NonBank Financial Institutions in India: Performance Trends and Outlook

1
Non-Bank Financial Institutions in
IndiaPerformance Trends and Outlook

• Fitch Friday Presentation
• Ananda Bhoumik Arshad Khan
• 5 December 2008

2
Agenda
NBFCs Backdrop
Performance
Sector Specific Trends
Outlook
3
Agenda
NBFCs Backdrop
Performance
Sector Specific Trends
Outlook
4
Role of NBFCs in the System

• Low share of financial system assets
• In the last 5 years has remained close to 2
• But market itself is expanding
• Loans/GDP ratio over the same period has grown to
  50 (from 30)
• Niche sectors better suited for NBFCs
• Requiring in-depth client knowledge
• High monitoring costs

5
Since the 90s Crisis

• The market has seen explosive growth
• Last 5 years asset CAGR of Fitch analysed NBFCsa
  was 40
• In comparison the CAGR of Fitch analysed banks
  was 22
• Dependence on public deposits has become
  miniscule, banks and mutual funds play key
  funding role
• Equity levels have gone up significantly
• CAGR of equity increase over the last 5 years was
  52
• Absolute infusion in Fitch analysed NBFCsa was
  over USD3bn
• Regulatory oversight has increased
• Though still significantly lesser than that of
  banks
• NBFCs have entered many new segments

ª Commercial and consumer finance companies
6
Regulatory Framework Differences Continue
Source Fitch
7
Fitch National NBFC Rating Universe
Source Fitch
8
Agenda
NBFCs Backdrop
Performance
Sector Specific Trends
Outlook
9
Disclaimer

• The data presented is for 18 consumer and
  commercial financing NBFCs in India
• It does not include housing finance companies,
  infrastructure finance companies and other
  quasi-government entities
• The combined asset base of these companies was
  more than 70 of the known asset base of the
  sector as defined above
• The bank data points used are medians of 56 banks
  analysed by Fitch
• The NBFC data points used are also medians

10
Asset Quality Concentration Risk Remains
A Mid-Sized Bank's Loan Book
The Most Diversified NBFCs Loan Book
Source Company annual report, Fitch
11
Asset Quality Loan Loss Expense

• Loan loss provisioning- a weak point given lower
  realisability in many asset categories NBFCs
  operate in
• Wide differences in provisioning norms

Loan loss expense medians
Source Company annual reports
12
Funding Liquidity Asset Liability Structure

• Assumptions differ widely, sector wide problem
• Most tenor matched NBFCs run interest rate risk

Gaps across time-buckets
Source Company ALM statements, Fitch
13
Funding Liquidity Concentrated Source!
A Mid-Sized Bank's Liability Profile
NBFC Liability Profile-Bank Driven
NBFC Liability Profile-MF Driven
Top 10 lenders to a bank would contribute less
than 10 of its total deposits, for an NBFC this
will be more than 50Source Fitch
14
Funding Liquidity ST Funding and Leverage

• Off balance sheet assets 10-20 of total assets
• ST funding peaked in FY07, medians used so
  picture may not represent all

Funding Profile
Source Company annual report, Fitch
15
Profitability Net Interest Margin

• Margin improvements due to
• Move into higher margin segments
• Funding cost increases better passed on as banks
  retreated from certain segments

Median NIMs
Source Company annual report, Fitch
16
Profitability Cost-Income

• Phase of branch expansion over, cost efficiencies
  to support RoA in the near term

Cost-Income ratio median comparison
Source Company annual report, Fitch
17
Profitability RoA

• NII driven
• Lower provisioning and treatment of assignment
  income provide support

RoA median comparison
Source Company annual report, Fitch
18
Profitability RoE

• RoE efficiency a myth too early to say?

Comparison of median RoE
Source Company annual report, Fitch
19
Agenda
NBFCs Backdrop
Performance
Sector Specific Trends
Outlook
20
Niche Sectors

• Lending sectors where the NBFC has been present
  for 10 years or more

21
Niche Sectors Construction Equipment

• Recent developments
• Sale of construction equipments down to 25 of
  April 08 levels in some cases
• Activity in most industry segments that use these
  assets muted
• Few new projects being launched in real estate
• Road projects, a possible driver in a slow down,
  are not finding takers
• Outlook
• Credit profile to see near term deterioration,
  reviewing
• Repossessed inventory behavior loss severity
• Management of repossessed assets
• Specialised players are managing delinquencies
  better thus far
• Near term mitigant Government spending rate
  cuts to spur demand
• NBFCs likely to remain competitive due to asset
  specialization

22
Niche Sectors Commercial Vehicles

• Recent developments
• Freight demand down payments delayed Customer
  cash flows in distress
• Repossession sale of repossessed vehicles up,
  resale values down 30
• Outlook
• Credit profile to deteriorate in the near-term as
  customers liquidity in stress
• Experience and solvency provide support
• Reviewing
• Loss severity and margin cushion
• Ability to manage bad loans- expect asset quality
  pressure to remain
• ALMs Could come under pressure if asset tenors
  lengthen
• Near-term mitigants
• Fuel price interest rate cuts to support all
  transporters
• Good harvest local nature of freight demand
  support small operators
• NBFCs likely to remain competitive in the
  long-term
• Relatively low value loans requiring specialized
  monitoring

23
Niche Sectors Cars

• Recent developments
• Nationalised banks have become active
• Disbursements down 30-50
• Equity funded purchases as high as 40 in Oct
  2008
• Less than 1 year loans has stopped
• Outlook
• Credit profile to deteriorate
• Exposure would put negative pressure as high loss
  severity expected
• The Nano effect?
• Unless the market moves to lower income segments,
  competing with banks could become difficult for
  NBFCs

24
Niche Segments Gold Loans

• Recent developments
• Demand has picked up
• Banks quick to restart lending
• Outlook
• Credit profile stable
• Indians have a huge stock of gold
• Margin stability and cost efficiencies should
  support RoA
• Short asset tenors, manageable LTVs, quality of
  collateral provide support
• NBFCs likely to retain competitive position due
  to valuation capabilities and speed of processing
• Ticket sizes to go up as gold loans gain wider
  acceptance
• Operational risk management to come into focus
  for NBFCs

25
Niche Segments Microfinance

• Recent developments
• Equity flows have increased
• Although bank lending has declined, nationalised
  banks have become more active
• Outlook
• Credit profile stable as downside limited
• Delinquencies to increase as
• Systems of big NBFCs yet to be tested at current
  scale
• Ever greening levels in high microfinance
  penetration areas unsustainable
• Suits NBFCs given high collection and monitoring
  costs

26
Niche Segments Consumer Durables Two Wheelers

• Two wheelers
• Annual disbursement around INR50-55bn
• NBFC market share 50
• LTV 80-85, declining
• 90dpd3-10
• Credit profile could deteriorate over short term
• Lower resale values and stress on client cash
  flows
• Consumer durables
• Annual disbursement INR6bn
• NBFCs dominate segment
• Market shrinking (5 of market financed)
• 90dpd 4-10
• Credit profile to deteriorate as borrower segment
  in stress

27
New Sectors

• Defined as sectors where the NBFCs presence has
  been for less than 10 years

28
New Sectors

• Personal loans
• Market size as measured by disbursements has
  shrunk in FY08
• STPL disbursement 20 of 2007, PL disbursements
  50 of 2007 levels
• Loss rates have risen by as much as 500 in last
  3-4 years
• 90dpd STPL _at_15-20, PL 4-10
• Credit loss assumptions proven wrong
• Credit profile negative in its present form
• Efficient collateralization a key imperative
• Loan against property
• A relatively new segment, NBFC market share
  10-15
• A key contributor to ALM mismatches
• A transient product in NBFC books- will possibly
  move to HFCs
• Credit profile negative due to low LTVs and
  unmatched ALMs

29
New Segments

• Small business loans
• Market segment Ticket sizes 0.1-0.25m
• Disbursements at INR400-500bn/year
• Dominated by nationalised banks, NBFC penetration
  increasing
• 90dpd 4-12
• Credit profile to deteriorate as segments loss
  severity is unknown
• Loan against shares
• Market size around 100-120bn
• Mostly promoter lending
• Are margins adequate for mitigating market risk?
• Credit profile neutral due to low activity

30
NBFC Model Structural Advantages Disadvantages

• Advantages
• Focus on assets
• Better outreach
• More calibrated monitoring and recovery mechanism
• Less regulatory costs

• Disadvantages
• High segment concentration
• Lack of scalability
• Inefficient liability structure
• Cost maturities
• Concentration
• Access to liquidity

31
Agenda
NBFCs Backdrop
Performance
Sector Specific Trends
Outlook
32
Fitch NBFC Ratings Key Determinants

• Risk management asset quality
• Appropriateness for business
• Concentration
• Adequacy prudence of recognition and
  provisioning
• Management of bad assets
• Income profile
• Recognition norms
• Diversity sustainability

• Funding liquidity
• Tenor interest rate matching
• Adequacy permanence
• Source concentration
• Capital
• Leverage (incl. managed assets)
• Ability to raise capital
• Parental support
• Ability rationale for support

33
Outlook Risk Management Asset Quality

• Asset quality
• Generally higher delinquencies, low provisioning
  cover and muted growth would lead to significant
  deterioration in reported NPL ratios
• Some sectors more adversely impacted than others
• Model specific trends will be different
• Captives
• Outsourced
• Self originate and recover
• Diversification efforts to continue but ALM a
  constraining factor
• Recoveries from NPAs to be lower in the next
  12-18 months
• Move towards NPA management
• ARCs can be expected to play a role

34
Outlook Funding Liquidity

• Will remain a challenge over the short to medium
  term
• Sources
• Banks cannot take the mutual fund slack and
  support growth
• Move to quality
• Deposits?
• ALM
• Application of uniform assumptions would reveal
  gaps across the board
• Limitations of wholesale funding would get
  magnified
• Tenor matching will improve but difficult to
  mitigate interest rate risk
• ALM gaps in new diversified NBFCs to continue in
  the short term
• Liquidity
• Emphasis on committed backups would increase
• Deposit taking NBFCs to keep more cash

35
Outlook Profitability

• To reduce significantly in the near term
• Negatives
• Lower leverage higher liquidity requirements
• Higher provisioning
• Low fee income
• Funding costs Many segments cannot take interest
  rate increases
• Positives
• Exit of banks from certain segments
• Originate sell activity may pick up
• Accounting treatment?
• Long-term profitability likely to revive
• Move to higher margin segments
• More informed pricing As actual credit loss
  levels emerge

36
Outlook Capital Support

• Capitalisation
• To support credit profiles in the near term
• Solvency (Net NPL/equity) remains reasonably
  strong
• Demonstrated ability to raise equity will support
  profiles
• Parental support
• To come under increased focus given
• Liquidity constraints
• Source concentrations of funding
• Limited ability to diversify asset portfolios
• Nature of linkage will be a key determinant of
  credit profile
• Criticality to parent

37
Rating Impact

• Upside may be limited
• Liability profiles
• Select downgrades possible
• Liability
• Asset quality
• Mitigating factors
• Capital
• Margins
• Track record

38
Fitch Ratings India www.fitchindia.com
6 Floor, Apeejay House, 3 Dinshaw Vachha Road,
Churchgate Mumbai 400020 91 22 40001700 91 22
40001701
414 421, 4th Floor, World Trade
Centre, Barakhamba Lane, Connaught Place New
Delhi- 110 001 T 91 11 4165 7230/ 4356 7230 F
91 11 4356 7231
Office No.1, 2nd Floor, Gokul Arcade, No. 2,
Sardar Patel Road, Adyar, Chennai 600 020 T 91
44 4340 1700 F 91 44 4340 1701
2 Floor, RoomNo. 34, Chowringhee Court, 55
55/1 Chowringhee Roa, Kolkata 700071 91 33
22823375 91 33 22823376