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Muted disbursements; PAT beat despite elevated credit costs

* Cholamandalam Inv & Fin (CIFC) reported 1QFY22 PAT of INR3.3b (11% beat), up 34% QoQ / down 24% YoY. This was on account of strong control over opex (12% below our estimates), despite elevated credit costs (up 10% QoQ to INR5.5b; annualized: 3.2%). NIM on AUM (calculated) stood at 7.4%, up 20bp QoQ.

* The PAT beat, however, belies the poor on-the-ground demand in 1QFY22 and gives credence to CIFC’s conservative underwriting. Disbursements were muted (down 55% QoQ / flat YoY) across both Vehicle Finance (VF) and LAP. We believe the blip in disbursements in 1QFY22 is only transitory and could be a function of the widespread lockdowns and CIFC’s core customer segment’s inability to make a purchase decision. Given the strong demand improvement since the relaxation of the lockdowns and improvement in business activity, we expect a strong pickup in disbursements from 2QFY22.

* Apart from mobility restrictions, part of the asset quality deterioration in 1QFY22 could be the result of its ‘earn and pay’ CV customer’s inability to earn in Apr/May’21 and to make repayments – leading to forward flows into Stage2/3. Collection efficiencies improved MoM in Jul’21; we should see a gradual improvement in asset quality over the remainder of FY22.  CIFC weathered the pandemic well in FY21. Despite high credit costs in 1QFY22, we expect normalization over the next two quarters – once the lockdowns are relaxed further and activity resumes at full normalcy. We model an AUM CAGR of 10% over FY21–24E, with RoA/RoE of ~2.3%/17%. The stock trades at 3.0x FY23E P/BV. We have high conviction in its ability to deliver strong disbursement growth and relatively superior risk-adjusted asset quality, with benign credit costs. We maintain a BUY rating, with unchanged TP of INR650/share (4.0x FY23E P/BV).

Disbursements impacted by slower activity; AUM down 3% QoQ

* Disbursements stood at INR36.4b, down 55% QoQ, due to muted business volumes across product segments. ECLGS disbursements during the quarter were insignificant (

* The quarterly repayment rate declined to 8.3% (non-annualized) from its usual run-rate of 9.5–10%. This marginally mitigated the muted disbursements and led to AUM decline of 3% QoQ (up 7% YoY) to INR678b.

* Within VF, while the AUM mix was largely stable QoQ, CIFC witnessed reduced traction in Used CV / Refinance.

Spreads improve 20bp QoQ and remain healthy; opex controlled

* Yield on loans improved 10bp QoQ to 15.2% despite the excess liquidity on the B/S increasing on a sequential basis.

* CIFC continues to benefit from a declining interest rate environment. Over the past year, cost of funds (CoF) has fallen 100bp to 7.0%. Going forward, there is limited scope for a significant reduction in CoF, in our view.

* As a result, spreads improved 20bp QoQ / 120bp YoY to 8.2% in 1QFY22.

* Total opex was down ~28% QoQ / up 7% YoY to INR3.7b on account of strong control over other operating expenses (up 18% YoY / down 12% QoQ).

Asset quality shows signs of stress buildup; CIFC upfronts provisions

* GS2 + GS3 deteriorated 10.7% QoQ. Restructuring under RBI OTR 2.0 stood at INR26.8b (~4% of EAD). The asset classification benefit extended by the RBI under “OTR 2.0” was used to the extent of 3.86%, and the remainder was classified under Stage 3. The total restructured advances outstanding stood at ~5.4% of EAD and has been prudently classified under Stage 2. (For further details on the restructuring, see Exhibit 1.)

* CIFC released INR4b in management overlay provisions in 1QFY22 – primarily Stage 1 COVID provisions, where customers continued to be in Stage 1 on a sequential basis. The company utilized this towards higher provisions (as per regular norms) on customers moving from Stage 1/2 to Stage 3.

Key highlights from management commentary

* Disbursements in Jul'21 were higher (relative to Jul'19) across Vehicle Finance (VF), Loans Against Property (LAP), and Housing Finance (HF).

* Management guided that it will endeavor to deliver better asset quality (lower GS3) in Mar'22 vis-à-vis Mar'21.  Within Stage 2, 80–85% of customers are paying their current-month dues. Within Stage 3, ~80% customers are paying their current-month dues, with some repossession seen as well. Customers who are not paying have committed to start paying from next month.

Valuation and view

* We expect strong recovery in disbursements from 2QFY22. Also, we expect asset quality to show gradual recovery – given the pickup in business activity and improvement in collections in the second half of Jun’21 as well as in Jul’21. Recovery in asset quality may be quicker if states such as Kerala, West Bengal, and Odisha (which are still reeling under relatively stringent lockdowns) start showing an improvement in business activity.

* Over the past year, CIFC has weathered the pandemic well. Its collection efforts have resulted in relatively better asset quality, without any large write-offs. While we expect a strong rebound in disbursements over the remainder of FY22, AUM growth is likely to be in the single digits in FY22E, followed by a pickup to 13–15% over FY23–24E.

* Its strong asset quality has been CIFC’s hallmark. It has delivered benign credit costs (sub-100bp) v/s peers such as SHTF and MMFS (200bp+). To factor in the impact of the second COVID wave, we estimate FY22E credit costs to remain elevated at 2.0% and expect normalization to 1.1% levels over FY23–24E.

* Our higher credit cost estimate in FY22E was mitigated by an expected improvement in NII and other fee income, leading to only a minor change to our estimates. We expect the company to deliver healthy RoE of 17–20% over the next two years. The stock trades at 3.0x FY23E P/BV. We maintain our Buy rating on the stock, with TP of INR650/share (4x FY23E BVPS).

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