Moody's: Demonetization adds to short-term adjustment pressure on India's non-bank finance companies, but will not derail their growing franchise

Moody's Investors Service says that non-bank financial companies (NBFCs) in India (Baa3 positive) will demonstrate broadly stable asset quality, but delinquencies will likely rise over the next 1-2 quarters, as demonetization adversely affects collections across asset classes.

"While the 90+days delinquency rate in the commercial vehicle (CV) loan segment largely stabilized in the first half of the fiscal year ending 31 March 2017, such delinquencies should build up in the near term due to the adverse impact of demonetization and tighter recognition norms for non-performing assets (NPAs)," says Alka Anbarasu, a Moody's Vice President and Senior Analyst.

Moody's also notes that the growth in loans against property (LAP) has outpaced overall retail credit growth in recent years, but relatively loose underwriting practices -- combined with intensifying competition -- will translate into higher asset quality risk for this segment.

Furthermore, over the past 3 years, NBFCs have gained some market share in the origination of retail lending, on the back of the faster growth exhibited by such entities when compared to the banks.

This is particularly the case when compared to public sector banks, which face significant challenges on their asset quality and overall solvency profiles.

"Nevertheless, we expect that competitive pressures from the banking sector will remain intense as banks are increasing targeting of the retail segment to offset weakness in their corporate lending. In addition, retail lending, particularly housing loans, is more capital efficient for the banks," adds Anbarasu.

And, while the NBFCs' capitalization levels are adequate, with average Tier 1 ratios in excess of 14%, capital generation will lag credit growth. Access to external capital will therefore be key in sustaining the NBFCs' growth momentum.

On funding, Moody's expects that the NBFCs' funding profiles will broadly remain stable, and funding costs should moderate gradually, given the reduction in systemic rates.

In addition, the NBFCs' profitability and capital, as well as funding and liquidity levels, will stay broadly stable. Moody's conclusion is despite the fact that in line with the global trend the funding and liquidity profiles of Indian NBFCs present key downside risks, particularly because of their dependence on confidence-sensitive market funding.

Moody's also says that the NBFCs will maintain well-matched asset-liability profiles despite their weak funding profiles a situation which will protect them against downside risks. However, adverse market events have exposed them to volatility in refinancing and remain a key credit challenge.

The NBFCs are growing at a fast pace, and have gained market share in the origination of retail credit. And, their share of LAP pose a potential source of risk, with such loans growing at a rapid compound annual growth rate of about 25% over the last four years compared to 17% for overall retail credit. Moody's says that the NBFCs' exposure to potential risks from LAP is broadly offset by their share of stable mortgage loans, because favorable demographics and economics, tax incentives for home loans and an increasingly affordable housing segment support asset quality. Moody's expects that the loss given default for both home loans and LAP will be limited, in light of the underlying collateral.

The performance of individual NBFCs varies widely, even as the sector as a whole shows better performance when compared to the banks. In addition, within segments such as for housing finance companies variation is also widespread, reflecting the nature of portfolios, as well as the ability to manage costs.

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