Retail Loans: Delayed impact expected from geopolitical stress - Ind-Ra

1 Apr 2022 , 02:29 PM

India Ratings and Research (Ind-Ra) believes that the ongoing conflict between Russia and Ukraine may affect the securitization pool performance with a lag and the impact will be varied across asset classes. With the fuel price increases percolating down to retail pumps in March 2022, the agency believes the impact on the economy and households will start playing out in 1HFY23 and such an impact may get deeper if such geopolitical situation continues for a long duration or if the intensity aggravates.

Ind-Ra in its FY23 Structured Finance Outlook report, published in February 2022, had highlighted indicators to watch including interest rates and international fuel prices, among others. Given the current geopolitical tension, these highlighted risks have gained more significance. The direct effects of geopolitical conflict have pushed up the commodity prices, freight and transportation costs higher, affecting the purchasing power of households and profit margins of small businesses.

In terms of indirect effect, the agency expects some segments of small business borrowers to see increased working capital needs, thus affecting their debt serviceability. Inflation, subsequent increases in interest rates along with diminishing savings are expected to impact the financial cushions of individuals and small business borrowers, the rating company says.

Ind-Ra expects stress, if any, in securitized transactions to be visible in terms of lower collections and increased delinquencies in 1QFY23 or later. Consequent rating actions if any would be transaction specific, dependent on the availability of internal and external credit enhancements and counterparty risks. 

Vehicle Loans: Ind-Ra expects an increase in the cost of ownership, due to higher fuel prices and input costs, affecting demand across the auto sector. The agency’s analysis of data pertaining to the FY12-FY14 period indicates that automobile entities’ revenue and EBIT growth remained under pressure when crude oil prices hovered around USD100/barrel previously. Such a situation would have an impact on vehicle borrowers’ unit economics, unless there is a concomitant rise in business realizations.

Increase in the freight prices proved to be the cushion that helped the commercial vehicle industry to protect margins to an extent in FY22. Also, vehicular movement has improved post-pandemic, which has increased the capacity utilization levels. However, a sustained increase in fuel prices, beginning the second half of March 2022, may have a detrimental effect on business margins, thereby marginally increasing pool delinquency in securitization payouts 1QFY23 onwards.

Also, another vector to watch for is the dynamics in semiconductor supply chain, leading to delays in the delivery of new vehicles and associated vehicle price rise. Such a situation can lead to better valuation of used vehicles and control in the supply of logistics capacity that can sustain utilization even in case demand marginally reduces.

Tractor Loans: Ind-Ra has maintained a neutral outlook for tractor loans for FY23. Russia and Ukraine are prominent producers and exporters of agriculture commodities and fertilizer suppliers for the world. Supply chain and production disruptions can elevate prices of both, raw materials and output, for Indian tractor loan borrowers. Government-led direct and indirect subsidies may aid against such risks. Post-pandemic revival in rural economic activity has helped in deploying tractors for non-agri uses as well sustaining loan performance.

Micro Finance Loans: Ind-Ra believes that the sustained high inflation and uncertain business environment are the major risks that can affect the microfinance industry. A rise in generalized inflation would be detrimental for borrowers’ financial condition in case of microbusinesses without pricing power. Also, repeat borrowers, on the face of possibly raising interest rates, may find themselves more indebted in the coming loan cycles.

Small Business Loans and Loan Against Property: Where small businesses are directly or indirectly exposed to geopolitical risks, in the form of first or second order effects, Ind-Ra expects them to witness a higher interest outflow and increased working capital needs. This would be owing to an increase in input costs, especially fuel cost and delay in receipt from debtors. With commodity prices increasing, the agency expects business margins to narrow, affecting the debt repaying capability of businesses with low pricing power.

Gold Loans: With the tag of being a safe asset, gold prices saw upward revisions at the onset of the crisis, before stabilizing at historically high levels. Ind-Ra believes such valuations can bring in additional top-ups and new gold loan portfolio being originated, as was witnessed in FY21. This could expose the industry to the risk of a higher loan to value ratio in case prices fall, and roll overs on the existing loans may happen at higher interest rates.

The geopolitical tension has come at a time when the domestic economy was starting to recover from the worst pandemic in the last couple of decades. Since the onset of the pandemic in FY20, originators have increased their focus on granularization of portfolio and tightened underwriting norms.

Also, the Reserve Bank of India circular of 12 November 2021 stipulates stricter NPA recognition norms and the same has led to lenders tightening their collection infrastructure to reduce roll forwards and, in some cases, enforcing the collateral earlier. Such measures have improved the investor confidence in loan transfers and securitizations, leading to improved deal volumes in 4QFY22.