Financial Institutions

Banks

2014 Outlook: Major Non-Bank Finance Companies

Cyclical Pressures to Ease
Outlook Report
Rating Outlook

S TABLE
(2013: S T A BL E )
Figure 1

Rating Outlook
NPL Accretion to Slow down in 2HFY15: Delinquencies will stay elevated in 2014 and reach
the highest level since FYE09 (end-March 2009) by March 2015. The new NPL addition should
however slowdown from 2HFY15 from a revival in industrial growth, investments and
infrastructure projects, which would directly and indirectly increase utilisation of financed
commercial assets. The credit costs will remain high, but are unlikely to significantly dent the
profitability of the eight major Indian non-bank finance companies (NBFCs). Ind-Ras stress
tests indicate resilience at the rated major NBFCs.
Ind-Ra estimates the gross non-performing loan ratio of the eight NBFCs to reach 4.20% at
FYE15 (FYE13: 2.53%). The credit costs could reach 2.3% of loans in FY15 (FY13:1.82%), but
will be well covered by the pre-provision operating profit (PPOP) of 6.17% (6.55%). However, if
the collateral values were to decline sharply and the industrial/economic growth does not pick
up as envisaged, the credit costs could spike and impact NBFCs with high unseasoned
portfolios in particular, though this is not Ind-Ras base case.

Sector Outlook

S TABLE
(2013: S T A BL E )
Uptick from 2HFY15.
Adequate profit and capital buffers

Slowdown in Loan Growth: Ind-Ra expects the moderate loan growth witnessed in 1HFY14
at these NBFCs to continue and management focus to shift more on improving recoveries and
collection efficiency, and control operating costs. The disbursements are likely to remain
subdued till 3QFY15 in various key segments, such as commercial vehicles (CV) heavy and
medium CVs (HMCVs), light CVs (LCVs), construction equipment (CE), and in passenger
vehicles (PVs). Agricultural equipment (AE), mainly tractor financing, is expected to remain
steady, although the 2014 monsoon will determine the outlook for 2015.

Satisfactory funding profile

Adequate Capital Buffer: Ind-Ra expects the NBFCs to maintain adequate capital buffers in
view of their high asset concentrations. The moderating loan growth will benefit their
capitalisation. All the major NBFCs had Tier I ratios above 10% in 1HFY14 and at FYE13.
Profitability to Dip, but Still Healthy: The rising credit costs and elevated funding costs will
impact NBFCs profitability, but it will still remain adequate. Ind-Ra expects return on assets
(ROA) of 2.20% in FY15 (FY13: 2.70%) and return on equity (ROE) of 15.60% (18.57%).

Related Research
2014 Outlook: Indian Banks

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

Dependence on Bank Funding Unlikely to Change: Ind-Ra does not expect any material
change in the NBFCs funding profile in 2014. The dependence on bank financing is expected
to remain high, as the Indian debt capital market remains underdeveloped and lacks depth.
Regulatory changes in the last two years, along with tight liquidity conditions in 2QFY14/
3QFY14 have also created challenges for the NBFCs to move away from bank financing.

What Could Change the Outlook

Stable Asset Quality is Key: The NBFCs have maintained stable asset quality, although
cyclical pressures have started to push up delinquencies. A stable operating performance has
facilitated their access to funding from banks and capital markets. A protracted and sharp
contraction in industrial activities (and overall economic growth) can adversely impact their
credit quality. The asset quality pressures in such a scenario could exceed Ind-Ras
assumptions and lead to negative rating actions. Conversely, a strong through-the-cycle
operating performance, stable asset quality, robust capital buffers and diversified funding
profile can lead to positive rating actions.

www.indiaratings.co.in

10 February 2014

Corporates
Key Issues
Transport Operators Operating Margins to Recover in 2HFY15
Ind-Ra expects the revival in industrial activity to start reflecting in higher utilisation of
commercial vehicles from 2HFY15. This will be driven by corporate capex revival and progress
in infrastructure projects cleared by the cabinet committee on investments (CCI) in the last few
months. The rebound to 4.1% industrial growth in FY15 (FY14: estimated 1.7%), gross fixed
capital formation (GFCF) growth of 6.2% and 5.6% in real GDP growth in FY15 will likely
provide tailwinds from 2QFY15 onwards (see Economic Outlook: Industry and Services to Push
Growth in FY15). NPL accretions could thus slowdown from the second half of FY15, on the
back of higher economic/industrial growth.
The NBFCs core customers- small road transport operatorsand owner-operators have weak
bargaining power and amid depressed freight availability, they have to quote lower freight rates
to utilise capacity. The low utilisation and lower freight compress their revenues, while at the
same time input prices (monthly diesel prices have continued since the partial deregulation in
January 2013) have continued to rise, thereby squeezing their margins. Based on Ind-Ras
discussions with the NBFCs and their CV borrowers, the agency believes many CV owners are
struggling to pay their equated monthly instalments (EMIs) as their operating margins are
weak. The NBFCs usually do not repossess the vehicles, and they negotiate and accept part
payments in many cases, aware that their borrowers cash flow problems are from weak
business environment and the re-sale prices are currently depressed.
Figure 2

CV Loan Delinquency Factors: IIP Growth, Freight Rates and Fuel Prices
IIP Change (3 month MA) (LHS)

(%)

Diesel Price Index (RHS)

Freight Rate Index (RHS)

Mar 15

Sep 13

Mar 13

Sep 12

Mar 12

Sep 11

Mar 11

Sep 10

Mar 10

Sep 09

Mar 09

Sep 08

Mar 08

Sep 07

Mar 07

200
180
160
140
120
100
80

Sep 06

25
20
15
10
5
0
-5
-10

Source: Bloomberg, RBI, India Ratings. Diesel Price Index: prices in Chennai in April 2006 as base.
Freight rate index: Adjusted 16 ton freight rates for the Chennai-Delhi corridor in May 2008 as base.

The operating environment and freight availability is likely to remain subdued till 2QFY15. The
lifting of mining bans in some regions (such as Karnataka) as well as clarity on sand mining is
providing some relief, but it is the uptick in corporate capex and industrial growth, and the
revival of infrastructure projects that will lead the turnaround. This will increase both the
utilisation rates of CVs/CEs and the bargaining power of NBFCs borrowers to pass on a part of
their rising input costs to customers, thereby improving their operating margins.

Applicable Criteria

Stable or marginally lower interest rates in FY15 could help new vehicle financings, but these
do not impact the current financing portfolio, as the NBFCs loans are mostly on fixed rates.
The delinquencies will remain high in HMCV, CE and LCV business lines, although the NPL
accretion in all these lines should slowdown from 3QFY15.

Financial Institutions Rating Criteria,

12 September 2012
Non-Bank Finance Companies Criteria,
12 September 2012

2014 Outlook: Major Non-Bank Finance Companies

February 2014

Corporates
Figure 3

Major NBFC's: Key Performance Trends

Asset quality - Gross NPL ratio and 1 year lag NPL ratio
(%)
14

NPL ratio (LHS)

1 year lag NPL ratio (LHS)

Net NPLs/equity (LHS)

Provision coverage ratio (RHS)

(%)
90

12

80

10
8

70

60

4
50

40
FY09

FY10

FY11

FY12

FY13

H1FY14

FY14E

FY15E

Source: NBFC Aggregate Data, India Ratings Estimates

Used HMCV financing has been less impacted during the current cycle and Ind-Ra expects this
to continue in 2014 (although NPLs remain high for this asset class). The prices of used
HMCVs have dropped due to aggressive discounts offered by most manufacturers, which has
made owning an old vehicle attractive to many first-time buyers - mainly drivers upgrading to
owned vehicle. Nevertheless, the low freight availability will continue to pressure the viability of
these new owners, who may not have appropriately figured out the dynamics of the protracted
weak utilisation of their vehicles.

New Financing Outlook Negative for Most Asset Classes

Ind-Ras outlook for new financing of most asset classes in 2014 is negative, barring agriculture
equipment/tractors. This is because the key business lines within the core CV financing
segment- HMCVs, LCVs and CEs have a high positive correlation with the change in the index
of industrial production (IIP). While the IIP is expected to show positive gains in FY15, the
impact on sales of these vehicles would take place with a lag, as the industrial growth needs to
be sustained for a few months to convince the transport operators to make purchase decisions.

HMCVs- Negative Outlook

New HMCV sales have a high positive correlation with IIP, and Ind-Ras study of these for last
five years shows increasing correlation in the last one year (December 2008- November 2013:
0.65%; December 2012- November 2013:0.84%). The immediate benefits of the expected
uptick in industrial growth would reflect in a higher utilisation of existing HMCVs, however, new
HMCV sales/financing would need a sustained increase in IIP. HMCV segment, which forms a
large proportion of the loan books of most NBFCs, remains a key risk to the asset quality of
these companies.
Figure 4

Relationship Between IIP and HMCV Sales

Monthly HMCV domestic sales (LHS)

(Units)

IIP general index (RHS)

50,000

200

40,000

180

30,000
160
20,000
140

10,000

0
Jan 07

Oct 07

Jul 08

Apr 09

Jan 10

Oct 10

Jul 11

Apr 12

Jan 13

120
Nov 13

Source: SIAM, RBI

Construction Equipment (CE) - Negative Outlook

Although the infrastructure project revival and some relaxation of the mining ban in some
regions (like Karnataka) will help revive demand in selected areas, the operating environment

2014 Outlook: Major Non-Bank Finance Companies

February 2014

Corporates
for the new CE financing is unlikely to see any significant turnaround in 2014. The specialised
nature of this asset class exposes it to higher risk in case of project/mining stalling, so the new
financings will be done with a longer lag other vehicles. Considering the losses taken by some
major NBFCs on this asset class following the ban on mining in recent years, Ind-Ra also
expects a cautionary approach from the major NBFCs. The agency therefore maintains a
negative outlook on the asset class in 2014.

LCVs- Negative Outlook

The lagged impact of the slowdown in industrial production reached the LCV segment in
1HFY14, and is reflecting in a sharp increase in its positive correlation with IIP (0.95% during
December 2012- November 2013, as against a 0.56% in last three years (December 2010November 2013). Ind-Ra believes the excess capacity generated during the boom years
(FY11-FY13), partly due to an aggressive push (to sell LCVs) by the automobile makers and
the financiers will lead to a lagged pick up in the overall demand for this segment. The agency
expects the new LCV financing to remain weak in 2014, and maintains a negative outlook for
this asset class.
Figure 5

Relationship Between IIP and LCV Sales

Monthly LCV Domestic Sales (LHS)

(Units)
60,000

IIP General Index (RHS)

200

50,000

180

40,000
30,000

160

20,000

140

10,000
0
Jan 07

Oct 07

Jul 08

Apr 09

Jan 10

Oct 10

Jul 11

Apr 12

Jan 13

120
Nov 13

Source: SIAM, RBI

Agriculture Equipment (AE) - Stable

The agency maintains a stable outlook on AE financing in 2014. This is supported by the
satisfactory monsoon in 2013, good crop production/high food prices and relative insulation of
the rural economy from the urban economy (the latter has been impacted more severely in the
current downturn). Nevertheless, the downside risk from a deficient monsoon in 2014 could
impact the asset class in 2015.

Passenger Vehicles (PV) - Stable to Negative

The high inflation and accompanying elevated interest rates will continue to depress demand
for passenger vehicles, such as cars, utility vehicles and other small vehicles used for
passenger transportation. The segment could however benefit from the relatively better
demand in rural India from higher agricultural income, while expected economic recovery can
increase demand for aspirational vehicles that have been hit hard by the high cost of ownership
and lower disposable incomes.

Home Equity/Loan Against Property (LAP) - Negative

While property prices have not corrected so far and the National Housing Banks (IND AAA/
Stable) RESIDEX Index has continued to rise in most cities, Ind-Ra is concerned about the
continued rise in customer leverage in the last six-seven years. The NBFCs loans are primarily
to small business owners, against residential property, which increases the propensity of these
borrowers to service the debt. Nevertheless, the agency believes the loan portfolios remain
susceptible to property price corrections and with no access to The Securitization and
Reconstruction of Financial Assets and Enforcement of Securities Act, the recovery and risks in
this asset class remain elevated. Further, with banks now increasing focus on housing loans
and SME loans, the pressure/competition on the NBFCs home equity loans will increase.

2014 Outlook: Major Non-Bank Finance Companies

February 2014

Corporates
Funding Profile Unlikely to Change
Ind-Ra does not expect the NBFCs high dependence on bank funding to change in 2014.
NBFCs had increased capital market funding in FY13 and the trend was expected to continue
in 2014 as the major NBFCs could raise debt from the market at 50-70 basis points lower than
banks base rates. However, due to the tight liquidity conditions in 2QFY14 following RBIs
decision to hike short-term interest rates (to protect the falling rupee), the market access of
most NBFCs was impacted for some time and the bank borrowings became a preferred
channel. The low corporate loan demand at banks has also supported NBFCs bank
borrowings.
In addition, the uncertain regulatory stance, following unfavourable regulatory changes in the
last two years, has underlined the importance of bank borrowing for NBFCs. In FY13, the
Securities & Exchange Board of India introduced a sectoral cap of 30% on mutual funds debt
investment, and in 2QFY14, RBI introduced rules that included limiting the number of investors
in private issuances, a floor on minimum subscription and a prerequisite for debenture issues to
be fully secured.
Ind-Ra however notes that individual NBFCs maintain relationships with a large number of
lenders, ranging from large and medium public sector banks, private sector banks, foreign
banks and other financial institutions, and the funding profiles remain relatively diversified. The
dependence on short-term funding (including current maturities of long-term loans) remains
high and is unlikely to change materially in FY14. A possible downward trend in interest rate
cycle in FY15 could lead to NBFCs increasing their long-term borrowings. The rated major
NBFCs usually maintain well-matched asset-liability tenors and the mismatches/gaps if any are
largely covered by liquid assets or undrawn bank lines.
Figure 6

Funding Profiles of Major NBFCs

As on end-March 2013
Banks

Off Balance Sheet (Banks)

MFs

Retail

PFs & Others

100%
80%

60%
40%
20%

0%
Shriram
Mahindra
Sundaram
Chola
Transport
Finance
Source: NBFC Disclosures, India Ratings Estimates

Tata Motors
Finance

Religare
Finvest

Magma

Shriram City
Union

Stress Tests Resilience Remains Adequate

Ind-Ra expects the delinquencies to remain elevated for the next 12-15 months. Gross NPLs
(largely on a 180 day due NPL norm, although some companies follow 90-day, 120-day and
150-day norms) at the eight major NBFCs are estimated to reach 3.90% at FYE14 and peak at
4.20% at FYE15 (FY13: 2.53%). The agency expects loan growth to bottom at around 20% in
FY14 and pick up to 25% in FY15 (FY13: 26%). The net NPLs/equity will likely peak at 12%13% at FYE15 (FYE13: 6.2%) as the NBFCs will only gradually increase their provision cover
from an estimated bottom of around 50% at FYE14 (FYE13: 57%), and estimate of 52% at
FYE15.
The NBFCs performance under Ind-Ras stress tests remains satisfactory. The stress test
assumes credit costs increasing by 2.5x and funding costs rising by 5%, while other income
and operating expenses decline by 10% and 5% respectively (from FY13 levels).
On an aggregated basis, the eight major NBFCs are able to absorb the impact without any
significant impairment of the common equity and Tier I capital on an aggregated basis remains

2014 Outlook: Major Non-Bank Finance Companies

February 2014

Corporates
strong at 14.08% (FYE13:14.53%). Most of the rated NBFCs are able to well absorb the
stressed credit costs with the PPOP buffer, and the small equity impairment at one rated major
NBFC does not impact its Tier I ratio significantly, which stays at around 13% (regulatory
requirement of 7.5%). The stress test results reflect adequately priced risks - risk adjusted
revenue margin (RARM; FY13: 3.34%), net interest margin (NIM): FY13: 6.55%) and solid
profitability (ROA; FY13: 2.70%) at these major NBFCs.
Figure 7

Tier I Capital Ratios After the Stress Test

Tier 1 ratio (Mar 13)

(%)
18

Tier 1 ratio after stress

15
12
9
6
3
0
Sundaram

MMFSL

Chola

SCUF

RFL

STFC

Source: Ind-Ra. NBFCs

Capitalisation to Benefit from Moderating Loan Growth

Ind-Ra expects the low growth in 1HFY14 (aggregate annualized loan growth of 24%;
aggregate managed receivables growth of 9%) to further slowdown in 2HFY14. This will
support the NBFCs capital ratios. All the eight major NBFCs maintained Tier I ratios above
10% (both at FYE13 and 1HFYE14), against the current regulatory minimum requirement of
7.5%. RBIs draft guidelines made public in December 2012 (based on the Usha Thorat
Committee report) had proposed Tier I ratio of 10% for retail finance NBFCs and 12% for
captive NBFCs. Ind-Ra expects the NBFCs to maintain higher capital buffers in view of the high
asset side concentrations at these companies and their largely wholesale funded liabilities.
The securitization of priority sector eligible loan receivables (mainly to private sector banks and
foreign banks) peaks during the last quarter, so managed receivables growth will pick-up in
2HFY14. While the deduction of credit enhancements provided in these pass-through
certificates (PTC) securitizations is capital dilutive, as these are to be deducted from capital,
the net impact is expected to be manageable and should not impact the major NBFCs capital
ratios.
Figure 8

Capitalisation Pressures
(%)
20

Tier 1 ratio (H1FY14)

Estimated impact of FY13 growth on capital

15
10
5
0
-5

Religare
Shriram City
Shriram
Mahindra
Sundaram
Tata Motors
Magma
Chola
Finvest
Union
Transport
Finance
Finance
a Estimated impact on Tier 1 ratio assuming internal accrual ratio of FY13 and RWA growth equal to FY13 loan growth
Source: NBFC Annual Reports, India Ratings Estimates.Tier 1 Ratio as on end-March

While loan growth is expected to pick up in 3Q/4QFY15, the satisfactory capital ratio, supported
by fresh capital raising in some cases (in FY13) and high internal accruals in FY14 at most
rated NBFCs are expected to buffer the capital ratios at most firms. The agency does not
expect the overall growth to be aggressive in FY15. Therefore the capital ratios are expected to
remain satisfactory at most NBFCs, although a few NBFCs with relatively low capital ratios
would need to further slowdown loan growth or require fresh capital injections.

2014 Outlook: Major Non-Bank Finance Companies

February 2014

Corporates
FY15 Performance: Another Challenging Fiscal
Figure 9

Major NBFC's: Key Performance Trends

Pre-provision profitability, credit costs and gross NPLs
Pre-provision Profits as % of avg. loans

(%)
10

Credit Costs as % of avg. loans

Gross NPLs

8
6

4
2
0
FY09

FY10

FY11

FY12

FY13

FY14E

FY15F

Source: NBFC Aggregate Data, India Ratings Calculations

Figure 10

Major NBFC's: Key Performance Trends

Return on assets and return on equity
Return on assets (LHS)

(%)

Return on equity (RHS)

(%)

3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0

24
20
16
12

8
4
0
FY09

FY10

FY11

FY12

FY13

H1FY14

FY14E

FY15E

Source: NBFC Aggregate Data, India Ratings Calculations

Figure 11

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)
(%)
Net interest margin ( NII/Avg. earning assets) (RHS)
10

(%)
5
4

0
FY09

FY10

FY11

FY12

FY13

FY14E

FY15E

Source: NBFC Aggregate Data, India Ratings Calculations

Figure 12

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

Operating expenses/average assets (LHS)

FY09
FY10
FY11
FY12
Source: NBFC Aggregate Data, India Ratings Calculations

2014 Outlook: Major Non-Bank Finance Companies

February 2014

Cost/income ratio (RHS)

(%)
50
40
30
20
10
0

FY13

H1FY14

FY14E

FY15E

Corporates
Annex 1
Figure 13

Ratings Table
NBFCs covered in this report
Shriram Transport Finance Co. Ltd. (STFC)
Mahindra & Mahindra Financial Services Limited (MMFSL)
Sundaram Finance Ltd (Sundaram)
Cholamandalam Investment and Finance Co. Ltd (Chola)
Tata Motors Finance Pvt. Ltd. (TMFL)
Religare Finvest Limited (RFL)
Magma Fincorp Limited (Magma)
Shriram City Union Finance Limited (SCUF)

Long-Term Issuer Rating

IND AA
IND AA+
IND AA+
IND AA
Not Rated (NR)
IND AA
Not Rated (NR)
IND AA

Outlook
Stable
Stable
Stable
Stable
NR
Stable
NR
Positive

Source: Ind-Ra

2014 Outlook: Major Non-Bank Finance Companies

February 2014

Corporates

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2014 Outlook: Major Non-Bank Finance Companies

February 2014