NBFC stocks: Basic & key parameters to analyze

NBFC i.e. Non-banking Financial Companies play a pivotal role in the Indian Financial System. These are establishments that provide Financial Services and Banking Facilities without meeting the legal definition of a Bank. Reserve Bank Of India (RBI) and Ministry of Corporate Affairs regulate the Working and Operations of NBFCs in India.

NBFCs provide Services like Loans, Credit Facilities, Retirement Planning, Investing and Stocking in the Money Market. NBFCs also provide a wide range of monetary advice like chit-reserves and advances. However, these Institutions are not allowed to take Traditional Demand Deposits – readily available funds, such as those in Savings accounts from the Public.

These Organizations play a crucial role in the Economy, offering their Services in Urban as well as Rural areas, mostly granting loans allowing for the growth of New Ventures.

(A) Types OF NBFCs

Types of NBFC in India

(B) Key Parameters To Analyze NBFC

(i) Revenue of NBFC

NBFCs borrow Money from one place and lend it to the People and Businesses at a higher Rate. Revenue is largely the Interest Income in the case of NBFCs. There are other sources of Income like Fee based Income such as Loan Processing Fees etc., but these are typically very small as compared to Interest based Income.

So the Revenue for a NBFC is simply the Lending Rate multiplied by the Size of the Loan Book (AUM – Assets Under Management).

(ii) Assets Under Management  (AUM) of NBFC

Assets Under Management are the Total Market Value of the Financial Assets that NBFCs manages on the behalf of its Clients. It is an Important Parameter while analyzing a NBFC as it measures size and success of the NBFC, compared with its history of Assets Under Management in previous periods and compared with its Peers in the Industry.

The Assets under management are directly proportional to the performance of a NBFC. Also, It is a strong performance indicator as a larger AUM is typically correlated with larger Revenues. AUM may increase when New Customers and New Assets are brought into the NBFC. Conversely, AUM reduces by Client defections, Redemptions or Withdrawals and other generally Adverse Events. 

Year-on-Year NBFCs Total AUM – Overall grew at a CAGR of 15% overall in last 6 years

Total AUM growth of NBFC in India in last 6 years

(a) AUM MIX

AUM mix of segments of NBFC sector estimates for FY21

*(E) – Expected, LAP – Loan Against Property, MFI – Micro Finance
Source: Crisil

(iii)  Interest Spread

Net Interest Spread is the another significant Parameter. The Net Interest Spread is the difference between the Interest expenses by the NBFCs and the Interest they receive from loans to consumers. In other words, it is the difference between the Borrowing and Lending Interest Rates of the NBFCs.

The Company generates Income from the spread, when the Interest that it earns from loans is greater than the interest it pays. The interest spread is a key determinant of the NBFCs profitability and it is considered as a measure of Profit Margin.

Greater the spread, the more profitable NBFC is likely to be. Both Lending and Borrowing Rates can fluctuate over time, which means that NBFCs needs to keep a close eye on them to prevent a substantial decrease in Income.

(iv) Net Interest Margin

NIM is a measure of the difference between the Interest Income generated by banks and the amount of Interest Paid out to their Lenders, relative to the amount of their Assets.

Net Interest Margin = (Interest Income – Interest Expenses)/ Average Earning Assets.

NIM is similar in concept to Net Interest Spread, but the net interest spread is the nominal average difference between the borrowing and the lending rates, without compensating for the fact that the earning assets and the borrowed funds may be different instruments and differ in volume.

Net Interest Margin is the most appropriate factor for evaluating the effectiveness and stability of NBFCs’ Operations. If NIM is positive, it means that NBFC is using its Assets effectively. Higher the Margin, higher will be the profit for NBFC.

Whereas a negative NIM means that the NBFC is not making the right business decisions. It simply means that it is not able to lend effectively.

(v) Sources Of Funds

Like Banks, NBFCs do not rely on Current Account Savings Account (CASA) Deposits for raising Funds, as CASA deposits are only meant for Banks. NBFCs do not have this advantage. It means, NBFCs needs to look for alternate sources of the money supply, where the interest rate offered is quite high than the deposits taken by Banks.

NBFCs raises Fund through various alternative Sources – Borrowing from other Financial Institutions, External Commercial Borrowings, Commercial Papers, Bonds & Non-convertible Debentures, Securitization and other loans. NBFCs should not depend on just one Source of Fund and must have a diversified Borrowing Profile in order to mitigate Risk.

In order to diversify, NBFCs are steadily increasing Market Borrowings via Masala Bonds, External Commercial Borrowings (ECBs) and Foreign Currency Bonds.

Borrowing Mix of all NBFCs in India during F.Y. 2020 is as follows –

NBFC sector borrowing mix for FY20

During F.Y. 2020, NBFCs’ Borrowings through NCDs decreased from 38% in F.Y.2019 to 35%. On the other hand, Funds raised by NBFCs from Banks increased to 36% in F.Y. 2020 from 32% in the previous Fiscal Year.

In the F.Y. 2020, share of Securitization remains same as of F.Y. 2019 i.e. 10%. On the other hand, contribution of Commercial Papers decreased to 4% from 9% in the year 2019. Also, the share of Other Loans increased from 11% in the previous year to 15% in F.Y. 2020.

(vi) Return On Assets

Return On Asset (ROA) is an important performance indicator for measuring the performance of NBFCs. This ratio tells that how efficient the NBFC is in its Operations & Fund raising.

Return On Assets = Net Profit /Average Total Assets

It shows how profitable a NBFC is relative to its total assets. ROA is best used when comparing similar companies or by comparing a NBFC to its own previous performance.

(vii) Return On Equity

Return on Equity (ROE) is a measure of Financial performance. This Ratio is a financial ratio that helps measure a company’s proficiency to generate profits from its shareholders’ investments.

Return On Equity = Average Shareholders’ Equity/Net Income​​

A sustainable and Increasing ROE over time can mean a NBFC is good at generating shareholder Value, because it knows how to reinvest its earnings wisely, so as to increase productivity and profits.

On the other hand, a declining ROE can mean that management is making poor decisions on Re-investing Capital in unproductive Assets.

(viii) Non-performing Assets (NPA) Ratios

The NPA are considered as an important parameter to judge the performance and financial health of NBFCs. If a NBFC has high NPA Ratio then its performance is considered as weak than that of a NBFC with lower NPA ratio. Also, it creates a bad effect on good will and equity value of the that NBFC.

With NPA Ratio, Non-performing Assets is expressed as Percentage of Total Advances. It gives an idea of how much of the Total Advances are not recoverable.

NPA Ratio is classified as follows –

(a) Gross NPA (GNPA)

Gross NPA Ratio is the Ratio of Total Gross NPA to Total Advances (loans) of the NBFC.

(b) Net NPA (NNPA)

Net NPA Ratio is calculated by subtracting Provisions from Gross NPAs i.e.

Net NPA = Gross NPAs – Provisions

(C) Profitability of NBFC Sector – RBI stats

RBI published overall performance ratios of NBFC

*Source: RBI

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