India Ratings & Research (Ind-Ra) has maintained a stable outlook on the major Indian non-bank finance companies (NBFCs) sector in 2014. This reflects the expectation of easing asset quality pressures from 2HFY15, although delinquencies will peak only by March 2015. At the same time, the major NBFCs' defences in the form of solid pre-provision operating profit (PPOP) and capital buffers provide a strong cushion against Ind-Ra's stress tests on scenarios of spike in credit costs and elevated funding costs.
The agency expects the revival of certain infrastructure projects (cleared by the cabinet committee in recent months), pick-up in industrial growth and corporate capex investments to benefit most of the commercial assets financed by the NBFCs, from 2QFY15 onwards. This would ease the pressure on the cash flows of their borrowers through enhanced utilisation of their assets and contain incremental delinquencies. New business growth, however, will likely remain subdued till 3QFY15, as it would require a longer period of sustained growth in the index of industrial production to entice operators to buy new vehicles. However, in a scenario of continued weak industrial growth and infrastructure projects remaining stalled, the asset quality pressures could intensify and adversely impact the NBFCs with large unseasoned portfolios, in particular.
Management focus is expected to increase on collection and recovery for the next two-three quarters as well as on controlling operating costs, to contain the impact of lower loan growth. Nevertheless, rising credit costs and elevated funding costs will suppress profitability, though it will still remain healthy, compared with commercial banks. Ind-Ra estimates the aggregate average return on assets (ROA) to decline to 2.2% in FY15 (FY13: 2.7%) at the eight major NBFCs. The agency's estimate for banking system average ROA for FY15 is around 0.8%.
Ind-Ra does not expect any material change in the major NBFCs' high dependence on bank financing in 2014. The regulatory changes implemented in last few years have not changed NBFCs' funding profile as the Indian debt capital markets lack depth. Tight liquidity conditions (as demonstrated during 2QFY14/3QFY14) can hinder access to debt markets, and underline the importance of bank relationships. Major NBFCs maintain borrowing relationships with a range of lenders/banks.
Ind-Ra's stress test on the major NBFCs-which assumes multi-fold increase in NPLs/credit costs and a significant increase in funding costs - shows strong resilience of the PPOP buffer to absorb the stressed credit and funding costs at most of the rated major NBFCs. This reflects an appropriate risk-pricing by these NBFCs.
The rated major NBFCs' steady operating performance (including stable asset quality) has facilitated their access to funding from banks, institutional investors and capital markets. A protracted and sharp contraction in industrial activities (and overall economic growth) could adversely impact the NBFCs' credit quality and operating performance. The asset quality pressures in such a scenario could exceed Ind-Ra’s assumptions and lead to negative rating actions. Conversely, a strong through-the-cycle operating performance, stable asset quality, robust capital buffers and diversified funding profile can lead to positive rating actions.
