NBFCs turn to newer asset classes in quest for returns

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Non-Banking Financial Institutions (NBFCs) have started restructuring portfolio strategies for better risk-adjusted returns by focusing on unsecured loans and micro, small and medium enterprise (MSME) finance, as rising interest rates and reduced competitiveness in traditional segments are expected to drive up funding costs. Like home and new Auto loans Due to intense competition from banks.

However, used auto loans will continue to be a key business segment for NBFCs as this space generates high yields and is not a focus area for banks.

Over the past few years, NBFCs have faced several challenges exacerbated by the Covid-19 pandemic.

Now, strong balance sheets, high provisioning and low leverage, diminishing asset-quality concerns and steady normalization of access to finance provide a strong foundation for NBFCs to grow.

Portfolio restructuring is already visible.

As a percentage of total disbursements to NBFCs, the share of unsecured loans increased to ~35% in the first half of this fiscal from ~31% last fiscal and ~24% in the previous fiscal. Disbursement of unsecured loans has more than doubled in the last financial year and increased by almost 50% in the first half of this financial year.

From an assets under management (AUM) perspective, unsecured loans are close to pre-pandemic levels at 20-25% this fiscal — higher than in the last two fiscals. Relatively low growth in AUM for unsecured loans as these are short-term loans and run quickly balance sheet Compared to home loans or auto loans. Following a slowdown in the last 3-4 years, disbursements in MSME funds have also picked up significantly in the last fiscal, rising ~55% in the last fiscal and maintaining momentum in the first half of this fiscal. In fact, supply has declined in fiscal 2021 due to a pandemic-induced slowdown.

In short, therefore, AUM improvement in these segments will drive growth for NBFCs going forward.

As large NBFCs turn to non-traditional segments to increase yields, we may also see more partnerships focusing on specific asset classes, particularly unsecured loans, co-lending with emerging NBFCs. This allows large NBFCs to expand into new domains in a more cost-efficient manner while reducing time to market; For emerging investors, it supports capital-efficient AUM growth.

This does not mean that traditional categories will not grow.

Home loans, the largest segment of NBFC AUM at around 40-45%, have seen structural factors driving end-user housing demand remain the same despite rising real estate prices and interest rates. This will boost growth to 13-15% in the next financial year.

This means that banks are more competitive in home loans and HFCs may lose market share to banks amid stiff competition in interest rates, especially in the urban and formal salaried segments. Hence, the share of retail trade is expected to rise as the growth of the banking sector moves forward.

Rising rates also boost borrowing Pricing of NBFCs and reduce their competitiveness against banks that have access to low-cost funds. NBFCs are expected to retain their hold in the self-employed professionals and affordable housing segments.

Auto finance, the second largest segment (20-25% of NBFC AUM), will grow at 13-14% next fiscal compared to ~12% estimated this fiscal, on the back of solid underlying asset sales. Strong demand and new launches will continue to drive car and utility vehicle sales. Resurgence in economic activity, demand for fleet replacement and focus on last-mile connectivity will support commercial vehicle sales.

In the new-vehicle finance segment, particularly cars, borrowers are more interest-rate sensitive, so competition from banks is tougher given their ability to offer better rates. As a result, NBFCs can leverage their core strengths of last-mile connectivity, customer relationships and strong understanding of innovation and micro markets to focus on used vehicle financing, which offers higher yields and better profitability from a risk-adjusted return perspective. .

While all segments are witnessing a strong rebound, real estate funding may continue to be channeled through alternative investment funds. Some NBFCs may look at a calibrated restructuring, as construction finance for large developers, lease rent discount loans and last-mile financing have relatively low risk and high return potential.

In short, NBFCs today are well placed to take advantage of the upcoming opportunities. The sector’s momentum should allow for quick realignment of portfolio strategies and ensure sustainable growth, although higher-than-expected inflation and interest rates remain key watchdogs.

(Teacher Senior Director and Deputy Chief Evaluation Officer CRISIL Ratings)


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