NBFCs: REGULATED DAYS AHEAD

Indian economy, which a few months back was grappling for growth, now seems to be coming back on track ever since the new government has taken over the reins. Reforms were the need of the hour to shrug off the economic dullness and therefore there are high expectations from the new cabinet which does seem to be putting in the required energy. Investors though aren’t just looking at what the government will do. The Reserve Bank of India is under observation too. While in the short term, a cut in repo rate is what investors want, over a long-term period significant reforms are expected in the banking and financial sectors.

With the issuance of the new banking license (IDFC and Bandhan Financial Services) the RBI has already taken a first step while guidelines on the payment banks is seen as another step towards a major change in the Indian banking sector. And even as the banking sector is already under limelight, the RBI has recently announced new revised guidelines for the non-banking financial companies (NBFCs) based on the recommendations of the Usha Thorat and Nachiket Mor committees. We are of the opinion that the RBI’s revision of guidelines is a move towards convergence of regulations between banks and large NBFCs.

Looking at the guidelines it is clear that these are not only expected to usher in more transparency through better disclosures but are also expected to strengthen the balance-sheets of many NBFCs. There are many guidelines revised by the RBI but we are only looking at the ones which could directly make an impact on the financial performance of the companies and then eventually affect the prices on the bourses.

The first and the foremost factor which would be making an impact on most of the leading NBFCs is that of translating the non-performing assets (NPAs) into 90 days past dues (dpd) from the earlier regulations of 180 dpd. A noticeable factor here is that the regulations for NPAs would be the same for all segments such as mortgages, gold, SME funding and commercial as well as equipment financing. The NPS regulations also have another clause which recommends an increase of standard assets’ provisioning to 0.40 per cent of standard assets from the level of 0.25 per cent. Another regulation which will directly affect the financial performance of the companies is to increase the minimum Tier 1 capital to 10 per cent in FY17 from the current level of 7.50 per cent. The move would be gradual with Tier 1 capital requirements being increased to 8.50 per cent in FY16 and then taking it to 10 per cent only in FY17. Let’s take a deeper look at both the regulations.

NPA Recognition Reduced to 90 Days

The new guideline of reporting NPAs after 90 days instead of the earlier norm of 180 days is likely to increase the NPAs significantly. And if the research reports by leading research firms are anything to go by, in some cases the gross NPAs are likely to even double for a few companies. Nevertheless, according to experts, the credit costs of NBFCs are not likely to follow a similar trajectory primarily due to two reasons. The first factor is related to the total credit costs which are a combination of write-off and provisioning for non-performing assets; the write-offs will not be impacted. According to FY14 data, the write-offs constituted over half of the total credit cost. Secondly, the coverage most of the NBFCs provide on delinquencies is significantly higher than the minimum prescribed. The management of some of the NBFCs agrees that there will be some moderation in provision coverage as the ultimate credit cost expectation is unlikely to change. According to the matrix provided by ICRA, if we consider a 10 per cent increment in the NPAs and 20 per cent loan growth, the profitability of NBFCs is expected to get impacted in the range of 1 to 5 basis points. Further, if take a look at the micro levels the players having off the balance-sheet items would also be less impacted. Companies like Shriram Transport Finance and Magma Fincorp have more of off the balance-sheet items. Here the impact of credit cost would be even lesser as provisioning expenses are only to the extent of book assets. One noticeable factor is that the RBI has also allowed a one-time adjustment of the repayment schedule of all the existing loans, which would not amount to restructuring.

This will help in reducing the NPAs. Given all these, it will be difficult to quantify the increase in NPAs for each company. However, some players are better placed than others since they were already following stringent asset quality norms and higher provision cover. Bajaj Finance, for instance, has already moved 95 per cent of its loan portfolio to a 90-day cut-off. Sundaram Finance already follows a 120-day norm for asset classification and M&M Finance follows a 150-day norm.

Increased Tier 1 Capital Requirement

At present, all NBFCs with asset size of Rs 100 crore and above are required to have minimum CRAR of 15 per cent. Consequently, Tier 1 capital cannot be less than 7.5 per cent. For infrastructure finance companies (IFCs), however, Tier 1 capital cannot be less than 10 per cent. Similarly, NBFCs primarily engaged in lending against gold jewellery have to maintain a minimum Tier 1 capital of 12 per cent. The regulation suggests that given the business activities of NBFCs, being generally niche in nature, concentration risk associated with such businesses, and on account of the re-definition of systemic importance, all NBFCs which have an asset size of Rs 500 crore and above shall maintain minimum Tier 1 capital of 10 per cent.

As mentioned earlier, compliance to the revised Tier 1 capital will be phased in as 8.5 per cent by end of March 2016 and 10 per cent by end of March 2017. The RBI regulations on capital adequacy are to ensure that the companies’ own capital is pegged to the risk profile of their borrowers. An increase in the capital adequacy ratio means that NBFCs will have to set aside higher capital to grow their assets by the same proportion. But most NBFCs already have Tier I well above the required 10 per cent and hence there will not be any significant impact on their growth prospects. On the other hand, gold loan companies could gain if the RBI lowers the capital requirement from the current 12 per cent to 10 per cent at par with the other NBFCs.

More Disclosures in Financial Statements

Earlier, NBFCs with assets of Rs 100 crore and above were required to make additional disclosures in their balance-sheets relating to CRAR, exposure to real estate sector (both direct and indirect), and the maturity pattern of assets and liabilities respectively. The above disclosures are now applicable for all NBFCs. However, those NBFCs already disclosing the above are encouraged to continue to do so, in line with prudent practice. We are of the opinion that more disclosures would result in more transparency.

So while in the short term the RBI regulations are expected to make some negative impact on the NBFCs, the long-term prospects are good and hence makes the NBFC sector as one of the good opportunities – the reason being that new regulations have ended the uncertainty over how the RBI will address the iniquity arising from the regulatory advantage that NBFCs have been enjoying over banks. Two, over the long run, a better regulatory framework to mitigate risk, improve disclosures, and strengthen governance standards will also reduce the perceived risks of NBFCs. Last but not the least while most of the changes have been in line with earlier recommendations, the additional time given by the RBI to comply with these norms comes as a relief for the sector. We feel there are good opportunities in the sector like Shriram Transport Finance Company, SKS Micro Finance and Bajaj Finance.