Want to bet on NBFCs? Keep these five factors in mind about asset quality

The cost of funds is moving up for lenders as the Reserve Bank of India (RBI) is going hammer and tongs at fighting inflationary pressures in the economy with policy rate hikes.

So, what does it mean for investors who are wondering if they can bet on beaten down stocks of shadow banks, or non-banking finance companies (NBFCs)?

Here are some notes on the asset quality picture of shadow banking system in the country.

Omicron impact

NBFCs as well as housing finance companies (HFCs) registered an improvement in their asset quality in Q4 FY2022 as the impact of the Omicron variant of Covid-19 was minimal.

Moreover, slippage from the restructured book was lower during the quarter and the lenders augmented their collections in view of the tighter Income Recognition, Asset Classification and Provision (IRAC) norms, which are applicable from October 2022.

Risky assets

The gross stage 3 (GS3), or potential risky assets, for NBFCs reduced substantially during the last quarter, reaching almost pre-Covid levels. However, improvement was relatively moderate for HFCs.

The GS3 for NBFCs reduced to 4.4% in March 2022 from 5.7% in December 2021. On the other hand, GS3 for HFCs moderated to 3.3% vis-à-vis 3.6% in December 2021.

Focus on collections

The RBI had provided some relaxation to the implementation of the tightened IRAC norms via a circular issued in February. However, most lenders which had already aligned their GS3 reporting with the tighter IRAC norms (entities can continue reporting GS3 as per IndAS, i.e., 90 days past due basis and, non-performing advances (NPAs) as per IRAC, if they wish to) continued to focus on collections and did not avail the deferment provided by the RBI.

Higher focus on collecting under the bucket of 30-90 days overdue, vis-à-vis the 60-90/90+ bucket in the past, supported asset quality.

Lower slippage

Slippage from the restructured book, especially for general NBFCs, was lower than expected, which also contributed to the asset quality performance.

According to credit rating firm ICRA, performance of this book would remain a monitorable, considering the weakening macroeconomic and operating environment and the balloon repayment schedule of some of these loans.

The standard restructured books of NBFCs and HFCs stood at about 2.7-3% and 1.4-1.6%, respectively, as of March 2022, down from the peak of 4.5% and 2.2%, respectively, in September 2021.

Profitability

The profitability of NBFCs and HFCs during the Covid-19 pandemic was supported by favourable cost of funds. This was despite the lenders facing a growth slowdown, having higher on-balance sheet liquidity leading to negative carry, building up their provisions in view of the uncertainties around the pandemic and undertaking sizeable write-offs without significantly impacting the earnings.

Although the GS3 has moderated, lenders continue to carry higher provisions. This would provide them with some room to deal with pressure on the margin in the current fiscal as their borrowing rates are going up.