With a pause in rate hikes, NBFCs, like banks, are in a sweet spot

Alongside banks, non-banking finance companies (NBFCs) have also done well on the back of an economic revival in the second half of the 2022-23 financial year (H2FY23).

The Reserve Bank of India’s (RBI’s) pause in interest rate hikes and a continuation of the revival of private consumption would boost NBFCs in the first quarter (Q1) FY24. 

Analysts believe that double digit growth -- in the 15-20 per cent range -- is likely in net interest income (NII), pre-provision operating profit (PPOP) and profit after tax (PAT) in Q1FY24. Business volumes should be driven by healthy demand for vehicle finance, mortgages, personal loans, business loans and gold loans. This implies NBFCs operating across multiple segments should see AUM (assets under management) growth. Cost of financing (CoF) will be tight but given a pause in rate hikes, CoF should stabilise in H1FY24.  

Mortgage demand should be better, given expectations of stability in interest rates. Affordable housing financiers and vehicle financiers should deliver strong growth. Gold loan NBFCs have witnessed systemic growth in gold loan demand due to elevated gold prices and a let up in competition in the segment from banks. 

Vehicle financiers may see NIM (net interest margin) compression in Q1FY24. Vehicle financiers may deliver NIM expansion only in H2FY24, given stable or declining interest rates. While affordable housing financiers have passed on higher interest rates to borrowers over the last 2-3 quarters, they could report some contraction in NIM due to rising CoF. Mortgage demand has been strong despite higher rates, and affordable housing volume growth should be higher than prime mortgages. Asset quality could remain stable or deteriorate marginally across NBFCs and HFCs (housing finance companies). Collection efficiency has reportedly been good. Alongside specialised NBFCs, diversified lenders with presence in MSME, tw0-wheelers, microfinance, consumer finance, pre-owned cars, and personal loans are also likely to see good momentum. 

The stock market has started factoring in good Q1FY24 results, but further share price rise will be driven by management guidance on growth and asset quality and any positive surprises. This strong growth and robust asset quality trend is also backed by an increased focus on retail and SME. Most companies have guided for normalising credit cost in FY24, which could be 40-50 per cent lower than FY23 levels (1-2 per cent) due to better asset quality, and better collection efficiency. 

Prior rate hikes between Mar-Apr’23 would support spreads in Q1FY24 for housing finance players. The spreads should improve or remain flat quarter-on-quarter (QoQ) in Q1FY24. AUM growth for HFCs may be up by 2 per cent QoQ, despite likely lower disbursements due to seasonality. However, NBFCs with higher bank borrowings could see higher CoF and more NIM compression. 

NBFCs saw 16 per cent YoY growth in FY23 according to RBI as well as Q1FY24 provisional numbers. The formalisation and digitisation of finance and credit also aids growth. Players in the sector can take more informed credit decisions, given cycle-tested customers and better data allowing better analysis. Moreover, NBFCs could see good base effects given recovery from negative events such as IL&FS crisis, demonetisation, Covid-19, etc. NBFCs are now better capitalised with CAR (capital adequacy ratio) for the sector now at 27.5 per cent (Mar’23) versus 20 per cent in Mar’19. 

Downside risks would be macro-slowdown in economic growth rates or another inflationary spiral given unsecured loan books. If GDP growth continues as projected, and inflation continues to see a moderating trend, NBFCs will do well. Most analysts are upgrading target prices across the sector.