By Jyotivardhan Jaipuria
Indian MFI stocks have witnessed a meaningful run over the last 12-15 months. Despite that we like the sector, given stabilising asset quality after the turmoil witnessed post-Covid, return of growth and strong capital levels of companies. Most metrics are now at pre-Covid levels and regulatory changes allowing risk-based pricing (as against a cap of 10% on NIMs) have provided a level playing field for NBFC MFIs with banks. This is partly reflected in their recent growth numbers — the market share of NBFC MFIs stands at 38% in December 22 against 31% for FY21. With growth rates normalising and outlook sanguine, MFIs are on track to grow at 20-25%. Credit costs will be significantly lower than those witnessed during Covid, driving profitability ratios.
The first driver for profitability is the change in norms, which enables higher margins. Until March 22, NIMs for NBFC MFIs were capped at 10% while there was no such cap on banks. However, RBI has now allowed risk-based pricing and higher household income (enabling total household indebtedness up to Rs 3 lakh). This aids higher NIMs and greater financial inclusion. While this led to slower growth in Q1FY23, growth rates have since normalised. The growth rates have been explained by higher ticket sizes coupled with new client acquisitions. For the nine months ended December in FY22, active loan accounts/average ticket sizes increased by 19%/16%, respectively. The growth rates have been ~18% for the period and could likely remain +20% in FY24 given new client additions and higher ticket size.
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NBFC MFIs have witnessed approximately 140 bps NIM expansion after the removal of interest rate cap of 10%. This is primarily driven by an upward revision in lending rates by NBFC MFIs. With interest rates having largely peaked, funding costs for NBFC MFIs should gradually soften. Given a fixed rate book coupled with peaking funding costs, NIMs for NBFC MFIs should remain healthy at 10.5-11%.
Secondly, asset quality pain for the MFI sector is now largely behind us —NBFC MFI GNPLs/ restructured book peaked at ~6.3/9.5% levels in March 2022 — these have likely fallen to ~3.5%/ 3% levels for FY23. Coverage ratios for most of these companies are in excess of 70%. With improving collection efficiencies coupled with strong provisioning cover for most companies, credit costs will likely fall rapidly for MFIs. Credit costs during Covid stood in excess of 5% but stood at ~3.5% in FY23 — these will likely moderate further and will be one of the key earnings drivers. However, we expect most players to make provisions higher than pre-Covid levels in order to ensure creating adequate cushions for events like Covid.
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Thirdly, capital adequacy levels have been healthy for NBFC MFIs driven by the capital raise by the companies post-Covid. Cumulatively, NBFC MFIs have raised Rs ~36 billion over the last couple of years. With asset quality outlook being sanguine, a large part of capital will be utilised towards growth rather than provisions. Profitability is likely to be strong with RoAs ranging from 3.5-4% levels. With leverage at ~4x we expect that the NBFC MFIs would generate healthy mid/high teen RoE over the next couple of years. Valuations for some of these names are attractive in the backdrop of mid to high teen likely RoEs and stable profitability.
(The writer is founder & MD, Valentis Advisors)