter of the fiscal to Rs.240.30 crore in the Q4FY17. The capital based segment witnessed a growth of 14.71 per cent in the fourth quarter on a quarterly basis, while the agency's contribution to the total income rose by over 9 per cent in the last quarter.

The company is expected to chart a robust growth in the coming quarter as an impact of rapid growth in wealth management segment. The Reserve Bank of India's aggressive stand towards eradicating NPAs is likely to boost demand of the ARC segment.

CENTRUM CAPITAL

BSE Code: 501150 FV: 1 CMP: 47.70 
Market Cap (F.F.): Rs.1,349.44 Crore

Centrum Capital is India's full service investment banking major. The company has executed transactions worth over Rs.1.6 trillion till date. On the financial front, Centrum Capital's revenue decreased 40.69 per cent to Rs.26.81 crore in FY17 as compared to the previous fiscal. However, the company's operating profit rose 267.99 per cent to Rs.81.51 crore in FY17 on a yearly basis. Its profit after tax also increased 515.08 per cent to Rs.37.52 crore in FY17 as compared to the previous financial year.

On a segmental basis, the company's housing loans and loans and small business loans were the main growth drivers in the FY2017, while forex-related operations of the company substantially contributed to the revenues of the company.

The conducive environment in the housing finance segment is likely to provide an edge to the company as the lending operations in housing forms one of the significant parts of the company's operations. India's strengthened foreign exchange position is likely to benefit the company further. Centrum Capital's increasing presence in digital space is also expected to enable the company to expand to new markets. With a crackdown on defaulters, the company's core operations, especially debt syndication, is also expected to witness a noteworthy growth in the coming quarters.