Moratorium extension: Impact on Banking & NBFC Sector

Moratorium extension by RBI does provide relief to the borrowers but is negative for financiers who are already staring at high NPAs. It is severely negative for low duration products like micro finance, credit card, commercial vehicle loans etc. This moratorium is like a double whammy for the financiers as it increases the overdue amount, depletes the asset value. This along with borrowers’ falling income generating opportunity could be a perfect combination for loan default.

RBI extended the moratorium on term loan instalment by another 3 months i.e. from 1st June 2020 to 31st August 2020 (total moratorium period is 6 months). Banking and financial services stocks which have seen deep cut in last 2-3 months on rising NPA risk arising from Covid-19 disruptions, were further pulled down, as investors are becoming jittery on the borrowers’ uncertain behavior once moratorium period ends.

Moratorium extension does provide relief to home & auto buyers, real estate sector and small corporate facing working capital issues but is negative for financiers who are already staring at high NPAs.

In our view, moratorium extension is severely negative for low duration products like micro finance, credit card, commercial vehicle loans etc. As per management commentaries during earnings call, moratorium opted by MFI, CV and auto loans has been very high in the range of 70-80% of loans (in value terms)

Moratorium Extension: Double whammy for the lenders:

It is like a double whammy for the financiers – six-months moratorium will increase the financial burden (overdue amount) on borrowers, especially micro finance borrowers where interest rates are very high (22-24% p.a.). On the other hand, this long moratorium period could be enough for the depletion of asset value of some of the asset financing NBFCs. So, the depleting asset value, higher overdue amount and falling income generating opportunity are likely to be a perfect combination for rise in NPAs for these lending institutions.

In terms of segment, MFI is more vulnerable with the moratorium extension, as it could destroy the credit culture and hence -ve for Bandhan bank or Small finance Banks like Ujjivan and Equitas or any other NBFC-MFIs.

 

The next vulnerable segment could be unsecured credit card & personal loans, if the moratorium by value increases. Large private banks like HDFC/ICICI/Axis do have exposure to this unsecured segment but this exposure as a % of overall loan book is small. On the other hand, they also have large exposure to the existing customers having liability relationships like salary account or current account with the bank.

Several of these banks have also indicated that the repayment history within moratorium customers is encouraging and hence we assign low probability of “Loss Given Default” on large part of their exposure to these moratorium customers.

Expect one-deep restructuring for working capital borrowers:

On the other hand, deferment of Interest on Working Capital Facilities for another 3 months and converting the accumulated interest over the deferment period into a FITL (Funded Interest Term Loan) which has to be repaid before the end of current FY (March 31, 2021) is only a stop-gap arrangement and not an effective measure, in our view.

 

This would ease the one-time interest payment criteria set previously, however the burden of interest on FITL would increase the overall financial burden further at a time when business activity would take time to come back of normalcy. Hence the only solution to this could have been a one-time deep restructuring. We might see this announcement in near future.

 

Similarly, RBI has allowed lending institutions for working capital facilities sanctioned in the form of cash credit/overdraft to recalculate the ‘drawing power’ by reducing the margins till the extended period, i.e., August 31, 2020. Banks have been allowed to restore the original margin by end of FY21. Further, lending institutions are permitted to reassess the working capital cycle of a borrowing entity up to FY21, which is likely to provide necessary leeway to the lenders to make an informed assessment about the impact of the pandemic on the entity concerned.

 

Financial sector: Tough operating environment

Banking sector is facing two major issues on its revenue growth – Weak loan growth and margin (NIM) pressure. Loan growth is hovering in the range of 6-7% while NIM is under pressure as falling rate environment is always negative for lending institutions (loan re-pricing happens faster than the liability re-pricing). On the other hand, risk to collections and credit culture has been deteriorating, which could increase the provisioning requirements for the banks.

 

Historically, we have seen that NPAs rise after any kind of regulatory interventions (waivers/moratoriums). Agri waiver of 2008-09 saw agri NPAs rising from 10.5% in FY10 to 18% in FY12. Similarly, PAR 90 (portfolio at risk for 90 days) rose for MFIs after regulatory intervention in 2010 & 2016.

 

There is higher NPA risk on portfolios like MFI, Commercial vehicles, Construction Equipment, Small businesses, credit card/Personal loan etc. As a result, profitability of sector would see a major beating during FY21 and is likely to rebound in FY22/23E. Return ratios are likely to come to healthy levels only in FY23 and as a result we expect stronger players with strong capital adequacy will benefit and gain market share.

 

Many of these names having strong liability franchise and well diversified asset book have already seen deep cut in their share prices – 30-50%, since Feb 2020. Several of these names are not only trading below its 10-years average valuations, but also below the minimum valuations seen during GFC 2008.

 

As we think, these negatives are already in the price, we can accumulate the quality names like HDFC Bank, ICICI Bank, Axis Bank and SBI that are well capitalized and have strong liability franchise which translates into lower cost of funding and trading at relatively cheap valuations.

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