A near-term recovery for India's non-bank financial institutions (NBFIs) is not probable, as the sector continues to wrestle with the fallout from the coronavirus pandemic, says Fitch Ratings.
An investor poll at the annual Fitch on India event, held in early July 2020, revealed that more than 75% of participants believed Indian NBFIs would take more than one year to show a convincing recovery in light of the effects of the pandemic.
It says, "The poll results are in line with Fitch's expectations. We believe the significant economic disruption and prevailing uncertainty caused by the pandemic will impede a return to a more normal operating environment for NBFIs, with consequences for new loan disbursements, asset quality and provisioning, sector profitability, and funding conditions."
"We see uncertainty stemming from depressed consumer demand and a sustained high level of coronavirus infections, notwithstanding a gradual economic reopening that has improved collections and funding availability since June 2020," it added.
According to the ratings agency, the sector is nearly two years into its crisis, which was triggered by the default of Infrastructure Leasing & Financial Services (IL&FS) Ltd, and nearly 40% of investors polled still expect it to take another two years before a recovery is evident.
"This is longer than Fitch's base-case assumption, but a downside scenario - where the economy continues to struggle to recover in the aftermath of the pandemic - could prolong the sector downturn beyond the two-year horizon and cause irreversible damage to parts of the NBFI industry, with mid- to small-sized franchises at greatest risk of branch closures and staff redundancies to trim costs. In this scenario, more firms could exit from underperforming business segments," it added.
As per the ratings agency, construction finance is one area that is ripe for downsizing, with several announced portfolio sales and strategic shifts aimed at shrinking the segment amid delayed construction activity and lower unit sales. Other segments that may also witness consolidation should the downturn persist include infrastructure finance, low-yielding corporate loans as well as loans against property in urban areas.
Nonetheless, Fitch says, NBFIs in India are highly differentiated and some lending segments will benefit from a quicker recovery. "Those in the gold-backed loan sector could see an earlier revival due to lower ticket sizes, greater market confidence in the loan collateral and a more robust outlook for the rural sector, where many larger gold lenders are focused. Other commercial segments, such as commercial vehicle finance, should see a gradual pick-up as freight demand improves - although Fitch expects India's GDP to remain weak in the next quarter or two, contracting by 5% in the fiscal year ending March 2021 (FY21) before recovering to 8% growth in FY22".
"We believe a sector turnaround is only likely once loan repayments recover and liquidity buffers have been replenished following months of depressed collection inflow. This would also stabilise NBFIs' current credit ratings. Strengthened capital adequacy would also help to shore up credit profiles in the face of an anticipated hike in bad debts upon the expiry of the regulator's loan relief," the ratings agency says.
Accordig to Fitch, NBFIs with competitive advantages and stronger franchises—mainly the sector leaders - are better placed to navigate these hurdles.
Fitch-rated entities have reported gradual improvements in loan collections and funding access over the past month with the reopening of the economy.
"Equity issuance may also pick up in the near term as issuers seek to bolster capital positions," the ratings agency says, adding, "A number of NBFIs, such as Shriram Transport Finance Co Ltd, Mahindra & Mahindra Financial Services Ltd, L&T Finance Holdings and HDFC Ltd have announced equity issuance plans in recent weeks."