Over the past few months, NBFCs have had to accept stricter rules and appear to be on even keel with banks on how they classify assets and bad loans. The double whammy has come in the form of the nervous macro environment in India where sustained tightening and rise of rates by the Reserve Bank of India (RBI) stymied credit growth. This has also expanded the risk of bad loans, especially, for those NBFCs that have concentrated portfolios in the areas of power, construction or even infrastructure.

Spotlight on infra NBFCs: as interest rates have gone up significantly, the cost of funds has shot up leading to margins pressures. In addition, the limited ability to pass on rates to borrowers (especially vehicle fin­ance companies) and growing asset quality risks have slowed down business gro­wth. The fund-raising process for fresh ca­pital has also become difficult for NBFCs due to extremely tight liquidity that has pushed costs to unreasonable levels.

Earlier, RBI had raised concerns on strong growth in banks’ exposure to the NBFC sector, which has impacted bank funding to NBFCs. Further, the fresh set of regulations by RBI on capital adequacy, securitization and asset classification, among others, will impact the performance of NBFCs.

“The mortgage finance companies have done relatively better, but rising reality prices and National Housing Bank’s recent circular could impact the earnings outlook. On the other hand, infra NBFCs (REC, PFC, IDFC) are plagued by asset quality concerns due to ongoing issues in infra projects (power sector),”. The recent trend in results shows the strain among strong NBFCs that were hit by forex losses. Rural Electrification Corporation (REC) reported a Q2FY12 net profit of Rs 620 crore, which was flat in year-on-year (y-o-y) terms. Owing to adverse currency movement, REC booked foreign exchange losses of Rs 120 crore during the quarter, dragging down the bottom line. PFC’s net profit fell by 40 per cent y-o-y to Rs 420 crore, in line with estimates and also due to forex losses on unheeded forex loans. While its loan growth picked up by 26 per cent, top line growth lagged behind due to compression in margins. Only IDFC (Infrastructure Development Finance Company) 2QFY12 profit rose by 55 per cent y-o-y to Rs 524 crore, led by higher profit from sale of investments worth Rs 260 crore. Being largely wholesale-funded makes IDFC’s funding costs very sensitive to rate cycles. However, infrastructure NBFC s’ status has provided some buffer in terms of increasing the mix of cheaper overseas borrowing and picking up of tax-free retail bonds from the market, analysts said.

Home Loan NBFCs: In this segment, after HDFC, the second largest firm is LIC Housing Finance. However, analysts feel its prospects are quite dull.

“While we continue to believe that LIC Housing Finance is a robust franchise given the competitive advantages on both sides of the balance sheet, its present valuation appears to more than factor in these strengths, even as cyclical pressures impacting growth and margins, coupled with regulatory changes, could lead to muted 8 per cent earnings CAGR over FY11-FY13,” said Agarwal.

Margins of housing finance NBFCs appear to be under threat for those with falling incremental spreads. In addition, a bigger fixed rate portfolio in a high interest rate environment, lower proportion of high-yield developer portfolio, coupled with increased borrowings are challenges.

Hire purchase and lease NBFCs appear weak: Shriram Transport (SHTF) recorded a muted performance for 2QFY12, which was well below market consensus. Higher provisions for NPAs dragged down performance. The management has attributed the sharp increase in provisions to the sudden deterioration in the performance of assets that were deployed in Karnataka for transporting iron ore. But, most importantly, the company’s management lowered the guidance for disbursement volumes sharply.

Mohan Swamy, head of research at RBS Equities, believes that financing de­mand in the auto sector is headed for cy­clical moderation driven by high interest rates, fuel costs and a weak economic outlook. That said, RBS has recently initiated coverage on another auto financier Ma­hindra Finance on the back of continued demand buoyancy in its core rural market, diversified loan book and low regulatory risks compared with other NBFC peers.

With more than 30 % correction since its October 2010 peak, Shriram Transport Finance’s regulatory risk appears to be priced in, but could remain an overhang over the near term, RBS added. While both NBFCs are strong candidates for a bank licence, Mahindra Finance’s M&M parentage and predominantly rural and semi-urban focus (in sync with RBI’s financial inclusion focus) makes it a stronger contender for an eventual licence.