A perilous journey ahead for NBFCs: Cheaper funds, slipping credit profile

Recent measures by govt and RBI will help those issuing bonds. But the need is to cover term loans also, says chief of NBFC lobby group

Non-banking financial companies (NBFC) are now getting access to cheaper cost of funds, but their credit profile is simultaneously slipping. Rating agencies have warned of a huge pile-up in non-performing assets (NPA).

The road has been tricky for NBFCs since the IL&FS crisis in 2018, but the pandemic has worsened the situation altogether, with banks and markets hesitant in providing funds to the sector.

However, measures taken by the RBI — such as targeted long-term repo operations (TLTRO) — have helped ease the liquidity pressure to an extent. The central bank on Wednesday announced operational guidelines for accessing liquidity under a government scheme, but it meant that only better-rated NBFCs could enjoy a three-month liquidity window.

In addition, investors in bonds are likely to benefit more, rather than the NBFCs themselves.

“A large number of small and medium-sized NBFCs continue to face challenges in fundraising, given they do not access capital markets but are dependent on loans from banks and financial institutions,” said Raman Aggarwal, co-chairman of Finance Industry Development Council (FIDC), an NBFC lobby group. 

Recent measures by the government and RBI will help those issuing bonds. But the “need is to cover term loans too”, said Aggarwal, adding: “Credit rating being an all-important parameter, it acts as a hindrance to small- and medium-sized NBFCs as these firms struggle to obtain even investment-grade ratings simply on account of their size.”

The government’s credit guarantee schemes are yet to take off, with small- and medium-sized NBFCs remaining dependent on bank funding.

Though banks have started lending again, it’s yet to reach the earlier levels. There is clear risk aversion, and this may spell trouble once the moratorium period ends.

Most lenders had refused to extend the moratorium to NBFCs. Those that did manage to avail of it have said repayment will be a problem because NBFCs have themselves extended the facility, with liquidity position running dry. 

For example, Mahindra & Mahindra Financial Services said 75 per cent of its customers have opted for a moratorium on EMIs, which has impacted daily cash flow and liquidity. The situation for smaller NBFCs is even more dire.

In most cases, they are on borrowed time. This may eventually lead to folding up or merger with larger entities. 

“The NBFC space should see consolidation, with the business model for smaller NBFCs evolving to an ‘asset-light originate, underwrite, season, and sell’ type. Life will come full circle for niche players — with strong domain knowledge of asset classes and geographies — who focus on their core strength of originating, underwriting, and servicing of loans for larger balance sheets,” said Nachiket Naik, head (corporate lending), Arka Fincap. 

S&P, while downgrading ratings of Shriram Transport Finance, Bajaj Finance, Manappuram Finance, Hero FinCorp, and Muthoot Finance, said worsening operating conditions following Covid-19 have increased risks for financial institutions.

“We expect a recession to hurt the financial sector. We expect the asset quality of Indian finance firms to deteriorate, credit costs to rise, and profitability to decline over the next 12 months,” said S&P. 

On similar lines, ICRA said NPAs of non-banks will likely touch 5-7 per cent by the end of March 2021, against 3.3-3.4 per cent in March 2020. This is assuming a slippage of 5-10 per cent in assets under management of shadow banks.

Nevertheless, risk appetite in money markets has revived. 

On Monday, Indiabulls Housing Finance raised Rs 250 crore at 9 per cent for an 18-month maturity period. For a similar maturity, ECL Finance paid 8.9 per cent to raise Rs 175 crore. 

Among other deals, Ananya Finance raised three-year bonds at 11 per cent, Piramal Capital and Housing Finance raised Rs 325 crore at 8.75 per cent for a maturity of 2 years 11 months, and L&T infrastructure Finance raised 10-year bonds at 8.10 per cent. 

NBFCs are increasing issuances in the bond market. In March, NBFCs issued Rs 24,900 crore of bonds, which slumped to Rs 20,900 crore in April. This jumped to Rs 41,700 crore in May, though in June the total issuance stood at Rs 32,400 crore. 

The spread between bonds issued by NBFCs — particularly housing finance companies (HFC) — is progressively reducing, and NBFCs now witnessing a higher share in incremental credit of bank loans being disbursed. Therefore, in FY19, NBFCs accounted for 15 per cent of banks’ incremental credit.

Now, this share has increased to 28 per cent in FY20, ICRA said during a webinar on Wednesday. 

Nevertheless, funding challenges will persist. While commercial paper (CP) rates have moderated substantially, issuance is happening for a select set of entities. External commercial borrowings, which supported funding during FY20, are also expected to remain muted, it further added.

CP issuances stood at Rs 2 trillion by June 2020, with maturities of around Rs 1.2 trillion expected to come up between June 2020 and June 2021. Similarly, bank loan maturities of close to Rs 3 trillion are coming for NBFCs this financial year.

“Increased bank borrowings by larger entities (direct/indirect) could impact fund flow to mid- and small-scaled entities. While the targeted funding initiative of the RBI and government is a positive, sustained funding to these entities remain to be seen,” the rating agency said.