Kotak Institutional Equities maintains a ‘positive’ outlook on NBFCs and expects Mahindra Finance, Shriram Transport, IDFC and Reliance Capital while bearish on HDFC, Rural Electrification Corporation (REC), Bajaj Finserv

Kotak Institutional Equities (Kotak) has voiced positive sentiments on Non-Banking Financial Companies (NBFCs) on the back of the recently announced draft guidelines issued by the banking regulator, the Reserve Bank of India (RBI). The report released on 13 December 2012 stated, “We are positive on the business of asset-finance NBFCs even as the recent rally caps upside.” In other words, it is positive on the sector even though the market has discounted the upside movement because it believe the guidelines will make NBFC fundamentally stronger over the long-term. It expects most of the NBFCs under coverage to report 7%-10% lower pre-tax earnings if these guidelines are to be implemented straightaway instead of in 2015 as stipulated in the draft guidelines. It bullish on Mahindra Finance, Shriram Transport, IDFC and Reliance Capital while it is bearish on HDFC, Rural Electrification Corporation (REC), Bajaj Finserv.

Check here for some of our write ups on NBFCs.

Some of the highlights of the draft guidelines are:

1. 90-day non-performing loan (NPL) recognition: The current practice is 180 days; which means that if a loan has not been recovered within 180 days of its due date, it has to be recognized as bad loan or NPL and be written off. Now the RBI has made this 90 days, which means NBFCs need to tighten their screws if they are to recover loans quickly, else they will just keep piling up. It will be implemented after March 2015. One could expect cleaner and healthier balance sheet and a safer industry but a possibly impacted bottom-line on account of more NPL and higher provisioning.
2. 10% Tier-I Capital Adequacy Ratio (CAR) for most NBFCs: Infrastructure Financing Companies (IFCs) are required to have a minimum CAR of 10%, which is lower than the 12% mentioned in the Usha Thorat Committee Report. This is somewhat more lenient and provides some breathing space, in terms of capital requirements. However, gold-loan NBFCs and captive finance companies would need to maintain CAR of 12%. While NBFC-NDs are required to have a higher threshold of 15%. This should be implemented by March 2015.
3. NBFCs would need to take permission of RBI of shareholding changes by over 25%: Sometimes, NBFCs, from time to time, may need capital infusion if there is a crisis or urgent need of capital. In this case, it might need to sell stake. But if the stake sale is more than 25% or there’s change in control in a NBFCs, it would need to seek RBI’s permission. This is to ensure that RBI has some level of understanding and control over the industry.

Kotak stated, “RBI’s proposed guidelines for NBFCs are marginally better than expected.” The final guidelines are slated for January 2013, which will be implemented by NBFCs. Other than impact on pre-tax earnings, it finds that its universe of NBFCs has CAR of over 15% (as of September 2012) which is well above stipulated norms. For instance, according to the report, Shriram Transport has 16.8% Tier-I CAR, Muthoot Finance has 14% tier-I CAR (this is flirting with the 12% norm and could go lower if gold prices crash). Mahindra Finance has around 14% tier-I CAR. IFDC is well placed with tier-I CAR of 19.2%.

According to the Kotak report, some of the companies likely to be impacted on account of higher provisioning due to stringent NPL norms are Power Finance Corporation, Rural Electrification Corporation and L&T Finance Holdings. The table below shows which companies are likely to be impacted and their overall loan picture.
 

However, Kotak said that these guidelines will not impact significantly the companies it covers. It says, “We don’t find a significant impact of the draft guidelines on sustainable earnings of NBFCs under our coverage”. It furthermore said, “While M&A activity in the sector will be exposed to higher regulatory scrutiny, higher regulatory control will provide comfort to stakeholders”.

On 12^th December, RBI released draft guidelines to address issues and concerns in the NBFC sector. The draft guidelines are based on recommendations on the basis of Usha Thorat Committee Report. The Committee reviewed existing regulatory and supervisory framework of non-banking finance companies (NBFCs) and to strengthen the overall regulatory framework. The draft revised guidelines relate to entry point norms, principal business criteria, prudential regulations, liquidity requirements for NBFCs and corporate governance.

Check here for our take on some of our Kotak Institutional Equities reports.