Due Diligence . Three metrics to look for in NBFC results

If you’ve invested in fixed deposits with finance companies (NBFCs) or small finance banks (SFBs), the new business risks created by Covid-19 have made it necessary for you to keep a hawk eye on their financials. Borrowers, hit by income cuts, have been delaying loan repayments.

The RBI had directed lenders to declare a holiday (moratorium) on repayments until August 31. The Supreme Court has been hearing a case on extending this holiday, while stopping lenders from recognising bad loans until it decides.

With these developments, the already jargon-packed results from banks and NBFCs have acquired some new terms. Here are three new metrics you need to get a grip on.

Collection efficiency

The collection efficiency ratio is one performance metric that has materially moved NBFC and small finance bank (SFB) stocks in the recent results season. This is the proportion of loans that a lender has collected in the month or quarter to the outstanding dues at the beginning of the period. The closer it is to 100 per cent, the greater the comfort that borrowers are repaying their dues on time.

During the April-June lockdown, sudden income shocks and the inability of collection agents to visit borrowers severely impacted the collection efficiency of SFBs that gave out micro-finance loans.

Equitas Small Finance Bank, for instance, saw its overall collection efficiency fall to 11 per cent in April. But with unlocking and revival, it improved to 94.3 per cent by October. The ratio can vary for different types of loans.

Stage 1, 2 and 3 assets

Earlier, Indian lenders reported their doubtful loans based on defaults they had already incurred. Loans unpaid for over 90 days were treated as non-performing assets (NPAs). But with Ind AS, lenders such as NBFCs are now required to use an “expected credit loss”, or ECL framework, to recognise doubtful loans.

Here, each lender is expected to forecast expected defaults over the next 12 months and over the life of each loan. These are, in turn, classified and disclosed as Stage 1, Stage 2 and Stage 3 loans.

Stage 1 loans are those where the lender has not seen any change in default risk from the time of disbursement. Stage 2 loans are those where there has been some increase in the default risk from the date of giving out the loan, though there is no objective evidence of this.

Stage 3 loans are those where there’s objective evidence of defaults. The proportion of Stage 2 and Stage 3 loans in an NBFC’s books and the provisions against them can tell you if a big spike in NPAs is coming in future quarters.

Proforma NPAs

With the apex court imposing a standstill on recognising defaults after August 31 as NPAs, official NPA numbers reported by lenders no longer reveal the true state of bad loans. To get around this , some lenders have taken to disclosing ‘proforma NPAs’.

Proforma gross and net NPAs tell you what the lender’s NPAs would have looked like, if it had continued to recognise bad loans without applying the court concessions.

Bajaj Finance, for instance, has said that its proforma gross NPAs and net NPAs for the September quarter would have been 1.34 per cent and 0.56 per cent, respectively, instead of the reported 1.03 per cent and 0.37 per cent, had the SC concession not applied. This is a more reliable estimate than that reported.numbers.

COMMENT NOW