Updated March 26th, 2024 at 16:15 IST

Challenges mount for NBFCs as spreads widen, threatening net interest margins

The brokerage said that bond spreads have expanded by 11 basis points to 78 basis points over the last three months for non-AAA/non-corporate backed NBFCs.

Reported by: Abhishek Vasudev
Representative image for NBFC | Image:PTI
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NBFC sector outlook: In a turbulent time for non-banking finance companies (NBFCs), concerns loom large over the widening spreads for non-AAA/non-corporate backed entities. The phenomenon, coupled with a projected growth moderation and delayed rate-cut-driven margin tailwinds, paints a challenging picture for the sector, IIFL Securities said in a report.

The Mumbai-based brokerage said that bond spreads have expanded by 11 basis points to 78 basis points over the last three months for non-AAA/non-corporate backed NBFCs. The surge surpasses the long-term average, even eclipsing levels observed during financial upheavals such as the taper tantrum and the IL&FS crisis.

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The growth trajectory for NBFCs is set to witness a moderation, attributed to various factors including a slowdown in unsecured loans, stricter compliance requirements, and the imperative to lessen reliance on bank borrowings.

Furthermore, the delay in expected rate cuts by the Reserve Bank of India (RBI) adds to the sector's woes. With inflation estimates suggesting a headline consumer price index (CPI) of 4.5 per cent in FY25, the rate cuts are now expected to be backloaded towards the end of the fiscal year. This delay prolongs the impact on quarterly cost of funds (COF), with a projected increase before a subsequent decline by FY26.

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The outlook for net interest margins (NIMs) appears divergent, with fixed-rate NBFCs expected to see varying outcomes. While some may witness compression, others are projected to see expansion or remain relatively stable, reflecting the complexities within the sector.

In response to these challenges, analysts at IIFL Finance recommend a selective approach, favouring larger NBFCs with robust credit ratings, diversified funding profiles, and strong parentage. Institutions like Cholamandalam Investment and Finance Company (CIFC) and Bajaj Finance stand out, with growth forecasts still outpacing system credit growth. Additionally, Shriram Housing Finance and Five Star garner attention among smaller players, with an upgrade for Mahindra & Mahindra Financial Services following an underperformance.

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Amid these headwinds, attention is also drawn to the importance of focusing on liabilities. The recent spread widening underscores the necessity for NBFCs to fortify their liability franchises, emphasising the resilience of their funding structures in navigating volatile market conditions, IIFL Finance added.

 

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Published March 26th, 2024 at 16:12 IST