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Credit and credit quality in jeopardy

The Elara NBFC universe is bracing for turbulence in Q3FY25E – Earnings indicate a subdued outlook, with flat-to-negative sequential growth and a modest 14% YoY rise, down from 30% in Q3FY24. The sector is grappling with elevated credit costs, cautious growth trajectories, stalling NII and an increasingly stringent funding landscape. Optimizing funding costs has become a strategic imperative as the cost of bank borrowings escalates, particularly for A-rated and below players. Layered onto this are relentless regulatory interventions and geography-specific pressures, intensifying the challenges for non-banking financiers. Given the current circumstances, the focus should be on NBFCs with diversified product mix and resilient balance sheets. Selectivity is crucial – Prefer PSU financiers and opportunities with favorable risk-reward dynamics. So, we favor Housing & Urban Development Corporation (HUDCO IN), Power Finance Corporation (POWF IN), Muthoot Finance (MUTH IN), Bajaj Finance (BAF IN) and Shriram Finance (SHFL IN), while CreditAccess Grameen (CREDAG IN) and Mahindra Finance (MMFS IN) warrant caution.

Festival season fails to uplift aggregate growth: Aggregate growth for Elara NBFC universe may be restricted to 17.6% YoY/4% QoQ in Q3E. NBFCs’ credit growth in Q3FY24 was very high at 20% YoY but has since decelerated rapidly. The growth moderation could prolong till FY25-end as NBFCs tackle challenges of funding, balance sheet risks and resultant business remodeling. While housing and gold financiers, given favorable tailwinds, should be better off on credit offtake, microfinanciers (MFI) are likely to lurch. MFI normalization may be expected only in H2FY26 as borrower indebtedness-led challenges may continue to add to MFI woes. Besides, commercial vehicle & consumer financiers are also likely to experience subdued growth, as borrowers continue to face cashflow constraints. Infra financiers may see steady credit demand, but FY25 growth may be soft due to a slowdown in GoI spending, which may pick up in the next fiscal. Given industry-wide challenges, we reckon largely diversified product-led business models (applicable for housing finance industry too) would be able to navigate the rough waters. Outliers for Q3FY25 are HUDCO, Cholamandalam Investment and Finance Company (CIFC IN) and BAF.

Pressing challenges pertaining to net interest margin: As against the popular belief of deceleration, bank borrowings continue to be the dominant source of borrowings for NBFCs, ranging within 37-38% and bond market being steady at ~40% (in Q2FY25). This is despite the fact that bank borrowings have become dearer by 20-50bps in the past three quarters as NBFCs prioritize ALM risk management. Nonetheless, the bond market may turn more attractive in the next few quarters given the expectation of a repo rate cut. This has been straining NBFCs’ pricing power and with calibration in businesses would imply pressing NIM challenges. Expect aggregate NIM in Q3E to drop 2bps QoQ/13bps YoY, with MUTH, Rural Electrification Corporation (RECL IN) and POWF as outliers. Effective liability management, impending debt maturity and liquidity chest may determine the margin trajectory ahead.

Loan loss to max out; outlook gloomy on asset quality front: NBFCs’ asset portfolios are beset by credit quality headwinds, given systemic overleveraging, regional challenges, & heightened regulatory scrutiny. The bulk of NBFC stress is concentrated in retail loans (35% of NBFC credit), with MFIs (representing 3.4% of total loans and 9.6% of retail loans), a key concern. Q3 may peak out in terms of credit cost, but Q4 credit cost outlook is also gloomy, given persistent industry headwinds and conservative provisioning strategies led by increased regulatory oversight. Expect NPAs for Elara NBFC universe to rise by 11bps QoQ/6bps YoY and credit cost at 2.0% to rise by 11bps QoQ/ 56bp YoY. YoY, Q3E may witness ~55bps spike. We closely monitor trends and commentaries. Expect GNPA for HUDCO, RECL and POWF to improve in the space.

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