Financial Institutions

Financial Services

2013 Outlook: Major Indian Non-Bank Finance Companies

Stable, but Strong Headwinds Remain
Outlook Report
Rating Outlook

STABLE

Rating Outlook
Rising Credit Costs, Elevated Funding Costs: India Ratings has maintained a stable outlook on the Indian non-bank finance companies (NBFC) sector for 2013. The sector faces the dual impact of rising credit costs and elevated funding costs in the year; however, India Ratings stress test on asset quality and funding costs shows that the robust pre-provision operating profit (PPOP) at most of the major NBFCs rated by the agency provides a strong buffer against expected credit quality pressures. The expected uptick in economic growth will ease some cyclical pressures. Nevertheless, industrial production is unlikely to improve soon, and this, together with the uncertainty around infrastructure projects and rising diesel prices, will weigh on credit quality. Funding costs will also remain elevated a result of the unfavourable regulatory changes in last two years. Asset Quality Pressure: The harsh operating environment around the heavy and medium commercial vehicles (HMCVs, a key asset class for most NBFCs) and construction equipment (CE) segments will keep asset quality under pressure. The light commercial vehicles (LCVs) segment that has grown aggressively in last few years is also likely to face moderate asset quality pressure in the next 12-18 months. The agency estimates the aggregate gross non-performing loans (NPL 180 days overdue) ratio at the eight major NBFCs to rise to 2.7%-3.0% in 2013 (2.1% at FY12). However, unless there is a steep erosion of collateral values, PPOP (FY13: estimate 6.4%) can well absorb the spike in credit costs. Return on assets (RoA) is estimated at 2.3%-2.5% (FY12: 2.7%). Proposed Regulatory Changes Favourable: India Ratings believes that the draft guidelines for NBFCs, issued by the Reserve Bank of India (RBI) in December 2012 (based on the Usha Thorat Committee report), will strengthen the sector fundamentally. The impact on profitability will also be manageable. The proposed guidelines include, among others, enhancements to corporate governance and disclosure standards, transition to a 90-day NPL norm by Q1FY16, requirements of holding high-quality liquid assets/investments to cover liquidity gaps in the 1-30 day buckets and Tier I ratio of 10% for retail finance NBFCs and 12% for captives NBFCs. Funding Profile Unlikely to Change: NBFCs dependence on banks along with mutual funds for funding remains high (estimated 81% at FY12) and is unlikely to change materially in 2013, although dependence on banks could increase, due to the new 30% sectoral caps on mutual funds debt investments. The exclusion of bank loans to NBFCs from priority sector lending of banks and restrictions on bilateral assignments have not reduced the dependence of NBFCs on bank funding. Funding costs will remain elevated despite softening interest rates. Capital Buffers Adequate: India Ratings expects the NBFCs to maintain high capital buffers, in view of their high loan concentration. At FY12, all major NBFCs had a Tier 1 ratio above 11%. However, if the high growth continues, most NBFCs will need to raise capital in 2013-2014.

Related Research
India Ratings Wire: RBIs Draft Guidelines Positive for NBFCs, Limited Financial Impact, dated 19 December 2012. India Ratings Wire: Asset Finance NBFCs to see Sharp Increase in Credit Costs, dated 30 October 2012

Analysts
Ehsan Syed +91 22 4000 1722 ehsan.syed@indiaratings.co.in Urval Goradia +91 22 4000 1710 urval.goradia@indiaratings.co.in Prakash Agarwal +91 22 4000 1753 prakash.agarwal@indiaratings.co.in

Figure 1

Rating Outlooks
(Major Indian NBFCs)
(%) 100 80 60 40 20 0 Positive Stable Source: India Ratings 16 Negative

84

What Could Change the Outlook

Asset Quality Deterioration: NBFCs ability to maintain stable asset quality through the cycles has facilitated access to stable funding from banks, institutional investors and capital markets. A significant increase in delinquencies (beyond India Ratings expectations) or signs of deterioration in funding can lead to negative rating actions on NBFCs.

www.indiaratings.co.in

31 January 2013

Financial Institutions
Key Issues
Challenging Operating Environment
The operating environment for some of the key business lines of NBFCs remains challenging in 2013. Although large NBFCs have attempted to diversify their business in recent years, bulk of their business is still vehicle finance, and the diversification has been largely within different types of vehicles. Exposure to non-automobile business lines - small business loans, property loans, gold loans, personal loans, remains small at most NBFCs and is unlikely to change substantially in the near-to-medium term. CV and passenger vehicle volumes are likely to remain muted in 2013. While the expected decline in interest rates could gradually improve business and consumer sentiments, the deregulation of diesel prices and planned monthly increases in diesel prices for the next 12-15 months (freight rates have not increased in tandem with diesel price increases) and continued slowdown in infrastructure projects will weigh down new financing and existing loan books. The sales of new HMCVs are positively correlated with growth in the index of industrial production (IIP). IIP remained weak in 2012 and is unlikely to see a significant and sustainable improvement till H2FY13. This is despite softening interest rates and RBI cutting its policy lending rates (repo rates) by 25bp on 29 January 2013.

Structural Changes in CV Industry

Structural changes in the CV industry from an expansion of the hub-and-spoke model in India are leading to increasing demand for large tonnage and low tonnage CVs, while medium tonnage CVs are being squeezed. This also reflects in the vehicle financing portfolio of NBFCs - LCV financing has been growing sharply while HMCV financing is shrinking. The trend is likely to continue for the medium term. The use of LCVs for the intra-city movement of consumer goods, rural/urban taxis and captive use has also supported high sales and financing growth.
Figure 2

A Shift in the CV Industry Profile

Based on Sales Volumes
(units sold) 600,000 500,000 400,000 300,000 200,000 100,000 0 FY08 9MFY13 data is annualised Source: SIAM, India Ratings
a

Upto 7.5tons

7.5tons to 16tons

16tons to 25tons

25tons and above

FY09

FY10

FY11

FY12

9MFY13

Figure 3

A Shift in the CV Industry Profile

Based on Sales Estimates
(INRbn) 300 250 200 150 100 50 0 FY08
a

Upto 7.5tons

7.5tons to 16tons

16tons to 25tons

25tons and above

Related Criteria
Financial Institutions Rating Criteria, dated 12 September 2012 Non-Bank Finance Companies Criteria, dated 12 September 2012

FY09

FY10

FY11

FY12

9MFY13

9MFY13 data is annualised Source: India Ratings Estimates

2013 Outlook: Major Indian Non-Bank Finance Companies January 2013

Financial Institutions
Asset Classes Outlooks
HMCVs: Negative; Will Remain Weak
New HMCV financing will remain weak in 2013, as new sales are likely to be muted/negative, until IIP improves significantly on a sustained basis. India Ratings analysis shows a strong positive correlation between new HMCV sales and IIP (0.65 during December 2009-December 2012, 0.82 in the last one year). With the IIP unlikely to show sustainable growth until the later part of the year, new HMCV financing at NBFCs will remain weak. Used HMCV financing will also be negatively impacted. Owner drivers/small road transporters (main buyers of used HMCVs) bargaining power for freight rate increase is weak, and diesel price increases will hit these borrowers (most NBFCs borrowers) most in 2013. The sentiments of drivers to upgrade to owner-drivers and small road transporters to own more vehicles are thus unlikely to be strong during the year. The existing HMCV loan portfolios of NBFCs will come under credit pressures from increasing diesel prices, high interest costs (bulk of the loans are fixed interest rate), amid weak industrial and infrastructure activities. Asset quality will therefore also come under pressure, at the same time as credit growth in this business line remains weak. This asset class will thus remain weak in 2013.
Figure 4

Relationship Between IIP and HMCV Sales

(%) 45,000 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 Jan 07 Source: SIAM, RBI Monthly HMCV Domestic Sales (LHS) IIP General Index (RHS) 200 180 160 140 120 Nov 12

Dec 07

Dec 08

Dec 09

Dec 10

Dec 11

Construction Equipment: Negative; Under Stress

New financings and the existing loan credit quality will remain under stress in 2013 and the possibility of actual credit losses is high in the CE segment. This is because of the stalling of new infrastructure project activities and the ban on mining in some regions. As construction equipment cannot be easily re-deployed in other applications, delays or closure of a project leads to equipment becoming idle, and recoveries from re-possessed CEs are low. The exposure of most NBFCs covered in this report to this asset class is low though.

LCVs: Stable, but Pressure Points Building Up

India Ratings expects the financing of LCVs to remain stable in 2013. The increasing usage of these vehicles for intra-city transportation, rural/urban taxis and last-mile, short-distance transportation in the hub-and-spoke model, captive use by larger businesses etc., has resulted in strong sales and financing by NBFCs. The segment has seen decreasing correlation with IIP (0.86 in the last five years, 0.58 in the last three years and 0.47 in last one year). India Ratings is, however, concerned about the aggressive growth in the LCV segment at some NBFCs in recent years, and believes that the huge thrust on sales of LCVs by automobile makers and financing by NBFCs has led to some dilution of underwriting standards. The agency believes that the seasoning of many of these loans will put moderate pressure on asset quality in this asset class in next 12-18 months.

2013 Outlook: Major Indian Non-Bank Finance Companies January 2013

Financial Institutions
Figure 5

Relationship Between IIP and LCV Sales

(%) 60,000 50,000 180 40,000 30,000 20,000 140 10,000 0 Jan 07 Source: SIAM, RBI 120 Nov 12 160 Monthly LCV Domestic Sales (LHS) IIP General Index (RHS) 200

Dec 07

Dec 08

Dec 09

Dec 10

Dec 11

Agricultural Equipment: Stable

Agricultural equipment new financing and the credit quality of the existing loan portfolio are likely to remain largely stable in 2013. This is backed by the stable cash flows of farmers and near normal monsoon rainfall in 2012, although a colder than normal winter in many parts of country might have some impact on some crops, especially vegetables. Low incremental growth in rural economy, from development programmes by the government, could be compensated by the governments initiatives for direct payment of subsidies to economically weak sections.

Property and Small Business Loans: Negative

India Ratings maintains a negative outlook on loans against property and small business loans asset classes. These loans are restricted to a few NBFCs and though the portfolio quality has not shown stress thus far, the low seasoning of these loans, illiquid nature/non-productive real estate assets backing these loans make downside risk more prominent. In the case of NBFCs, where most clients originate from established affiliated networks like chit funds, downside risks are limited.

Resilience to Overall Stresses in Asset Quality

With a tough operating environment around the key HMCV segment and pressures on some other segments, the loan growth of major NBFCs will moderate to around 25% in 2013 (35% in FY12) . The agency expects gross NPL ratio to reach around 3.0% in 2013 (2.14% at FY12). However, even with a 65% provision coverage ratio in 2013 (PCR; 65% in FY12), estimated PPOP provides 3.4x cover for estimated credit costs in FY13 and 2.8x cover in FY14. Under India Ratings stress test, which assumed incremental NPLs at 8% at each NBFC and a simultaneous 10% increase in funding costs, PPOP on an aggregated basis for the group is able to absorb stressed credit costs without impairing capital or general loan loss reserve. On an individual basis, a majority of the NBFCs are able to absorb stressed credit costs with PPOP and/or general loan loss reserve, and the impairment of capital occurs only at two rated NBFCs and is below 10%. This reflects high yields and low operating cost structure and is reflected in robust PPOP (FY12: 6.8%) and RARM (average 3.75% in FY12). RARM deducts operating expenses, credit costs and financing costs from net interest income and securitisation income. NBFCs follow a 180-day delinquent norm, as against a 90-day norm at banks. While 90-day NPLs are estimated at nearly double the 180-day level as of FY12, the agency believes that if the RBIs new draft guidelines on 90-day NPL norm are implemented in Q1FY16, NBFCs will have adjusted their monitoring and collection systems. The borrower behaviour would also change in many cases and 90-day delinquencies will reduce in the long term.

2013 Outlook: Major Indian Non-Bank Finance Companies January 2013

Financial Institutions
Figure 6

CV Loan Delinquency Factors: IIP Change, Freight Rates and Diesel Prices
(%) 25 20 15 10 5 0 -5 -10 Apr 06 IIP Change (3 month MA) (LHS) Mumbai - Delhi Freight Rate Index (RHS) Diesel Price Index (RHS) 170 160 150 140 130 120 110 100 90 80 Dec 06 Oct 07 Jul 08 Apr 09 Dec 09 Oct 10 Jul 11 Apr 12 Dec 12

Source: Bloomberg, RBI, India Ratings. Diesel Price Index: prices in April 2006 as base. Freight rate index: 9 ton freight rates for the Mumbai-Delhi corridor in May 2008 as base

Figure 7

Major NBFC's: Key Performance Trends

Asset Quality - Gross NPL Ratio and 1 year Lag NPL Ratio
NPL ratio (LHS) (%) 14 12 10 8 6 4 2 0 FY09 Provision coverage ratio (RHS) 1 year Lag NPL ratio (LHS) Net NPLs/equity (LHS) (%) 90 80 70 60 50 40 FY10 FY11 FY12 FY13 Est. FY14 Fcst.

Source: NBFC Aggregate Data, India Ratings Estimates

Wholesale/Institutional Funding Profile

Banks and mutual funds remain the major creditors of NBFCs, despite unfavourable regulatory changes in the last two years - bank loans to NBFCs excluded from priority-sector lending from 1 April 2011 (except to eligible micro finance institutions), restrictions placed on providing credit enhancement in bilateral assignment transactions under the revised securitisation guidelines of August 2012 and the sectoral cap of 30% on mutual funds debt investments (by the Securities & Exchange Board of India in October 2012). India Ratings estimates that banks and mutual funds provided over 81% of total debt at FY12. Amid weak corporate loan demand, banks have continued to lend to NBFCs. As underdeveloped corporate bond market in India also limits options for NBFCs, their dependence on banks could increase in 2013. NBFCs dependence on short-term borrowings remains high. Together with long-term debt maturing in the next 12 months, the proportion was high at 45% at FY12, nearly unchanged from FY11. India Ratings expects this to reduce moderately, as the interest rate cycle turns and in view of the tightening regulatory guidelines.

2013 Outlook: Major Indian Non-Bank Finance Companies January 2013

Financial Institutions
Figure 8

Funding Profiles of Major NBFCs

Banks 100% 80% 60% 40% 20% 0% Shriram Transport Mahindra Finance Sundaram Chola Tata Motors Finance Religare Finvest Magma Shriram City Union Off Balance Sheet (Banks) MFs Retail PFs & Others

Source: NBFC Disclosures, India Ratings Estimates

Figure 9

Major NBFC's: Funding Profile

As on end-March 2012
Short term 22%

Long term (Maturity >1yr) 57%

Long term (Maturity <1yr) 21%

Source: India Ratings, NBFC disclosures

Capitalisation: Fresh Capital Raisings, or Growth Slowdown

In view of NBFCs high asset side concentration, India Ratings expects these companies to maintain higher capital ratios than banks. All the eight NBFCs maintained regulatory Tier I capital ratio above 11% at FY12, against the current regulatory minimum of 7.5% and above the RBIs proposed Tier I capital ratio of 10% for retail NBFCs. The quality of NBFCs capital is also high, with very little hybrids included. Nevertheless, as the bilateral securitisation route is nearly closed now and as NBFCs increasingly utilise the pass-through-securities (PTC) securitisation route for funding, this will become capital dilutive as the credit enhancements under PTC transactions are to be deducted from the capital. Major NBFCs loan books have continued to grow at a much higher rate than at banks in recent years (FY12: 35%) as credit growth at banks has slowed down (FY12: 18%). If the high loan growth continues, the faster growing NBFCs, in particular, will have to raise fresh capital as internal accruals remain low.
Figure 10

Capitalisation Pressures
(%) 20 15 10 5 0 -5 Shriram Transport
a

Tier 1 Capital Ratio

Estimated Impact of FY12 Growth on Capital

Sundaram

Mahindra Finance

Shriram City Union

Religare Finvest

Magma

Tata Motors Finance

Chola

Estimated impact on Tier 1 ratio assuming internal accrual ratio of FY12 and RWA growth equal to FY12 loan growth Source: NBFC Annual Reports, India Ratings Estimates.Tier 1 Ratio as on end-March

2013 Outlook: Major Indian Non-Bank Finance Companies January 2013

Financial Institutions
Proposed Regulatory Changes
India Ratings believes that the draft guidelines proposed by the RBI in December 2012, if implemented, will be positive for the NBFC sector in the long-term even though some of the clauses can impact profitability in the early stages of implementation. However, the proposed increase in standard asset provision to 0.40% (from 0.25%) from Q1FY14 will marginally impact NBFCs profitability in 2013. India Ratings expects these new proposals to have limited financial impact on the major NBFCs. On the basis of FY12 figures, the incremental provision on 90-day NPLs and general provisions on standard assets at 0.40% (current 0.25%) will lead to a reduction in RoA by 540bp at various NBFCs. That being said, the agency expects NBFCs collection and monitoring systems and borrower behaviour to largely adjust in the interim period (by Q1FY16) and 90-day delinquencies should drop. The agency does not expect any material impact from the requirements of higher Tier 1 ratio and liquid asset coverage (for cumulative mismatches in 130 day buckets), as major NBFCs maintain high capital ratios and well-matched asset-liability tenors. If the proposed requirement of registration of NBFCs at an asset size of INR250m is implemented, India Ratings expects small and mid-sized NBFCs to consolidate further. This is because a huge majority of NBFCs are small, non-deposit-taking. On the basis of the RBI data, as at 30 June 2012, there were 12,385 registered NBFCs. At end-March 2012, there were 297 deposit-taking NBFCs and 365 systematically important non-deposit-taking NBFCs, which would be largely unchanged at end-June 2012. The RBI proposed new draft regulatory guidelines on NBFCs based on the recommendations of the Usha Thorat Committee on 12 December 2012. The key proposals are listed below: 1. The Tier 1 ratio of registered NBFCs should be increased to 10% (12% for captive finance companies - financing 90% of parents products), and three years be given to achieve the required ratio (currently the minimum Tier 1 ratio for retail finance NBFCs is 7.5%). Asset classification and provisioning norms similar to those for banks are to be introduced in a phased manner. This includes standard asset provision at 0.40% (current 0.25%), the 90 days overdue norm for classifying NPLs from Q1FY16, to be transited through a 120day NPL from Q1FY15, and a one-time restructuring to be allowed for borrowers, which will not be treated as default. Liquidity ratio requirement for all registered NBFCs, such that cash, bank balances and government securities fully cover the gaps, if any, between cumulative outflows and cumulative inflows for the first 30 days (currently only deposit-taking NBFCs are required to hold 15% of their public deposits in the RBI-defined liquid assets). Strict corporate governance standards to be followed by large NBFCs. RBI permission necessary for change in control, or sale of 25% stake, and appointment of CEOs for NBFCs with asset size of over INR10bn. Higher disclosures have been suggested by the RBI. These cover provision coverage ratios, liquidity ratios, asset liability profiles, the extent of financing of a parent company's products and the movement of non-performing assets. Capital market and real estate exposures. Risk weights will be increased to 125% for capital market exposures and 150% for commercial real estate exposures (from the current 100% for both these categories). NBFCs with asset size below INR250m will be exempted from registration with the RBI; existing non-deposit taking NBFCs (asset size below INR250m) with have to provide a roadmap to the RBI, for increasing their asset size to this level or above within two years.

2.

3.

4.

5.

6.

7.

2013 Outlook: Major Indian Non-Bank Finance Companies January 2013

Financial Institutions
Figure 11

Major NBFC's: Key Performance Trends

Pre-provision Profitability and Credit Costs
(%) 10 8 6 4 2 0 FY09 FY10 FY11 FY12 FY13E FY14F Source: Indian Ratings, NBFC disclosures
Figure 12
Pre-provision Profits as % of avg. loans Credit Costs as % of avg. loans

Major NBFC's: Key Performance Trends

Risk Adjusted Revenue Margins and Net Interest Margins
Risk adj. revenue margin (NII + Securitisation Income - Opex - Provisions)/Avg. earning assets (LHS) (%) 5 4 3 2 1 0 FY09 FY10 FY11 FY12 FY13E FY14F Source: NBFC Aggregate Data, India Ratings Calculations Net interest margin ( NII/avg. earning assets) (RHS) (%) 10 8 6 4 2 0

Figure 13

Major NBFC's: Key Performance Trends

Operating Expenses to Average Assets and Cost/Income Ratio
(%) 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 FY09 FY10 FY11 FY12 FY13E FY14F Source: NBFC Aggregate Data, India Ratings Calculations Operating expenses/average assets (LHS) Cost/income ratio (RHS) (%) 45 40 35 30 25 20 15 10 5 0

Figure 14

Major NBFC's: Key Performance Trends

Return on Assets and Return on Equity
(%) 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 FY09 FY10 FY11 FY12 FY13 Est. FY14 Fcst. Source: NBFC Aggregate Data, India Ratings Calculations Return on assets (LHS) Return on equity (RHS) (%) 24 20 16 12 8 4 0

2013 Outlook: Major Indian Non-Bank Finance Companies January 2013

Financial Institutions
Figure 15

Major NBFCs Covered in the 2013 Outlook Report

Company name Shriram Transport Finance Co. Ltd. Mahindra & Mahindra Financial Services Limited Sundaram Finance Ltd Cholamandalam Investment and Finance Co. Ltd Tata Motors Finance Pvt. Ltd. Religare Finvest Limited Magma Fincorp Limited Shriram City Union Finance Limited
Source: India Ratings NR: Not rated

Long-Term Issuer Rating IND AA IND AA+ IND AA+ IND AA NR IND AA NR IND AA

Outlook Stable Stable Stable Stable NR Negative NR Stable

2013 Outlook: Major Indian Non-Bank Finance Companies January 2013

Financial Institutions

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2013 Outlook: Major Indian Non-Bank Finance Companies January 2013

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