COF: Yet to peak; to remain higher even in FY25

3 Oct 2023 , 10:26 AM

While interest rates have risen 160-230bps, NBFCs’ cost of funds (COF) has increased by 25-160bps since Q4FY22. Analysts of IIFL Capital Services analysis of NBFCs’ funding profile and bond repricing indicate that COF should rise 5-25bps from Q1FY24 levels over the remaining part of M9FY24. Analysts of IIFL Capital Services expect RBI to cut rates post Q2FY25; their sensitivity analysis indicates that a 25bps rate cut in FY25 will result in only 0-10bps reduction in COF. Consequently, analysts of IIFL Capital Services believe that COF for NBFCs will remain higher for the next 1- 1.5 years, assuming 25bps rate cut. Risk to their estimate lies in sharp moderation in G-sec yields after India’s inclusion in global bond index. 

Bank funding to NBFCs has grown at 16% Cagr 

Since the IL&FS crisis, market access for many NBFCs was either cut-off or had become disproportionately expensive. Consequently, their reliance on bank funding increased, which now constitute 36% of borrowings at the system level (FY22). In the four years from FY18, bank lending to NBFCs / HFCs has grown at 16% Cagr.

COF to rise by 5-25bps from hereon in M9FY24 

Based on analysts of IIFL Capital Services analysis of NBFCs’ funding mix and maturity pattern, they expect COF for NBFCs to rise 5-25bps from Q1FY24 levels. With the recent CPI inflation readings of 7.4% and the core at 5.0% (Jul’23) being above RBI’s target of 4% (+/- 2%) — analysts of IIFL Capital Services expect RBI to hold rates for the remaining part of FY24. In fact, NBFC bond yields at the shorter end of the yield curve (3 months to 1 year) increased ~8bps, after the Jul’23 inflation data. With headline CPI expected to be at 5.2% even in Q1FY25, as per RBI’s forecast, analysts of IIFL Capital Services expect rate cuts only after Q2FY25. Their analysis indicates that 25bps rate cut in FY25 will result in 0-10bps reduction in the NBFCs’ COF in FY25.

In the previous rate cut cycle, analysts of IIFL Capital Services saw MCLR rate transmission of ~65%. This 65% transmission is intuitive given changes to MCLR rate is based on changes in marginal COF; also, given system-wide CASA share of ~45%, increase in COF for banks on a marginal basis will be lower. Analysts of IIFL Capital Services believe that MCLR rate has peaked (save for any incremental repo rate hike by RBI), as MCLR rates have already passed through ~55% of repo rate hikes. Indeed MCLR rates have held steady since Jun’23. However, impact of these MCLR rate changes gets passed through with a 3-9 month lag (reset period). Analysts of IIFL Capital Services estimate that 70% of 140bps MCLR rate hikes have been passed onto borrowers (NBFCs), with the balance 45bps to be repriced in Q2/Q3FY24 for NBFCs, assuming 50% of NBFC’s bank funding linked to MCLR. Analysts of IIFL Capital Services’ analysis indicates COF to increase 5-12bps, as the remaining MCLR rate hike gets reflected. However, the actual impact could be lower as many NBFCs may negotiate lower spread on repricing anniversary.