While CRISIL had flagged these risks in November 2016, the rise in delinquencies (measured by 90 days' past due, or dpd) has been sharper and sooner than expected, affecting non-banks (including non-banking finance companies, or NBFCs, and housing finance companies, or HFCs).
The LAP segment has been growing at break-neck speed, with assets under management (AUM) rising 17% to Rs 1.7 lakh crore in fiscal 2017 from Rs 1.5 lakh crore in 2016, which, in turn, was a 29% growth over 2015. Banks then joined the fray because of continuing sluggish demand for corporate credit.
But this rising trend in AUM is set to reverse with risks manifesting and delinquencies rising. CRISIL foresees a 200-400 basis points (bps) decline in AUM growth to 13-15% by fiscal 2020, as competition from banks intensifies and ticket sizes of loans shrink.
And intensifying competition has meant 'seasoning' of LAP loans - which is important to asset quality - has been low, with aggressive intermediaries spurring balance transfers in approximately 7 out of 10 loans. While the typical contracted tenure of a LAP product is 7-10 years, majority of customers have been shifting out in 36-42 months.
To get a handle on asset quality when adjusting for rapid growth and low seasoning, CRISIL considers delinquencies on a two-year lagged basis. By this yardstick, delinquencies are expected to rise even more, to 4.5%, this fiscal, or 370 bps higher than what's expected in home loans.
Interestingly, the rise in delinquencies last fiscal was not uniform, said Krishnan Sitaraman, Senior Director, CRISIL Ratings. While large HFCs and a few NBFCs with robust diligence ecosystems managed their portfolios well, some others have reported over 100 bps increase. We believe systemic delinquencies will rise further as LAP portfolios season.
Intense competition has also culled yields by 200 bps in the past 18 months, materially narrowing the spreads between LAP and home loan rates. But profitability is unlikely to decline by much because borrowings costs have fallen, too. As a result, CRISIL estimates net interest margins (NIMs) to slip 50-70 bps to 3.5-4% this fiscal.
To be sure, credit costs will tick up as delinquencies rise, but they will remain manageable. That, coupled with income from prepayment charges of 2-4%, is expected to result in return on assets of 1.4-1.8% this fiscal, compared with 2-2.5% in fiscal 2016.
Given the pressure on yields, ability to manage operating and credit costs will determine business sustainability over the medium term. So non-banks with a large customer base - and therefore, cross-selling opportunities - could benefit from lower cost of customer acquisition and access to credit history.
One LAP segment where yields and profitability have sustained so far is loans below Rs 25 lakh, because of fewer lenders, said Subha Sri Narayanan, Associate Director, CRISIL Ratings. However, small-ticket loans are not an easy business to master. Higher risks to cash flows of borrowers, collateral quality issues, and high operational intensity make rapid scale-up difficult in the segment.
Lenders that prudently assess borrower cash flows, control loan-to-value ratios, practice strict valuation discipline, and keep a hawk's eye on portfolios will be able to sustain a profitable business over the longer term. In this business, cash flows are the key driver of repayment trends, and collaterals offer only a fall-back option.
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