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Finance companies’ outlook turns sombre

Finance companies’ outlook turns sombre
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First Published: Sun, Jun 26 2011. 09 02 PM IST
Updated: Sun, Jun 26 2011. 09 02 PM IST
After a cushy uptrend for the last two years, fortunes of non-banking financial companies (NBFCs) seem to have hit a roadblock. Rising interest rates to quell galloping inflation will have an adverse impact, simmering demand for loans and, consequently, lowering growth rates.
Most leading NBFCs such as Shriram Transport Finance Co. Ltd (STFCL) and Mahindra and Mahindra Financial Services Ltd (MMFSL), Bajaj Auto Finance Ltd (BAFL) and LIC Housing Finance Ltd (LICHFL) lend to retail consumers by way of auto, home mortgage and other retail loans.
Also See Grim Prospects (PDF)
In the past three years, these firms reflected the robust growth in gross domestic product (GDP). Shares of most firms also mirrored their performance and outperformed the CNX mid-cap index on the National Stock Exchange in the last 18 months. Healthy margins trickled down to deliver a 20% plus compounded growth in earnings and an average 15% return on equity in the last three years.
But the outlook for the next year or so is expected to be grim. The central bank has restricted the universe of lending by NBFCs and curtailed the flow of funds from banks to these firms. Increased interest rates imply higher cost of funds for NBFCs.
Further, banks are now unwilling to buy loan portfolios of NBFCs, which they did earlier to fulfil priority sector lending requirements. This, in turn, would increase assets on the NBFCs balance sheets, adding stress on margins as the cost of funds rises. Besides, hiccups in volume growth are almost certain. STFCL’s performance, which hinges to a large extent on commercial vehicle (CV) loans, will moderate as higher fuel prices, interest rates and economic slowdown will see such sales growth nearly halve from last 24-month levels. A Macquarie Research report says, “There is a 80% relationship between CV and auto sales and STFCL and MMFSL.”
Likewise, firms which lend to housing sector such as LICHFL may continue to see growth in income. But the net interest margins are likely to compress. Also, stiff competition in the home loan space has led to some NBFCs lowering rates to capture market share. In other words, demand slowdown and lower margins along with higher provisioning towards defaults will see earnings growth soften for the next 12 to 24 months. No doubt, the sector has become more efficient in the recent past, which will see few NBFCs coming to naught—a fear that besieged the sector about a decade ago.
But earnings downgrades for the medium term will drag valuations and stock prices down, as has been seen in the last three months.
Graphic by Yogesh Kumar/Mint
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First Published: Sun, Jun 26 2011. 09 02 PM IST