NBFC’s RoE to improve, cost of borrowing to fall: Capital First
In an interview on CNBC-TV18, V Vaidyanathan of Capital First said that the cost of borrowing is expected to fall by 100 basis points and all NBFCs will see improvement in return on equity (RoE) due to the change in bond pricing.
Moderation in bond yields is expected to benefit non-banking financial companies (NBFCs) as cost of borrowing is estimated to fall, which in turn may see support from increased demand on the back of good monsoon and the seventh pay commission.
In an interview on CNBC-TV18, V Vaidyanathan of Capital First said that the cost of borrowing is expected to fall by 100 basis points and all NBFCs will see improvement in return on equity (RoE).
In the same interview, Gagan Banga of Indiabulls Housing Finance said that it is important to see how credit growth is channelized going forward. He expects to see a loan book growth of 30 percent by the end of the fiscal.
Below is the verbatim transcript of Gagan Banga and V Vaidyanathanâ€™s interview to Latha Venkatesh, Sonia Shenoy and Anuj Singhal on CNBC-TV18.
Latha: How much has the cost of money fallen for your own company and what do you think will be the potential fall of money in the next 12 months?
Vaidyanathan: The incremental cost of borrowing to the NCD market or the bond market is about 100 bps cheaper than borrowing from a bank. So, basically even if an Non-Banking Financial Company (NBFC) replaces its bank borrowing to the extent of 30 percent or incremental lending does through bonds to the extent of 30 percent then you get a 30 bps benefit to the profit before tax (PBT) line and that is one of the reason why NBFCs and HFCs should look forward to an increase in margins in the years to come.
The second thing that happens is that in the bond market for NBFCs the benefit comes with a lag. Unlike banks which have a bond business which they do as a trading business and they see the benefit immediately the re-pricing takes time for an NBFC but it comes with a lag. The best of that is yet to come in the next one year.
Sonia: How much could your own margin improve because of lower cost of borrowings?
Banga: Cost of borrowings will have fallen over the last six months to the tune of about 60 bps. We have also done close to about Rs 16,000 crore of new bond borrowings over the last 90-100 days and that should allow us to replace a substantial piece of bank borrowings and also fund our next two quarters growth and for us bond borrowings are to the extent of about 120 points cheaper than the relevant bank borrowings.
More importantly from a longer term perspective any large balance sheet is looking for diversification of sources of funds. And the bond markets also ensure that. So, today what we have going are multiple levers. So, we have domestic banks lending to us, we also have domestic institutions.
Since our upgrade to AAA we got access to longer term paper which was the state insurance companies and the state owned provident funds. And in the last 90 days we have been able to access international markets through the masala offering as well as the public markets through a public issue.
So, today we have on practical basis all the possible levers which under the license that we hold have and that from a long term financial stability perspective is far more important than the additional 30-50 bps that we can possibly make over the next six months.
Latha: You said you see money 100 bps cheaper for you. But at the PBT level the gain will be 30 bps. So, should I assume therefore that your spreads or your net interest margin (NIMs) will rise by 30 bps?
Vaidyanathan: No, I would like to clarify the numbers for you. You get bonds at 100 bps cheaper than what you borrow from banks. But if you replace 30 percent of your borrowing through bonds that 30 percent of 100 bps that is 30 bps. So, the spreads remain the same.
Latha: Will spreads remain the same? Are you therefore suggesting you will pass it all on to your borrowers or will you still be able to bolster margins?
Vaidyanathan: No, I would like to clarify. When we say spreads remain the same I really meant that this 30 bps will come back to the P&L and after tax which is about 10 bps you will get about 20 bps to the profit after tax (PAT) and usually if you see any good NBFC which could replace the growth with their effort that 20 bps leveraged about seven times will give you about return on equity (RoE) improvement about 150-200 bps.
So, all NBFCs uniformly should see an improvement on RoE as a result of change of pricing in the bond markets.
Anuj: What is your outlook on RoE because that has become an important parameter from stock market’s point of view?
Banga: We have historically been operating at a RoE of 25-31 percent. As we speak we are somewhere in between 25-26 percent. I am hopeful of being able to climb up the RoE curve at the rate of a 100-150 bps every year over the next 3-4 years and to get back to over 30 percent by 2020. So, that is one of the goals that we have set for ourselves. And the bond borrowing program will enable us to get past that, first the 1 lakh crore mark and then the 1.5 lakh crore mark.
So, I appreciate and agree with Mr Vaidynathan when he says the bonds will improve spreads and potentially can improve RoE but what also needs to get appreciated is that as some of the larger housing finance companies and NBFCs add up scale what is extremely crucial is for that scale to continue in a stable manner. You have to continue to diversify.
And what is happening with the bond markets is not only about a yield play in the short term where the government securities are correcting and therefore yields and corporate bonds are following in line what is more important is that the well rated paper is today getting accepted in places and institutions which otherwise would be hesitant and would be restricting themselves to exposure to bank CDs or AAA public sector undertaking (PSU) bonds and as that acceptability improves you will have a whole lot more of stability in the borrowing profile of large NBFCs which are essentially today doing the heavy lifting as far as the credit growth and the credit intermediation of the country is concerned.
So, this is more a longer term growth story. Yes, there will be an impact on short term financials but the more important thing is how does credit growth over the next two to three years get channelised through the HFC and NBFC sector.
Sonia: So, how do you think that could shape up because for Indiabulls Housing Finance loan growth in the quarter gone by was very strong, you were 31.5 percent. How are things looking currently and what kind of disbursement growth do you hope to see over the next couple of quarters?
A: We had at the start of the year officially guided for the book growth to be in the range of 25-30 percent. We believe that we will definitely end book growth towards the higher end of the range. And on the profit growth we had looked at a 20-25 percent guidance and I am reasonably hopeful that with all the maturity that we are seeing on the evolution of the liability side we should for the next couple of years hope to now compound growth at the higher end of that range also. More importantly the bond program will allow us to press the pedal harder as and when the credit market is on an overall basis is going to improve.
So, today while we have extremely strong growth on the home loan side we continue to be circumspect about the commercial real estate portfolio that we have which is close to about 20 percent of our loan book. Now that as and when the credit conditions in the country are to improve can also grow a lot faster. So, what we have today is ammunition to actually press the pedal as and when the credit profile of the country is to improve a lot harder than the 30 percent that we are anyways compounding at.
Latha: Some numbers, on what you expect by way of loan growth because the public sector space is receding in terms of being able to service. So, what is the loan growth you are expecting for your own company as well give us some idea of how much your margins might improve?
Vaidyanathan: For us we feel quite confident to grow the company by 25 percent this year. We closed the book the last financial year at Rs 16,000 crore and a 25 percent growth on that should be very comfortable. We feel more confident today than maybe six months ago.
Number two, as far as profit growth is concerned analysts\\’ estimates are that our profits will grow by about 50 percent this year and we don\\’t see a problem with that either.
Latha: You concluded your answer by saying that 20 percent of your book is exposed to commercial real estate. Now, after the arrest of Pujit Aggarwal there is a bit of a flutter about the entire exposure to real estate. Are you quite confident of this 20 percent or is that one downside in the entire NBFC space this market is not factoring in this exposure to real estate?
Banga: Historically I would say Reserve Bank of India (RBI) has been an extremely prudent regulator and there is a lot to be read in the fact that couple of years ago the RBI had actually reduced the risk weights which were assigned to loans such as construction finance.
So, if you have been prudent in building your book close to about 60 percent of our commercial real estate book is lease rent discounting which is essentially the loan version of a mortgage backed security which is service through rents which has got no execution risk and is in a structure which is bankruptcy remote to the builder and the rest is done which is a very small part of our book, which is roughly about nine percent of our balance sheet is residential construction finance where projects are maturing.
So, there would be some gaps in organisations which do not understand how to evaluate project execution risks but as has been proven adequately now in the credit system that there would always be lending institutions which are whole lot of more mature on risk management. We have a fairly long track record of lending to the sector and even on that 8-9 percent of my balance sheet I am extremely confident on the type of risk that we have taken.
Not only for ourselves I can say that I can make that argument for at least five other mature lenders.
Latha: Your comment on the system itself. The entire NBFC lot, what is the risk of this lending to commercial real estate. I don’t think it is as facile as Gagan is making it out to be?
Vaidyanathan: Gagan is right to the extent that if you tie up your receivables through the escrow very tightly and you lend to good developers with a good track record your should broadly be very safe. Large ticket residential financing or corporate financing last decade is generally more black swanish in our opinion.
In fact in our case we have actually reduced the exposure to wholesale financing to 90 percent many years ago to 10 percent now and our retail has now become 90 percent. So, it is just a philosophical view we have about wholesale financing, maybe it is not our line of business we want to proceed in but if it is very tightly structured maybe there is a story.