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Regulatory changes to impact NBFCs
The RBI has withdrawn the priority sector status on direct loans by banks to NBFCs
Currently, this has minimal impact on earnings for MMFS and SHTF
Should the RBI remove the status on securtized loans also, earnings could be impacted
by about 10% and CARs could decline, in our view.
Final guidelines and clarification are expected by Jun ’11, post which we will revisit our
estimates.
The RBI has withdrawn the priority sector status on loans by banks to NBFCs. This is unlikely to
have a major earnings impact for either MMFSL or Shriram (3% for M&M Finance and zero for
Shriram). However, the bigger fear is that the RBI may also withdraw priority sector status
attached to securitized loans sold by NBFCs to banks. If that happens, earnings for both M&M
Finance and Shriram could decline by 10% (taking FY11 reported earnings as base).
The RBI guidelines expected in Jun ’11 will clarify whether priority sector status currently
attached to securitized assets sold by NBFCs to banks will stay. In addition, norms for
securitization can also change putting pressure on capital adequacy as currently capital
requirements for loans assigned are lower than off book loans. Shriram has clarified that its CAR
will decline by a huge 500bps over current levels if this happens but it will still remain healthy at
20%. Similar implications for gold financiers.
Stock prices have already corrected 10-13% wow. However, we believe regulatory uncertainty
and potential risks to earnings will continue to weigh on stock price performance.
NBFCs borrow from banks in two ways: 1) Direct term loans from banks. Some of these term
loans depending on the size of the loan and end use can be classified as priority sector loans by
banks. 2) Banks also buy securitized assets from NBFCs through loan assignments which are
classified as priority sector loans.
The RBI clarified that bank loans given to NBFCs can no longer qualify as priority sector except
loans given to housing finance companies and to microfinance institutions. However, the RBI has
clarified that as of now securitized loans that banks purchase from NBFCs continue to be
classified as priority loans. The RBI mentioned that it is reviewing guidelines relating to priority
sector and relating to securitization and will make a final decision by Jun ’11. The RBI also
clarified that as of now that it is comfortable with securitized assets being classified as priority
sector loans because banks do due diligence while purchasing these assets. In brief, as of now
all bank loans to NBFCs lose their priority status. The priority status for securitized assets
purchased by banks from NBFCs stays till guidelines are reviewed.
Securitized assets losing priority status is a bigger risk than the priority status for bank loans to
NBFCs being taken away. Most banks, especially the larger PSU banks, do not differentiate
between loans given to NBFCs that they can classify as priority and loans they give to NBFCs
that are not classified as priority when it comes to pricing these loans. However, some banks that
have huge priority shortfalls may be giving concessional rates to NBFCs for the loans that carry
priority status.
We spoke to M&M Finance and Shriram to clarify these issues.
Shriram Transport Finance
Total bank loans to Shriram are around Rs90bn or 45% of borrowings of Rs199bn. Of these,
bank loans that have priority sector status attached to them are Rs40bn or 20% of total. These
loans were borrowed 1.5 years ago and have contractual maturity of 3-4 years. They were
borrowed at a fixed rate. According to Shriram, it borrowed ‘priority’ and ‘non-priority’ loans from
banks at similar rates and there is no concessional rate attached to loans that banks classify as
priority. Therefore, there will be no impact from the current change in guidelines for Shriram.
The risk, however, in our view is if securitized assets lose their priority sector status in future.
Contribution of securitized AUMs to total AUMs for Shriram is high at 45% in FY11 up from 38%.
Securitized loans gives Shriram 100bps higher spread relative to the spread on ‘on book’ loans.
Earlier the spread differential between securitized and non-securitized loans was higher at
200bps but it has come down since the implementation of the base rate to 100bps now.
Assuming no hike in lending rates (more than what we had expected), a 100bps
compression in spread on securitized loans could bring down earnings by 10% on
reported numbers of FY11, in our view.
Shriram management reiterated that the proportion of securitization increased sharply in 4Q
because it wanted to take advantage of securitization while it lasts.
Fig 1 – Earnings impact from withdrawal of PSL status on bank borrowings
Rs bn
Total bank borrowings 90
Of which priority sector 40
Impact due to withdrawal of priority sector -
Impact on reported FY11 net profit 0.0%
Source: Company data, Standard Chartered Research estimates
Fig 2 – Impact on reported PAT for FY11 from new norms
Rs m
Securitized AUMs 163,170
Impact from withdrawal of priority sector status 1,631.7
Impact on reported PAT for FY11 9.3%
Source: Company data, Standard Chartered Research estimates
M&M Finance
We spoke to M&M Finance.
Around 35% of its total loans from banks carry the priority tag for banks. Banks can classify these
loans as agri priority loans. M&M Finance gets these loans cheaper by 50-75bps compared to
other loans. Withdrawal of priority sector status on loans borrowed from banks could drive down
earnings by 2.6%.
Withdrawal of priority sector status and change in guidelines on securitized loans (loans
assigned) could result in a 10.5% additional earnings decline for M&M Finance. Two key points:
1) Around 15% of total AUMs for M&M Finance come from securitized loans. M&M earns
spreads that are 200-250bps higher than spreads on normal loans from these
assignments. The spread differential for off book and on book AUMs is higher for M&M
Finance compared to Shriram as loans for M&M Finance get classified as ‘agri priority’.
For Shriram, they get classified as priority but not under the agri bucket. The total impact
of withdrawal of priority status on loans securitized could be 6%.
2) In addition, M&M Finance upfronts income and some expenses on securitized loans. If
upfronting is disallowed, earnings could drop by 4%. To put this in perspective, M&M
Finance earned gross securitization income of Rs1.5bn in FY11 which was booked
upfront. In addition it also charged upfront expenses of Rs1bn. So the net securitization
income it earned during the year was Rs530m. Further, it wrote back some expenses
that it had upfronted in the past and were no longer required amounting to Rs365m. So
in all, it booked net pre-tax income of Rs900m from securitization. On an incremental
basis, if rules change, the gross securitization income will have to be spread over 2.5
years. So instead of Rs1.5bn booked in FY11, M&M would have booked only Rs600m if
upfronting was not allowed. M&M Finance will also not need to make upfront ad hoc
provisions and costs and will just debit the actual costs to the P/L. So the Rs100m of
expenses provided for in FY11 will also be done away with. The write back income of
Rs360m booked in FY11 will also not be available on an ongoing basis as there will be
nothing to write back if there are no upfront costs or provisions. Therefore, if we recast
FY11 securitization income of Rs900m, it will lower to Rs296m causing net profit to
decline by 4.5%.
Cumulative impact of the above changes will be 13% for MMFS on reported FY11 numbers.
If MMFS had to provide capital on off-book loans in a similar manner as on book loans, the total
CAR would decline by 180bps.
Fig 4 – Securitization income
Old norms New norms
Gross securitization income 1,500 600
Upfront expenses and provisions 970 -
Net income 530 -
Write back of expenses of earlier years 370 -
Total securitization income charged to P/L 900 600
Difference -300
Difference as % to reported FY11 net profit -4.5%
Source: Company data, Standard Chartered Research estimates
Fig 5 – Impact on reported PAT for FY11 from new norms
Rs m
Total assets securitized; 19,474
Decline in income due to higher discount rates -389
Impact on FY11 net profit -5.9%
Source: Company data, Standard Chartered Research estimates
Fig 6 – Earnings impact from withdrawal of PSL status on bank borrowings
Rs m
Total bank borrowings 65,717
Of which priority sector 23,001
Impact of 75bp due to withdrawal of priority sector 173
Impact on reported FY1 net profit -2.6%
Source: Company data, Standard Chartered Research estimates
Shriram’s stock price has corrected 11% over the past one week and MMFSL’s stock price 10%.
Shriram trades at 2.4x P/BV FY12E and MMFSL trades at 2.6x P/BV FY12E. Earnings risks and
regulatory uncertainty could continue to weigh on stock price performance.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Regulatory changes to impact NBFCs
The RBI has withdrawn the priority sector status on direct loans by banks to NBFCs
Currently, this has minimal impact on earnings for MMFS and SHTF
Should the RBI remove the status on securtized loans also, earnings could be impacted
by about 10% and CARs could decline, in our view.
Final guidelines and clarification are expected by Jun ’11, post which we will revisit our
estimates.
The RBI has withdrawn the priority sector status on loans by banks to NBFCs. This is unlikely to
have a major earnings impact for either MMFSL or Shriram (3% for M&M Finance and zero for
Shriram). However, the bigger fear is that the RBI may also withdraw priority sector status
attached to securitized loans sold by NBFCs to banks. If that happens, earnings for both M&M
Finance and Shriram could decline by 10% (taking FY11 reported earnings as base).
The RBI guidelines expected in Jun ’11 will clarify whether priority sector status currently
attached to securitized assets sold by NBFCs to banks will stay. In addition, norms for
securitization can also change putting pressure on capital adequacy as currently capital
requirements for loans assigned are lower than off book loans. Shriram has clarified that its CAR
will decline by a huge 500bps over current levels if this happens but it will still remain healthy at
20%. Similar implications for gold financiers.
Stock prices have already corrected 10-13% wow. However, we believe regulatory uncertainty
and potential risks to earnings will continue to weigh on stock price performance.
NBFCs borrow from banks in two ways: 1) Direct term loans from banks. Some of these term
loans depending on the size of the loan and end use can be classified as priority sector loans by
banks. 2) Banks also buy securitized assets from NBFCs through loan assignments which are
classified as priority sector loans.
The RBI clarified that bank loans given to NBFCs can no longer qualify as priority sector except
loans given to housing finance companies and to microfinance institutions. However, the RBI has
clarified that as of now securitized loans that banks purchase from NBFCs continue to be
classified as priority loans. The RBI mentioned that it is reviewing guidelines relating to priority
sector and relating to securitization and will make a final decision by Jun ’11. The RBI also
clarified that as of now that it is comfortable with securitized assets being classified as priority
sector loans because banks do due diligence while purchasing these assets. In brief, as of now
all bank loans to NBFCs lose their priority status. The priority status for securitized assets
purchased by banks from NBFCs stays till guidelines are reviewed.
Securitized assets losing priority status is a bigger risk than the priority status for bank loans to
NBFCs being taken away. Most banks, especially the larger PSU banks, do not differentiate
between loans given to NBFCs that they can classify as priority and loans they give to NBFCs
that are not classified as priority when it comes to pricing these loans. However, some banks that
have huge priority shortfalls may be giving concessional rates to NBFCs for the loans that carry
priority status.
We spoke to M&M Finance and Shriram to clarify these issues.
Shriram Transport Finance
Total bank loans to Shriram are around Rs90bn or 45% of borrowings of Rs199bn. Of these,
bank loans that have priority sector status attached to them are Rs40bn or 20% of total. These
loans were borrowed 1.5 years ago and have contractual maturity of 3-4 years. They were
borrowed at a fixed rate. According to Shriram, it borrowed ‘priority’ and ‘non-priority’ loans from
banks at similar rates and there is no concessional rate attached to loans that banks classify as
priority. Therefore, there will be no impact from the current change in guidelines for Shriram.
The risk, however, in our view is if securitized assets lose their priority sector status in future.
Contribution of securitized AUMs to total AUMs for Shriram is high at 45% in FY11 up from 38%.
Securitized loans gives Shriram 100bps higher spread relative to the spread on ‘on book’ loans.
Earlier the spread differential between securitized and non-securitized loans was higher at
200bps but it has come down since the implementation of the base rate to 100bps now.
Assuming no hike in lending rates (more than what we had expected), a 100bps
compression in spread on securitized loans could bring down earnings by 10% on
reported numbers of FY11, in our view.
Shriram management reiterated that the proportion of securitization increased sharply in 4Q
because it wanted to take advantage of securitization while it lasts.
Fig 1 – Earnings impact from withdrawal of PSL status on bank borrowings
Rs bn
Total bank borrowings 90
Of which priority sector 40
Impact due to withdrawal of priority sector -
Impact on reported FY11 net profit 0.0%
Source: Company data, Standard Chartered Research estimates
Fig 2 – Impact on reported PAT for FY11 from new norms
Rs m
Securitized AUMs 163,170
Impact from withdrawal of priority sector status 1,631.7
Impact on reported PAT for FY11 9.3%
Source: Company data, Standard Chartered Research estimates
M&M Finance
We spoke to M&M Finance.
Around 35% of its total loans from banks carry the priority tag for banks. Banks can classify these
loans as agri priority loans. M&M Finance gets these loans cheaper by 50-75bps compared to
other loans. Withdrawal of priority sector status on loans borrowed from banks could drive down
earnings by 2.6%.
Withdrawal of priority sector status and change in guidelines on securitized loans (loans
assigned) could result in a 10.5% additional earnings decline for M&M Finance. Two key points:
1) Around 15% of total AUMs for M&M Finance come from securitized loans. M&M earns
spreads that are 200-250bps higher than spreads on normal loans from these
assignments. The spread differential for off book and on book AUMs is higher for M&M
Finance compared to Shriram as loans for M&M Finance get classified as ‘agri priority’.
For Shriram, they get classified as priority but not under the agri bucket. The total impact
of withdrawal of priority status on loans securitized could be 6%.
2) In addition, M&M Finance upfronts income and some expenses on securitized loans. If
upfronting is disallowed, earnings could drop by 4%. To put this in perspective, M&M
Finance earned gross securitization income of Rs1.5bn in FY11 which was booked
upfront. In addition it also charged upfront expenses of Rs1bn. So the net securitization
income it earned during the year was Rs530m. Further, it wrote back some expenses
that it had upfronted in the past and were no longer required amounting to Rs365m. So
in all, it booked net pre-tax income of Rs900m from securitization. On an incremental
basis, if rules change, the gross securitization income will have to be spread over 2.5
years. So instead of Rs1.5bn booked in FY11, M&M would have booked only Rs600m if
upfronting was not allowed. M&M Finance will also not need to make upfront ad hoc
provisions and costs and will just debit the actual costs to the P/L. So the Rs100m of
expenses provided for in FY11 will also be done away with. The write back income of
Rs360m booked in FY11 will also not be available on an ongoing basis as there will be
nothing to write back if there are no upfront costs or provisions. Therefore, if we recast
FY11 securitization income of Rs900m, it will lower to Rs296m causing net profit to
decline by 4.5%.
Cumulative impact of the above changes will be 13% for MMFS on reported FY11 numbers.
If MMFS had to provide capital on off-book loans in a similar manner as on book loans, the total
CAR would decline by 180bps.
Fig 4 – Securitization income
Old norms New norms
Gross securitization income 1,500 600
Upfront expenses and provisions 970 -
Net income 530 -
Write back of expenses of earlier years 370 -
Total securitization income charged to P/L 900 600
Difference -300
Difference as % to reported FY11 net profit -4.5%
Source: Company data, Standard Chartered Research estimates
Fig 5 – Impact on reported PAT for FY11 from new norms
Rs m
Total assets securitized; 19,474
Decline in income due to higher discount rates -389
Impact on FY11 net profit -5.9%
Source: Company data, Standard Chartered Research estimates
Fig 6 – Earnings impact from withdrawal of PSL status on bank borrowings
Rs m
Total bank borrowings 65,717
Of which priority sector 23,001
Impact of 75bp due to withdrawal of priority sector 173
Impact on reported FY1 net profit -2.6%
Source: Company data, Standard Chartered Research estimates
Shriram’s stock price has corrected 11% over the past one week and MMFSL’s stock price 10%.
Shriram trades at 2.4x P/BV FY12E and MMFSL trades at 2.6x P/BV FY12E. Earnings risks and
regulatory uncertainty could continue to weigh on stock price performance.
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