NBFC: Widening spreads to weigh on NIMs and growth

26 Mar 2024 , 01:41 PM

NBFCs, especially the smaller ones, are likely to face a bumpy road ahead with: 1) wholesale bond spreads widening for nonAAA/non-corporate backed NBFCs, 2) growth moderation due to slowdown in unsecured loans, tighter compliance and need to reduce dependence on bank borrowings, and 3) rising COF and rate cut driven margin tailwinds delayed. Bond spreads have widened 11bps to 78bps in the last 3M for non-AAA/non-corporate backed NBFCs, is higher than LTA during the normal times and even higher than ~65bps during taper tantrum/IL&FS crisis. Consequently, analysts of IIFL Capital Services cut their estimates by 1-6% with a preference for larger NBFCs having strong credit rating, parentage and a diversified funding profile. Analysts of IIFL Capital Services like CIFC, BAF (0.5-0.9x PEG) followed by SHFL and Five Star among the smaller NBFCs. They upgrade MMFS to ADD following the underperformance, end of earnings downgrades and improvement in the profitability hereon.

Signs of spread widening for non-AAA/non-corporate backed NBFCs

Risk aversion after RBI imposing business restrictions on some NBFCs and the liquidity tightness — has led to spreads for AA rated NBFCs over AAA rated peers expanding 11bps from 67bps in mid-Dec 2023 to 78bps now. These spreads are 21bps higher than LTA of 57bps during ‘normal times’ over the last 12 years. In fact, spreads are higher than during the taper tantrum and IL&FS crisis when it averaged 63-67bps respectively. Analysts of IIFL Capital Services bottom-up analysis also indicates widening credit spreads for non-AAA or non-corporate backed NBFCs. Spreads for SHFL, JM Fin, Indostar have expanded by ~5-30bps, relative to their AAA rated / corporate-backed NBFC peers, over the last few months. SHFL has done well to scale up its deposit book by 2x and diversify funding post IL&FS. Given the high liquidity levels, low leverage and recent successful bond issuances by these entities, analysts of IIFL Capital Services do not expect liquidity tightening redux like in the aftermath of IL&FS. But the widening credit spreads necessitate focus on liability franchise of NBFCs like the RISQ framework (link).

Growth to further moderate, but large diversified NBFCs to grow at 1.7-1.8x of the system

In addition to unsecured loan moderation, NBFCs have to strengthen their compliance functions and also reduce dependence on bank borrowings. Consequently, analysts of IIFL Capital Services further trim growth estimates for NBFCs under their coverage by 80-260bps to 15-32% Cagr for FY24- 26. Despite that, analysts of IIFL Capital Services expect BAF/CIFC to grow at 24-25% Cagr (FY24- 26) followed by 15-21% Cagr for SHFL/MMFS/LTFH; led by product and distribution expansion. Analysts of IIFL Capital Services note that BAF/CIFC’s growth will still be 1.7- 1.8x system credit growth of ~13-14%, justifying their growth oriented multiples. Whereas analysts of IIFL Capital Services expect growth to moderate by 220- 260bps to 21-32% Cagr for Five Star /Fusion.

Rate-cut-driven margin tailwinds to be delayed (again)

With headline CPI inflation estimated to be 4.5% in FY25, analysts of IIFL Capital Services expect rate cuts by RBI to be back ended towards the end of FY25. Consequently, they expect 15-30bps further increase in the quarterly COF (from Q3FY24 levels) before declining 15-30bps by Q4FY26, based on analysts of IIFL Capital Services repricing analysis. However, analysts of IIFL Capital Services expect divergent NIM outcomes for even fixed rate NBFCs in FY25 (on YoY basis): 50-75bps compression for BAF/Five Star, flattish for SHFL/Fusion and 10-75bps expansion for CIFC/MMFS/LTFH. Similarly, in FY26, analysts of IIFL Capital Services expect NIMs to expand 10-25bps for MMFS/LTFH/CIFC, remain flattish for SHFL and decline 15-70bps for BAF/Fusion/Five Star.

Remain selective

Notwithstanding the growth and margin moderation, analysts of IIFL Capital Services expect large NBFCs under analysts of IIFL Capital Services coverage to deliver earnings growth of 15-30% Cagr (FY24-26) vs 1-17% Cagr for the large Private & PSU banks, even as these NBFCs trade near their LTA multiples. Analysts of IIFL Capital Services preference remains for large NBFCs, CIFC and BAF (0.5-0.9x PEG). Analysts of IIFL Capital Services also like SHFL and Five Star and upgrade MMFS to ADD as profitability improves and negative earnings revision are likely done.