India Equity Research | Banking and Financial Services Sector Update

NBFCs
Business model in question November 26, 2008

NBFCs facing near-term structural challenges

Kunal Shah
In the wake of weakening macro environment and tight funding, non-banking finance +91-22-4040 7579
companies (NBFCs) are currently encountering structural challenges in the form of kunal.shah@edelcap.com
increased refinancing risk, short-term asset-liability mismatch leading to decelerating
growth, margin compression, higher credit costs, and increased capital requirement. Vishal Goyal, CFA
Hence, we believe, their profitability (RoEs) is likely to be under pressure in the +91-22-4040 7540
vishal.goyal@edelcap.com
medium term. We interacted with managements of various NBFCs to understand their
asset-liability profile and growth momentum amidst the recent turbulence.

Refinancing at risk; margins likely to be under pressure

The proportion of borrowings maturing within a year for various NBFCs is estimated to
be in the 10-70% range (with an average at 25-30%) and their reliance on mutual
funds (MF) recently has increased significantly (CRISIL estimates MF borrowings to
have risen to 40-45%). In a tight liquidity scenario, NBFCs are finding it difficult to
refinance their short-term obligations. Down-selling opportunities are also low in an
inactive securitisation market. Though the Reserve Bank of India (RBI) has initiated
several measures to ease liquidity pressure on NBFCs in the short term, we believe,
margins will compress due to refinancing pressure, heightened funding disadvantage
compared to banks, and shift to low yield assets and longer dated liabilities.

Growth likely to moderate as core segments face headwinds

In the past two months, many NBFCs have deliberately put on hold incremental
sanctions as they are utilising inflows to repay their short-term obligations. CRISIL
estimates average decline in disbursements in this period at ~50%. Even if liquidity
eases, we believe, growth will be moderate over the next 12-18 months as core
segments, to which NBFCs primarily lend (viz., CV financing, personal loans,
securities-based lending, and home equity loans), are facing significant headwinds.

Higher risk of delinquencies

Many NBFCs, in the past two-three years, went up the risk curve and ventured into
riskier segments, viz., unsecured loans, used CVs, capital market lending, etc. NBFCs’
origination structure is also tilted towards direct selling agents (~85%) and customer
profile is concentrated on the self employed segment (~75%) which increases their
risk profile. Among retail loans, we believe, mortgages, though safest, may still
witness higher (than past) slippages of more than 1% due to declining property prices
and reduced repayment capacities. Auto and CV loans will carry relatively higher risk,
with NPAs in the 3-4% range. Two wheeler and other unsecured loans may witness
delinquencies upwards of 6%. Overall, slippages may increase by ~2%.

Valuation gap between better-positioned and average players to widen

The current downturn, when compared to the one in mid 1990s, appears similar with
respect to asset-liability mismatch and economic conditions, but is different in terms of
the regulatory framework and credit standards. NBFCs, by virtue of having greater
operating flexibility and ability to specialise in a high growth niche segment, will continue
to offer superior return potential. However, the performance gap between better-
positioned and average players in the sector will widen in the current turbulence.
Companies that build differentiation across: (1) specialisation in stable-to-high growth
and low risk segments; (2) flexibility in product and liability mix; (3) sound risk
management standards; and (4) established origination and recovery capabilities, will
successfully sail through this adverse period and benefit from premium valuations. While
valuation multiple of other players is likely to contract. We, therefore, recommend
investors to consolidate their portfolio in the NBFC space towards companies that qualify
on these parameters, viz., HDFC, LIC Housing Finance, and Power Finance Corp.
Edelweiss Research is also available on Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. Edelweiss Securities Limited

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NBFC

NBFCs facing near term structural challenges

In the wake of weakening macro environment and tight funding environment, the NBFC
sector is encountering serious structural challenges in the form of:

„ Increased risk of refinancing or rollover of their short-term borrowings (particularly

mutual funds) and higher short term asset-liability mismatch.

„ Decelerating disbursement growth - in a tight liquidity scenario, companies are

deliberately utilising incremental inflows to repay their short-term obligations than
growing the asset book. CRISIL estimates average ~50% decline in disbursements by
NBFCs (rated by it) in September and October.

„ Even if liquidity eases, we believe, growth will be moderate over the next 12-18 months
as core segments to which NBFCs primarily lend (viz., CV financing, personal loans,
securities-based lending, and home equity loans), are facing significant headwinds.

„ Over the medium term, NBFCs’ margins are likely to be under pressure due to
refinancing pressure, heightened funding disadvantage compared to banks with RBI
cutting CRR and SLR requirement aggressively, shift to low yield low risk assets
(mortgages, auto financing) and towards longer dated liabilities.

„ General economic slowdown, dip in prices of underlying assets, and higher interest rate
background may stress asset quality of NBFCs. Many players went up the risk curve and
ventured into riskier segments, viz., capital market lending, unsecured loans, home
equity loans, used CV financing, etc. Weakening macro environment and subdued capital
market conditions will increase the risk of delinquencies for NBFCs. However, particularly
for mortgages, declining interest rates will ease some pressure.

Consequently, their profitability (RoEs) is likely to be lower in the medium term from 16-18%
over FY04-08.

We interacted with managements of various NBFCs to understand their asset-liability profile

and momentum in growth in the past two months amidst the current turbulence and steps
initiated by them to face these adversities. In this report, we have tried to highlight:

• Asset-liability profile, particularly, the proportion of short-term borrowings vis-à-vis

assets;

• Why growth for the NBFC sector is likely to moderate in the near term and margins will
be under pressure?

• Outlook on their asset quality;

• How different is the current downturn from that in mid 1990s?

Despite the period of comparative difficulty that NBFCs may undergo over the next 12-18
months, we have also discussed the need for the NBFC business model and the key success
factors in the current environment.

Edelweiss Securities Limited

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 NBFC

Refinancing at risk (MF borrowings); short term asset-liability mismatch

NBFCs have resorted to short-term borrowings to fund assets with relatively longer maturity.
Our recent interactions with managements of various listed NBFCs and broad analysis of their
asset liability structure suggest that the proportion of borrowings maturing within a year is in
the range of 10-70% (with an average at 25-30%). Short-term borrowings are higher than
the industry average for Reliance Capital, Cholamandalam DBS, Mahindra Finance, Shriram
City Union and SREI Infra in the range of 40-70%; while this proportion is low for LIC
Housing and IDFC.

We also analysed asset and liability profile of various NBFCs across maturities to understand
if there is any significant mismatch in the near term. In case of HDFC, PFC, Mahindra Finance,
and LIC Housing Finance, assets and liabilities maturing within one year are matched
effectively. SREI Infra and Shriram City Union has more assets maturing within one year than
liabilities, while Reliance Capital and Cholamandalam DBS has more liabilities maturing within
one year than assets.

Chart 1: Relative proportion of assets and liabilities maturing within a year

High

Chola DBS Rcap

Liabilities

MMFS
SCUF

SREI
HDFC
REC

PFC
LICHF Shriram
Transport

Low
Low High
Assets
Source: Company, Edelweiss research

Besides this, NBFCs’ reliance on mutual funds as a source of funds has increased significantly
in the past two-three years, as finance from them was relatively cheap compared to banks
(due to tax arbitrage), and conducive capital markets supported their growth. According to
CRISIL, the proportion of borrowings through mutual funds by NBFCs (rated by it) has
increased to 40-45% currently, from 30% in FY08. Our interactions with managements of
various listed NBFCs suggest that borrowing through a mutual fund for a majority of them is
less than 20%. In case of Power Finance, Rural Electrification, LIC Housing Finance and
Shriram City Union, proportion of MF borrowings is below 10%, while it is higher for
Cholamandalam DBS, Reliance Capital, and Mahindra Finance (between 35-65%). With debt
funds increasingly facing redemption risk, refinancing of this will be relatively difficult and
NBFCs will have to resort to more expensive funding. Moreover, mutual funds will be more
selective in choosing sectors they would prefer to lend to.

Edelweiss Securities Limited

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NBFC

RBI initiatives to ease liquidity crunch

In the current tight liquidity conditions, NBFCs are finding it increasingly difficult to roll over
or refinance their short-term obligations, thereby adversely impacting their ability to sustain
growth. In the past two months, RBI has initiated several measures to augment liquidity for
NBFCs to enable them to continue lending for productive purposes and also maintain asset
quality:

„ Risk weights on banks’ exposure to non deposit taking systemically important NBFCs
(NBFC-ND-SI) reduced to 100% from 125% earlier, irrespective of their credit rating.
Moreover, exposure to asset financing companies, which attracted higher risk of 150%
based on credit rating, stands reduced to 100%.

„ Standard asset provisioning requirement for banks on advances to NBFCs has been
reduced from 2% to 0.4%.

„ Special term repo facility has been instituted under LAF for banks with associated SLR
exemption of 1.5% of NDTL to ease liquidity stress faced by NBFCs and mutual funds.

„ NBFCs (NBFC-ND-SI) and housing finance companies have been temporarily permitted to
raise short-term foreign currency borrowings under the approval route to the extent of
50% of their net worth.

„ NBFCs have been allowed to issue perpetual debt instruments that can be included in tier
1 capital (up to 15% of the total tier 1 capital).

Edelweiss Securities Limited

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 NBFC

Growth likely to moderate as core segments face headwinds

Though growth momentum was sustained till July 2008, many NBFCs have deliberately put
on hold incremental sanctions/approvals in the past two months. They are utilising inflows
(through borrowings and repayments) to repay their short-term obligations rather than
growing the asset book. CRISIL estimates ~50% decline in disbursements for NBFCs (rated
by it) in September and October. It sees significant decline in personal loans, particularly
small-ticket, as many players are exiting this business. Disbursement in home equity loans is
also slowing down due to longer maturity of these products and anticipation of dip in real
estate prices; while slowdown in CV and car financing is in line with industry-wide
deceleration in demand.

Even if liquidity eases, NBFCs’ growth will moderate further over the next 12-18 months as
the core segments NBFCs primarily lends to are facing significant headwinds:

„ Personal loans: Being a non-collateralised product, the risk of delinquencies is high as

a weakening economy will adversely impact average annual income and unemployment
rate. Consequently, aggressive push, as witnessed in the past, is not expected to
continue and NBFCs will turn cautious and adopt stringent underwriting norms.

„ Auto finance: Dip in demand of underlying asset classes is likely to be a major drag.
Rise in default levels has unnerved the market, prompting some players to curtail their
operations or exit the two-wheeler finance market.

„ Capital market lending: Lack of IPO financing and weakness in capital market activity
will affect margin funding and promoter financing activities.

„ Infrastructure lending is highly levered to economic growth and deceleration in GDP

growth may adversely impact project implementation with a lag effect.

Comments from management of IDFC and Reliance Capital:

IDFC: “…we would be facing significant headwinds that come from increasing macro risk…we
will be focused more on managing our existing assets and will be risk averse about booking
new assets. Our focus would be on increasing our asset yields more than growing our assets
and also on allocating capital to businesses, which, overtime, generate higher RoE. You have
seen a slowdown in our overall balance sheet growth. You have seen a slowdown in the
growth of our loan book, you have seen a decline in our gross disbursements, and you have
seen a decline in our approvals…”

“…We, 6 months ago, decided to slow down the growth of our book. We continue to remain
cautious for exactly the same reasons that we were 6 months ago. In fact if anything there
are reasons to be even more cautious than we were 6 months ago and to that extent, there
is no change in our strategies whatsoever, as we said earlier this is the time to focus on
conserving liquidity, focusing on profitability and not really worrying about asset growth and
that is what we will continue to do for the remainder of this year…”
Source: Q2FY09 earnings call

Reliance Capital: “…Our focus in this business has always been on the quality of credit that
we sourced and not just growth. However, in the light of prevailing market conditions, we
have deliberately further slowed down the growth till September 2008. In fact, from October,
we have put on hold further disbursals and will review resumption as the situation in credit
markets improve…”
Source: Q2FY09 earnings call

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NBFC

Margins likely to be under pressure

Amidst lack of liquidity, currently, demand for credit is huge, and NBFCs are effectively
successful in passing on pressure of increased funding cost to customers and maintaining
spreads. However, over the medium term, we believe NBFCs’ margins will be under pressure
due to the following:

„ Refinancing of short-term borrowings at relatively higher cost in a tight liquidity

scenario—spreads between AAA corporate bonds (one year) and treasury bills (one year)
have shot up 250-300bps to 4-5%.

Chart 2: Spreads between AAA bonds and T-bills widened to 4-5%

6.0 

5.0 

4.0 
(% points)

3.0 

2.0 

1.0 

0.0 
1‐Sep‐06

1‐Sep‐07

1‐Sep‐08
1‐Mar‐06

1‐Jul‐06

1‐Mar‐07

1‐Jul‐07

1‐Mar‐08

1‐Jul‐08
1‐Jan‐06

1‐Nov‐06
1‐Jan‐07

1‐Nov‐07
1‐Jan‐08

1‐Nov‐08
1‐May‐06

1‐May‐07

1‐May‐08
(1.0)

3 months 6 Months 1 year 10 Year

Source: Bloomberg

„ Lower dependence on wholesale funding and rising reliance on retail deposits, the cost of
which is higher than wholesale funding on a steady state basis. Besides, NBFCs will
increasingly shift their borrowing mix in favor of longer dated maturities to match the
duration profile of asset. Over the past four years, the top listed NBFCs (mentioned in
Annexure) have increased their dependence on bonds/debentures/CPs (proportion has
gone up to 53% in FY08 from 42% in FY04), while the proportion of deposits and
borrowings from banks/FIs has declined significantly from 12% to 5% and from 43-45%
to 39%, respectively.

Table 1: Rising dependence on borrowings through bonds/debentures/CPs

Proportion (%) FY04 FY05 FY06 FY07 FY08
Bonds/Debentures/CPs 41.5 42.8 44.8 47.9 52.9
Loans from banks/FIs 43.5 46.9 45.6 43.5 39.1
Working capital/cash credit 2.5 2.0 2.8 2.5 2.7
Deposits 12.5 8.3 6.8 6.1 5.3

Leverage (x) 5.2 5.7 6.3 6.8 6.6

Source: Capitalline, Edelweiss research

„ Funding disadvantage compared to banks will reappear with the RBI cutting CRR and SLR
requirements aggressively; 20-25bps benefit to margins of banks due to recent CRR cut
of 350bps to 5.5% and 100bps SLR cut to 24%.

Edelweiss Securities Limited

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 NBFC

Table 2: Funding disadvantage to NBFCs compared to banks (INR)

Banks Deposit taking
Pre CRR/SLR cut Post CRR/SLR cut NBFCs
Amount of loan 100.0 100.0 100.0
Assumptions
Leverage (x) 13.0 13.0 5.5
CRR rate (%) 9.0 5.5 -
SLR rate (%) 25.0 24.0 15.0
Equity contribution 7.7 7.7 18.2
Deposits/borrowings required 92.3 92.3 81.8
Amount raised for maintaining SLR 33.9 31.2 15.1
Amount raised for maintaining CRR 9.5 6.2 -
Total deposits/borrowings 135.7 129.7 97.0
Incremental cost of deposits/borrowings (%) 7.2 7.2 9.5
Yield on retail loan (%) 12.0 12.0 12.0
Yield on SLR (%) 8.0 8.0 8.0
Yield on CRR (%) - - -
Interest earned on loan 12.0 12.0 12.0
Interest on SLR 2.7 2.5 1.2
Interest on CRR - - -
Interest expenses 9.8 9.3 9.2
Net interest income 4.9 5.2 4.0
Net interest margins 3.4 3.7 3.5
Source: Edelweiss research
Note: Difference in operating expenses and credit costs may further increase variance in RoAs of banks and NBFCs

„ Shift from high yield, high risk products (STPL loans, capital market financing, two-
wheeler financing) to low yield, low risk products (mortgages, auto financing).

Chart 3: Interest yield on various asset classes

Small ticket PL
Used CV
Big ticket PL
2-wheeler
IPO financing
Margin funding
New CV
New car
Mortgage

0 10 20 30 40 50
(%)
Interest yield
Source: CRISIL estimates, Edelweiss research

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NBFC

Higher risk of delinquencies

Many NBFCs have built significant scale in the past two-three years and during this period
many players went up the risk curve and ventured into riskier segments. During weakening
macro environment and subdued capital market conditions, this increases the risk of
delinquencies for NBFCs. Mortgages, though safest among retail loans, may still witness
higher-than-past slippages of more than 1% due to declining property prices and reduced
repayment capacities. The risk will be relatively higher in auto and CV loans, with NPAs in the
3-4% range. Two wheeler and other unsecured loans may also witness delinquencies
upwards of 6%. Overall, slippages may increase by ~2%.

The target customer profile of NBFCs is also distinct when compared to banks. Since NBFCs
charge higher interest rates compared to banks and do not have access to a readymade customer
base (including corporate salary accounts) to cross sell retail finance products, they concentrate
more on the self employed segment. Self employed professionals and non-professionals constitute
~75% of their customer base, while the salaried class accounts for the balance.

Chart 4: NBFCs Banks

Salaried
class
24%
Self
employed
non-
Self profession
employed Salaried
40%
profession class
5% 50%

Self
employed
non-
Self
profession
employed
71%
profession
10%

Source: CRISIL estimates

Moreover, the origination structure for NBFCs is tilted towards direct selling agents (DSA)
compared with the direct selling team (DST) in case of banks. While the proportion of
business done by DSAs is ~85% for NBFCs, it is around 40% for banks.

Chart 5: NBFCs Banks

Direct
selling
team
15%
Direct
selling
agents
40%

Direct
selling
team
60%
Direct
selling
agents
85%

Source: CRISIL estimates

Edelweiss Securities Limited

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How different is current downturn from that in mid 1990s?

The current downturn, when compared to the one in mid 1990s, appears similar with respect
to asset-liability mismatch and economic conditions, but is different in terms of regulatory
framework and credit standards. In the 1990s, while the banking sector was highly regulated,
there were practically no entry norms for NBFCs (required to be registered only under the
Companies Act). In addition, low cost of operations and simplified sanction procedures with
flexibility and timeliness in meeting niche credit needs (in products and customer segment
unserved by banks) boosted growth of NBFCs. Their number increased to well over 40,000 by
1996. They were able to build dominant positions in segments like vehicle financing,
unsecured personal loans, among others, and had set up large countrywide distribution
networks on the back of buoyant economic conditions. However, their business model was
built by targeting short-term deposits/borrowings, while assets were lent for the long term,
thereby creating an asset-liability mismatch. Moreover, many of them lacked credit appraisal,
monitoring, and recovery skills.

Sensing the risk profile of these NBFCs and the need to protect and comfort depositors, the
RBI Act was amended in 1997. The new regulation required compulsory registration of all
existing and newly incorporated NBFCs with the central bank, it prescribed certain minimum
capital requirement as a basic entry norm, and tightened income and NPA recognition norms.

When economic recession and liquidity crunch triggered in the late 1990s, CRISIL
downgraded 149 NBFCs (FY98-99) in anticipation of their deteriorating business and credit
fundamentals. The risk profile of several NBFCs heightened due to:

„ Slow industrial growth and difficult business environment.

„ Lending turning bad in worsening economic conditions.
„ Small balance sheet size and low asset profile.
„ Asset-liability mismatch and inability to recapitalise themselves.
„ Regulatory changes related to limitation on deposit acceptance, NPA provisioning, and
default by certain large NBFCs.

This affected the solvency of NBFCs, with many companies defaulting their depositors, and
resulted in large number of weak companies exiting the market.

However, since FY01-02, business models of existing NBFCs improved significantly.

Companies have been able to expand their resource profile by diversifying their funding
avenues. Further, a strict control on credit standards and overheads, coupled with use of
innovative borrowing tools such as securitization, has resulted in improved profitability.

Chart 6: Asset quality improving since FY01

15.0

12.0

9.0
(%)

6.0

3.0

0.0
FY98 FY01 FY02 FY03 FY04 FY05 FY06 FY07
Gross NPAs Net NPAs
Source: RBI

Edelweiss Securities Limited

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NBFC

The current regulatory framework for NBFCs is relatively strong compared to the 1990s in
terms of higher capital adequacy requirement and more disclosure norms. Moreover, credit
appraisal and recovery mechanisms have improved significantly in the past few years.
However, NBFCs, even today, run the risk of asset liability-mismatch as they are highly
dependent on short-term borrowings (particularly from mutual funds) and prone to systemic
deterioration in asset quality.

NBFC business model has superior return potential over long term

The following 12-18 months are going to be a period of comparative difficulty for NBFCs as
the concerns begin to unfold. However, over the longer term, their business model will
continue to be relevant to the Indian financial system and will complement banks due to the
following unique advantages:

„ NBFCs have created a niche for themselves by being more specialised, nimble, and high
on service quality compared to banks.

„ They have better operating flexibility in terms of business segments and geographies,
unlike banks. The latter are subject to directed lending with respect to priority sector
lending and exposure cap on segments like commercial real estate and capital market
lending (which are perceived to be risky).

„ NBFCs have built strong origination capabilities with experience and better understanding
of regional dynamics and customer needs.

„ Allows flexibility in capital infusion - there is no cap on ownership limit for NBFCs and
even 100% foreign shareholding is allowed subject to minimum capitalisation
requirement under FDI norms. However, in case of banks, an entity cannot own more
than 10% without RBI approval and foreign holding is capped at 74% for private banks
and 20% for state owned banks.

Considering the above competitive advantage, we believe, NBFCs will continue to offer
superior returns and will remain relevant in the Indian financial services space.

Players able to face current turbulence will emerge winners

In the current environment, we believe, the performance gap between the better-positioned
and average players in the sector will widen. NBFCs, according to us, can build differentiation
on the following parameters:

• Product segment: NBFCs specialising in asset classes where growth momentum is

expected to continue and are in a relatively safer risk spectrum like residential
mortgages (HDFC and LIC Housing) and infra financing (PFC, IDFC, and REC) will fare
better compared to those operating in segments where anticipated dip in demand for
underlying asset class and risk of defaults may drag down growth and profitability
(MMFS, Shriram Transport, Magma Shrachi etc).

• Going up the risk curve: Many NBFCs have gone up the risk curve and diversified
their product portfolios into riskier asset classes (unsecured loan, capital market
lending, commercial real estate etc) to benefit from the credit boom. We believe,
weakening macro environment may increase the risk of delinquencies in this portfolio.
Moreover, NBFCs that have built this loan book probably in the past two-three years
will have more stress. NBFCs which have avoided venturing into riskier asset class will
tend to benefit.

• Episodic lending: Buoyant economic growth and conducive capital markets opened
up credit opportunities for short-term episodic lending. NBFCs had also increased their
focus on lending to certain segments like IPO financing, promoter funding, etc., which
though incidental, provided strong boost to their asset growth and profitability. These
opportunities have almost dried up in the present environment and may affect growth
prospects of NBFCs focused on this segment (NBFCs floated by brokers).

Edelweiss Securities Limited

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 NBFC

• Underwriting standards and recovery capabilities: Players with robust risk

management systems, prudent underwriting standards, established origination skills,
and strict credit appraisal/recovery capabilities will stand out in the current
environment (HDFC and Shriram Transport have strong historical track record on these
parameters).

• Renewed focus on product and channel innovation.

• Flexibility in product and liability mix: Shift from short-term funding to longer
dated loans/bonds and ability to increasingly tap more retail deposits, switch from high
yield, high risk assets to low yielding segments.

Companies that build differentiation across the above parameters will successfully sail
through this adverse period and benefit from premium valuations. While valuation multiple of
other players is likely to contract. We, therefore, recommend investors to consolidate their
portfolio in the NBFC space in favour of companies that qualify on the above parameters viz.,
HDFC, LIC Housing Finance, and PFC.

Chart 7: Price to book vis-à-vis RoEs of various NBFCs

30.0
STFC

25.0 HDFC (adj for

subs)
RoEs FY09(%)

LICHF
20.0
REC PFC SCUF
15.0 Dewan Gruh Fin
MMFS
IBFSL IDFC
10.0 Magma
Sundaram
SREI Finance
5.0

0.0
0.0 0.5 1.0 1.5 2.0 2.5
PB - FY09 (x)
Source: Edelweiss research

Edelweiss Securities Limited

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NBFC

Valuation metrics
Company name Price Mkt Cap P/B P/E RoEs Gross NPA Net NPA CAR Rating

(INR) (INR bn) (x) (x) (%) (%) (%) (%)

FY08 FY09E FY08 FY09E FY09E FY08 FY08 FY08

HDFC 1,351 384.1 3.2 2.7 15.7 15.0 19.4 0.7 - 16.8 Buy

Edelweiss Securities Limited

HDFC (adj for invt in associate/subs) 2.4 1.9 11.7 9.3 24.9 0.7 - 16.8 Buy

Power Finance Corp 106 121.9 1.2 1.1 10.0 8.4 16.0 0.0 0.0 17.2 Accumulate

IDFC 51 66.1 1.2 1.0 8.9 7.3 15.3 0.2 - 22.2 Accumulate

Rural Electrification Corp 57 48.6 0.8 0.7 5.6 4.3 18.6 0.9 0.6 14.0 Not rated

Shriram Transport Finance* 200 40.6 2.2 1.8 10.1 6.9 28.4 1.6 0.9 12.7 Not rated

Indiabulls Financial Services* 95 24.2 0.7 0.7 4.3 3.8 16.2 0.7 - 32.0 Not rated

Mahindra Finance* 190 18.4 1.4 1.3 10.2 10.1 15.1 7.6 2.9 20.7 Not rated

LIC Housing Finance 172 14.6 0.8 0.7 3.8 3.1 23.7 1.7 0.6 13.5 Buy

Shriram City Union Finance 343 15.7 3.3 2.1 15.8 14.8 19.7 1.5 0.9 20.0 Reduce

Sundaram Finance# 176 9.8 0.9 0.9 3.9 7.0 11.5 1.2 0.5 14.2 Not rated

SREI Infrastructure Finance 44 5.1 0.8 0.4 4.4 5.5 10.2 1.2 0.2 12.3 Buy

Magma Shrachi# 182 3.6 1.5 1.4 9.9 9.7 12.3 - - 15.3 Not rated

Dewan Housing# 66 3.7 0.9 0.8 4.5 4.8 17.1 0.7 0.6 16.7 Not rated

Gruh Finance# 91 4.0 1.7 1.5 7.4 9.9 15.5 1.1 - 18.2 Not rated

Bajaj Auto Finance# 76 2.8 0.3 0.3 13.4 18.3 1.4 7.8 5.6 40.7 Not rated

Cholamandalam DBS# 30 1.6 0.3 0.3 3.0 loss - 0.7 0.2 12.4 Not rated

* consensus estimates for FY09E

# earnings of H1FY09 annualised for FY09E, BV for H1FY09

 NBFC

NBFC business model has strengthened over the years

Buoyant economic growth, retail credit boom, and continued demand for wholesale funding
provided strong tailwinds for the NBFC sector. Over the past few years, NBFCs’ business
model has strengthened considerably on the back of a niche created by them (with respect to
products and geographies they cater to) and access to varied funding sources (borrowings
from mutual funds and resort to securitisation).

Most players are primarily active in the retail finance space, while there are a few specialised
financiers (viz., IDFC, SREI Infra, PFC, REC, etc.) that focus on wholesale lending, including
project and equipment financing. The retail finance market was estimated (by CRISIL) at
INR 2.7 tn in FY08, with housing finance being the largest segment at ~INR 1 tn (35% of
retail finance market), auto finance (excluding CVs) at INR 640 bn (24%), CV financing (used
and new) at INR 630 bn (23%), and personal loans at INR 450 bn (of which small ticket
would be ~10%).

Chart 8: Retail financing—Market size of INR 2.7 tn in FY08

1,250 60.0

1,000 48.0
(INR bn)

750 36.0

(%)
500 24.0

250 12.0

0 0.0

Small tkt PL
Mortgage

Used car

Big tkt PL
Old CV
New car

New CV
New UV

2-wheeler

Disbursements (FY08) NBFCs market share

Source: CRISIL estimates

Aggressive lending by banks in retail since 2001 has diluted the supremacy of NBFCs in
various segments and the latter’s market share has declined significantly in housing finance,
CV, and car financing. However, deliberate attempts by banks to stay away from some asset
class (viz., housing finance, two wheelers, small ticket personal loans, etc.) and regulatory
constraints on banks’ exposure to commercial real estate and capital market activity, has
helped NBFCs gain lost ground in the past 12-18 months.

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NBFC

Chart 9: Market share of NBFCs has declined with entry of banks

90

80

70

60

50

(%)
40

30

20

10

-
New car New CV Mortgage
FY02 FY08
Source: CRISIL estimates

Top listed NBFCs (mentioned in Annexure), on a consolidated basis, disbursed INR 1.25 tn
loans during FY08 (30% growth over FY07), thereby creating a loan book of ~INR 2.6 tn by
FY08 end. While mortgages and infrastructure financing maintained growth of 25-30%,
growth in CVs and personal loans was much higher than the industry average. The strong
disbursements momentum continued in H1FY09 as well, recording 20% plus growth for major
NBFCs.

Chart 10: Top 15 listed NBFCs disbursed INR 1.25 tn in FY08

625

500

375
(INR bn)

250

125

-
Infra Mortgage CV Car/UV / Personal Consumer
2-wheeler loans durable
FY07 FY08
Source: Company, Edelweiss research

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These top listed NBFCs, on a consolidated basis, reported 29% CAGR (over FY04-08) in
revenues (net of interest expense) to INR 136 bn in FY08 and 20% growth in profits to INR
65 bn. RoEs have been maintained in the 16-18% range over FY04-08, mainly due to
increase in leverage from 5.7x in FY04 to 6.6x in FY08.

Chart 11: PAT grew at 20% CAGR; RoEs maintained between 16% and 18%
150 4.8
20.0 7.2

120 4.5
16.0 6.8

(INR bn)
90 4.3
12.0 6.3

(%)
(%)

(%)
60 4.0
8.0 5.9

30 3.8
4.0 5.4

0 3.5
- 5.0
FY05 FY06 FY07 FY08
FY05 FY06 FY07 FY08
RoEs (LHS) RoAs (LHS) Leverage (RHS) Revenues (LHS) PAT (LHS) NIMs (RHS)

Source: Company, Edelweiss research

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Annexure

Listed NBFCs discussed in the report

HDFC
Power Finance Corp
IDFC
Rural Electrification Corp
Shriram Transport Finance
Mahindra Finance
LIC Housing Finance
Shriram City Union Finance
Sundaram Finance
SREI Infrastructure Finance
Magma Shrachi
Dewan Housing
Gruh Finance
Bajaj Auto Finance
Cholamandalam DBS

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 NBFC

Edelweiss Securities Limited, 14th Floor, Express Towers, Nariman Point, Mumbai – 400 021,
Board: (91-22) 2286 4400, Email: research@edelcap.com

Naresh Kothari Co-Head Institutional Equities naresh.kothari@edelcap.com +91 22 2286 4246

Vikas Khemani Co-Head Institutional Equities vikas.khemani@edelcap.com +91 22 2286 4206

Shriram Iyer Head Research shriram.iyer@edelcap.com +91 22 2286 4256

Coverage group(s) of stocks by primary analyst(s): Banking and Financial Services:

Allahabad Bank, Axis Bank, Federal Bank, Future Capital Holdings, HDFC Bank, ICICI Bank, IOB, ING Vysya Bank, Karnataka Bank, Kotak
Mahindra Bank, OBC, SBI, Yes Bank, IDFC, HDFC, LIC Housing Finance, PNB, Power Finance Corporation, Reliance Capital, SREI
Infrastructure Finance, Shriram City Union, Syndicate Bank and Union Bank.

Recent Research

Date Company Title Price (INR) Recos

25-Nov-08 Axis Bank Asset quality 377 Buy

concerns overdone;
Visit Note
06-Nov-08 Kotak Mah. Tough times ahead; 430 Reduce
Bank Result Update
03-Nov-08 Shriram Valuation premium 342 Reduce
City Union at risk; Result Update
Finance
3-Nov-08 SREI Infra Disbursements strong; 51 Buy
Finance MTM forex loss hits earnings;
Result Update

Distribution of Ratings / Market Cap Rating Interpretation

Edelweiss Research Coverage Universe Rating Expected to

Buy Accumulate Reduce Sell Total Buy appreciate more than 20% over a 12-month period

Rating Distribution* 82 56 29 8 178

Accumulate appreciate up to 20% over a 12-month period
* 2 stocks under review / 1 rating withheld
Reduce depreciate up to 10% over a 12-month period
> 50bn Between 10bn and 50 bn < 10bn

Market Cap (INR) 67 54 57 Sell depreciate more than 10% over a 12-month period

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