Non-banking financial companies (NBFCs) have started realigning portfolio strategies for better risk-adjusted returns, with focus on unsecured loans and micro, small and medium enterprise (MSME) finance, anticipating a surge in their cost of funds amid rising interest rates and reduced competitiveness in traditional segments such as home and new vehicle loans due to intensifying competition from banks.
Used vehicle loans, though, would continue to be a key business segment for NBFCs given the higher yields in this space and because it is not a focus area for banks.
In the past few years, NBFCs have navigated multiple challenges, exacerbated by the Covid-19 pandemic.
Now, stronger balance sheets with higher provisioning and lower leverage, receding asset-quality concerns, and steadily normalising funding access provide NBFCs a strong foundation to boost growth as credit demand piggybacks the ongoing economic rebound.
The portfolio realignment is visible already.
As a percentage of overall disbursements for NBFCs, in the first half of this fiscal, the share of unsecured loans increased to ~35% from ~ 31% last fiscal and ~24% in the previous one. Disbursement of unsecured loans had doubled on-year last fiscal and rose almost 50% in the first half of this fiscal.
From an assets under management (AUM) perspective, unsecured loans are seen growing 20-25% this fiscal — higher than in the past two fiscals — to near the pre-pandemic level. The relatively lower growth in AUM for unsecured loans vis-à-vis disbursements is because these are shorter tenure loans and run off quicker from the balance sheet as compared to home loans or vehicle loans.
Disbursements in MSME finance have also increased substantially, surging ~55% on-year last fiscal and maintaining momentum in the first half of this fiscal, following a slowdown in the past 3-4 years. In fact, disbursements had declined on-year in fiscal 2021 on account of the pandemic induced slowdown.
In short, therefore, AUM uptick in these segments will drive growth for NBFCs going forward.
As large NBFCs turn towards non-traditional segments to enhance yields, we may also see more partnerships, such as co-lending with emerging NBFCs focusing on specific asset classes, especially unsecured loans. This allows the large NBFCs to expand to newer domains in a more cost-efficient manner while reducing time-to-market; for emerging ones, it supports capital-efficient AUM growth.
This doesn’t imply the traditional segments will not grow.
In home loans, which is the biggest segment, making up 40-45% of the NBFC AUM, structural factors driving end-user housing demand are intact despite the impact of rising real estate prices and interest rates. That should drive 13-15% growth in the segment next fiscal.
That said, banks are quite competitive in home loans and HFCs could keep losing market share to banks amid intense competition on interest rates, especially in the urban and the formal salaried segments. As such, banking sector growth is expected to be buoyant going forward, with the share of retail in the advances expected to rise.
Rising rates will also lift the borrowing cost of NBFCs and lower their competitiveness versus banks, which have access to lower-cost funds. NBFCs are expected to maintain their hold in the self-employed professionals and affordable housing segments, though.
Vehicle finance, the second-largest segment (20-25% of NBFC AUM), will grow 13-14% next fiscal compared with an estimated ~12% this fiscal, on the back of solid underlying-asset sales. Strong pent-up demand and new launches will continue to drive car and utility vehicle sales. The ongoing rebound in economic activity, demand for fleet replacement, and focus on last-mile connectivity will support commercial vehicle sales.
In the new-vehicle finance segment, especially cars, interest-rate sensitivity of borrowers is high, so competition from banks remains tough given their ability to offer finer pricing. Consequently, NBFCs will likely capitalise on their core strengths of last-mile connectivity, customer relationships, and innovativeness and strong understanding of micro markets to sharpen focus on used-vehicle financing, which offers higher yields and better profitability from a risk-adjusted returns perspective.
While all segments will witness a strong rebound, real estate finance may continue to be catered via the Alternate Investment Fund route. Some NBFCs may look at a calibrated re-alignment of exposure to construction finance for large developers, lease rental discounting loans, and last-mile financing as these carry relatively lesser risk and potential for higher returns.
To sum up, NBFCs are well placed today to capitalise on the opportunities ahead. The nimbleness of the sector should allow for a quick recalibration of portfolio strategies and ensure sustained growth, though higher-than-expected inflation and interest rates remain key monitorables.
(The author is senior director & deputy chief ratings officer at CRISIL Ratings)
