Financial year (FY) 20-21 could prove to be the year of reckoning for small non-banking financial institutions (NBFCs) because of the ongoing business disruptions caused by the COVID-19 pandemic. This is especially for the new-age NBFCs that use technology substantially across the loan management cycle, i.e., financial technology NBFCs (FT-NBFCs), says a research note.
In a report, India Ratings and Research (Ind-Ra) says, "FT-NBFCs could be more disproportionately impacted than any other financial institution, given their borrower profile, majorly micro, small and medium size enterprises (MSMEs) and largely unsecured lending. In few cases, borrowers may also have leverage from traditional lenders and FT-NBFCs may have plugged the additional short-term borrowing needs."
The ratings agency has rated three FT-NBFCs, which it feels do not have immediate liquidity challenges. However, it says, they are likely to face elevated asset quality issues if MSME mortality intensifies with the extension of lock-down, followed by a slow recovery of overdues and refinancing and funding challenges in the short term.
While Ind-Ra-rated FT-NBFCs in the investment grade (three) have sufficient liquidity to cover liability obligations for two-three months, assuming nil inflows and no moratorium, this also in Ind-Ra’s opinion may damage the short-mid-term fund-raising capabilities as risk aversion intensifies.
Cumulatively, Ind-Ra-rated FT-NBFCs have a total debt outstanding of around Rs30.0 billion, of which 50% of debt is funded by banks and financial institutions, which may curtail funding or refinancing to NBFCs for the short-to-medium term, given concerns on the asset side. Moreover, many banks still are uncertain providing moratorium to these NBFCs.
Ind-Ra says it also does not expect material inflows to these NBFCs via the targeted long-term repo operations mechanism since most of them are in the lower investment grade. However, they might receive some support from the refinance policy institutions, especially given that Rs0.5 trillion would be provided to these institutions for the MSME segment, it added.
According to the ratings agency, during FY20-21, credit growth for FT-NBFCs would be muted and it would focus more on recovery of overdues.
Over FY17-18 to first nine months (9M) of FY19-20, the assets under management (AUM) of Ind-Ra rated FT-NBFCs grew at a CAGR of around 50% to Rs50.0 billion, with loans to MSMEs and SMEs (unsecured business loans) and merchant cash advance accounting for around 85%.
"They may lose out on more than a month’s revenue and also see a slow revenue recovery," the ratings agency says, adding, "This could also be aggravated by the loss of business opportunities and lower demand. The merchant cash advance product (daily repayment product) offered by some FT-NBFCs is likely to have minimal collections in the near-term, especially because discretionary spending could take longer and consumers may downscale in the short term."
"The overhang could be partially offset by the fact that collections are digital and if there are bank balances, the payment can be ‘pulled’. About 60% of the borrowers of Ind-Ra’s rated FT-NBFCs have already availed a moratorium and additionally 10%-20% may avail one, hence, even MSMEs operating in essential goods and services, which may have their cash flows intact, may prefer to delay the payments on account of an uncertain end to the lockdown," it added.
In addition, Ind-Ra says, these are mainly proprietor-driven businesses that are often the only source of income for the family. Hence, in its view, an immediate and main focus of NBFCs will be to recover overdues to minimise the credit costs, further affecting the profitability, it added.
According to the ratings agency, some FT-NBFCs may also re-strategise and revise their operating models and underwriting practices and conserve near-term liquidity, further contributing to the likely muted credit growth for FY20-21.
Most FT-NBFCs operate at yield plus fee of 23%-25% and are operating at higher end of the yield curve, implying the credit risk is the highest. "In view of the FY20-21 muted credit growth, the pre-provisioning operating profit (PPOP) could come under pressure due to high fixed costs (10%-16% of AUM) on which these entities are operating. Also, these NBFCs have been incurring credit costs between 3%-6% which is likely to increase for near-term," the ratings agency says.
It says, "Any reasonable data-based estimates on credit cost would require collection data over the next four months; two months of moratorium period and two months of normal repayment environment. These entities are operating at a lower PPOP due to the high operating fixed costs, as the operations are expected to breakeven at a certain AUM level, and on steady state basis would report a PPOP in range of 7%-9%. However, considering the current scenario, some of the entities may not be able to achieve the economies of scale and the credit costs may further increase by 2%-3%, which could exceed PPOP, further leading to net losses in the near-term."
Ind-Ra says its rated FT-NBFCs maintain adequate capital buffers and low leverage levels, with tier-I capital adequacy ratio at 30%-32% and debt and equity below 3.0 times, which is conducive for favourable asset liability management. It says, "This is also necessitated as they operate at the higher end of the yield curve and their steady state credit costs are at least twice of higher rated asset financing NBFCs."
"Historically, these FT-NBFCs have capped maximum leverage levels at 4.0 times and have been continuously supported with capital infusions by its equity investors for breakeven of operations, absorption of credit costs and growth prospects; however, in the Ind-Ra’s view, in this challenging environment, it may be difficult to conceive substantial equity support from the investor community as well," the ratings agency concludes.