NBFCs with strong liquidity buffers better placed to absorb shocks amid lockdown-led business disruption: Ind-Ra

NBFCs with strong liquidity buffers better placed to absorb shocks amid lockdown-led business disruption: Ind-Ra

India Ratings and Research (Ind-Ra) opines the headwinds and the other operational issues based on which it had assigned a negative outlook to the non-banking finance company (NBFC) sector have aggravated in light of the country-wide lockdown imposed to arrest the contagion of COVID-19.

The negative outlook was based on the likely continuation of asset quality challenges, low loan growth, high borrowing costs and weak operating performance of the sector entities in FY21. As NBFCs generally cater to the informal borrower profile, and mostly self-employed category, the COVID-19 impact is likely to be disproportionate on them.

Generally, 4Q is the strongest in terms of disbursements and asset quality pull back for the sector. Ind-Ra believes that Reserve Bank of India’s (RBI) announcement of allowing a three-month moratorium on term loan instalments by lending institutions would be availed by most of the NBFCs, which would alleviate the pressure on their borrowers to meet the loan obligations. However, the experience on asset quality post a moratorium period has not been encouraging. The incorrect interpretation of the loan moratorium as a loan waiver by borrowers, or political intervention is an additional overhang. This could give rise to idiosyncratic risk in some of the informal asset classes.

If banks become selective in offering the moratorium, then entities with strong liquidity buffers would remain afloat through these challenging times especially if they offer a moratorium to their customers.

Even if the three-month moratorium is offered, the most vulnerable segments where the borrower profile is the weakest and cash collection is high will face a greater extent of income disruption, leading to a long-drawn normalisation process for these entities. The severity of challenge is uncertain and will depend on the withdrawal of restrictions and pace of recovery of normal economic activity. Ind-Ra’s base case assumption is that the disruptions could last till mid-May before normal the cash flow normalisation starts. Having said that, each class of customer will show a varying ability of bouncing back to normalcy depending on their profile.

Most Ind-Ra rated NBFCs in investment grade carry adequate liquidity (liquid investments and unutilised bank lines) to meet their committed obligations of fixed cost and financial obligations even if the collection were to drop substantially for the next two months. The RBI’s announcement of Targeted Long-Term Repos Operations to be deployed for corporate bonds would have a calming effect on yields and improve liquidity for higher rated borrowers.

Retail NBFCs: These companies largely cater to the informal and self-employed borrower segment and thus would face a higher impact due to income volatility at the customer’s end. The severity would be higher for segments such as unsecured personal loans, two wheelers loans, used commercial vehicle loans, loan against property and light commercial vehicle loans.

The loss of income for light commercial vehicle players due to business disruption would be much higher, since this segment is the most vulnerable and depends on the local market economic activity to get freight. Furthermore, these set of customers do not carry enough liquidity cushion to tide over a prolonged crisis situation. Companies providing loans for purchasing heavy commercial vehicles would be impacted due to the reduced movement of goods because of the slowdown in the industrial activity, given that manufacturing plants have shut down facilities.

NBFCs’ exposure in the loan against property segment or vehicle financing segment (other than CV) is typically to the borrowers which have informal or volatile sources of income. This self-employed category of borrower faces higher chances of income disruption. 

Housing: Ind-Ra estimates a higher and a more immediate impact on small ticket affordable housing. On the affordable housing segment, a rise in early bounce rate could be seen. With the economic activity coming to a standstill, there can be job losses and reverse migration of labourers to their native places. In the informal segment, the impact of the job loss will be prominent. Furthermore, the affordable housing customers who have availed the Credit Linked Subsidy Scheme are only a notch above microfinance borrowers in terms of credit profiling, thereby creating a material impact on their creditworthiness. Ind-Ra believes loan growth would further fall for affordable housing financers in FY21, as the borrowers would delay their purchasing decision amid economic challenges.

Moreover, buyers in the large ticket housing segment would delay their purchase decisions. In particular, the self-employed segment is likely to face greater headwinds. However, salaried customers with a stable income profile could pose a lesser risk.

Wholesale NBFCs (corporate and real estate lending): These companies would face severe stress, as the borrowers would delay home purchases and the lack of progress of construction work by a quarter would squeeze developers’ cash flow. NBFCs focusing only on real estate would be under severe pressure on the asset side, in matching their inflows with periodic debt repayments. The situation can worsen with a large proportion of book moving out of the moratorium for many lenders. Ind-Ra believes carrying on-balance sheet liquidity covering the next six months of debt repayments, remains paramount in such volatile times even if it impacts profitability due to the negative carry.

Small Finance Banks (SFBs) and Microfinance NBFCs: Moratorium would help the weakest set of customers in the NBFC spectrum to tide over this crisis. However, the extent of income disruption could be higher for them. The government is trying to keep the supply chains of essential goods intact and the borrowers dealing with such goods and services thus may be better placed.

Institutions have become extremely slow on disbursements to conserve liquidity. While on the liability side, microfinance institutions have learned from the demonetisation impact and built-in substantial balance sheet liquidity and sought un-availed bank lines sufficient for four to six months without causing significant dependence on repayments, borrowers’ behaviour could be unpredictable for prolonged periods. While SFBs are better placed with the Reserve Bank of India being the lender of the last resort in addition to the lending support from policy institutions, asset-liability management challenges could crop up if there is substantial deposit withdrawal or non-renewal of deposits. Ind-Ra has already changed its outlook on both NBFC-MFIs and SFBs to negative for FY21 from stable in its outlook report.

Insurance: Life insurance companies could witness a varied impact based on their product mix. The impact could be due to a fall in equity market impacting Unit Linked Insurance Plan segment higher, as the pool for fee income moderates and there could be persistency issues in holding the customers. Many SME owners and salaried customers may start conversing cash. Also, interest rates may be brought down, impacting the guaranteed products sold by insurers under pension and annuity plans. However, the yields would be back-to-back hedged to some extent. The least impact would be on non-PAR products where exposure to equity stands minimal. There could be challenges in handling distribution franchise as the agents’ mobility would be hampered. Also, growth in medium term stands impacted with all distribution channels would take their own time to return to normalcy. The focus of insurer would be to monitor persistency of its existing customers rather than growth.

In general insurance, there could be pressure on renewals along with fresh business in auto own damage & third party products due to the slowdown in auto sales and disruption in auto life cycle. In health insurance side, there could be some improvement in loss ratios, as people delay their discretionary medical checks in the near to medium term. There could be a near-term impact on business growth, as individuals delay their discretionary spend and conserve cash; however, there could be an increase in the awareness of having health covers in the long run, benefiting the health insurance industry. The volatility in equity markets would marginally impact the investment book of general insurance companies; however, declining interest rates could affect their investment income, leading to a fall in profitability in the medium term.

Overall, Ind-Ra expects loan growth to be severely impacted in FY21 and profitability would be impacted due to a rise in credit cost for lending entities. However, capital buffers are comfortable and Ind-Ra does not expect a material impact on them. Furthermore, there would be lesser consumption of capital and some leverage correction due to the lower loan growth. Having said that, Ind-Ra is closely monitoring the situation as it unfolds and would take the necessary rating action for the segments that are expected to be disproportionately impacted.

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