Mahindra and Mahindra Financial Services Ltd (Mahindra Finance) reported an increase in provisions and a compression in its net interest margin (NIM), much to the chagrin of analysts and investors. Ramesh Iyer, Vice Chairman (VC) and Managing Director (MD) of the rural-focused non-banking financial company (NBFC) believes that the lender’s asset quality has improved.
In an interview with Moneycontrol, Iyer pointed out that the increase in provisions was due to losses, given default estimations under the IndAS accounting system, and provisioning needs would normalise from here on. Also, Iyer conceded that the management’s expectations of a decline in borrowing costs did not materialise, which was reflected in the margin compression. Margins are likely to improve from here on, and Mahindra Finance is on track to double its asset book by 2025, as guided earlier.
Edited excerpts:
Your year-on-year (YoY) provisions have increased. Even sequentially, there is a 20 percent increase. Are there any specific areas where you had to make provisions?
There are two things. One is that there is a slight increase in the LGD (loss given default). Under IndAS, LGD is based on the historical record of the past 42 months. So, if we had a quarter where there would have been a little higher loss in the past, maybe three or four years ago, well, that has slightly pushed up the LGD. Also, in the last 10 or 15 days of the month, some of the tractor payments got shifted to October. These are the two things that have caused a slight increase in the provisions. Our Stage 3 numbers are pretty stable, and Stage 2 numbers actually came down. So, there are no asset quality concerns except that there is a temporary shift in cash flow, which happened in September.
Is your business more vulnerable to volatility in LGD estimations?
I won't say it is more vulnerable. When you work with an earn-and-pay segment, it will have some impact on how historical data is calculated. In between, we also saw COVID-19, and that has impacted us as well. But internally, there are some discussions around how we should treat the COVID period while formulating LGD. The pandemic did not dent the fundamentals of the business; it was an event. Maybe by the end of the year, we should have some answers. Now that we are getting into a cycle of more stable NPAs (non-performing assets), you will see our LGD starting to decline in the next couple of quarters. Because LGD is all about your ability to recover from a delinquent account and what you eventually write off.
The tractor portfolio has been resilient. What is your outlook on the farm sector and, consequently, rural recovery?
The data says the monsoon is 94 percent of the long-term average, and relevant states like Bihar, UP, Maharashtra, and Madhya Pradesh have done well. I don't think there is any negative impact that one should even look at or factor in from the monsoon. I think the farm cash flow will be very positive. The overall rural sentiment is very positive, as you can see from the festival demand. In fact, Dusshera was one of its best if you look at the OEM (original equipment manufacturer) numbers, even for cars, and their expectations for Diwali are as buoyant.
There is a big drop in the SME segment. Is that by design?
No. About a year ago, we were actually doing more institutional lending, which, if you recall, we had stopped more than a year ago. So, there is a writedown that is happening in that book. But if you look at the pure disbursement for the year on SMEs in this entire book, I think just about Rs 900 or 1,000 crore is institutional, and the rest is all new book that has been built. So, we are growing even in the SME segment, but the growth is not visible because the rundown of the institutional book is faster.
The rundown is over now. Therefore, our belief, as we said, is that by 2025 we will get to Rs 12,000 crore, and this is very clearly visible. We are already at about Rs 5,000 crore, and in the next three-four months we will add more. In a year’s time, the SME would be close to 10 percent of the book.
Are you comfortable with the quality of the new book for SMEs?
Our NPA ratio at SMEs is around 1 percent; so that says a lot. Also, we have built a separate vertical for the SME business, and it is not going to be a small number. We are looking at clear growth here. There are two segments: agriculture, auto, engineering, etc., where we can provide working capital support and even capex. Another is the LAP (loan against property) and this is all micro LAP with a size of Rs 10-25 lakh in the geographies in which we are present.
Have net interest margins reached the bottom, and will they improve from here on?
Margins have three elements for us. One is that we are moving into a segment called Prime X, which is a high-quality loan and obviously comes with a little lower yield, but it is also expected to have low operating expenses and a low credit cost going forward. So that's a very conscious strategic decision.
Second, we were expecting that the borrowing cost would come down by around festival time, and therefore, we did not increase our lending rates with that expectation. But clearly, now, the indications are that the borrowing cost may not come down before March. We will be lucky if it doesn't go up. So, we have decided to increase our lending rates for certain segments, which we will announce immediately. That should cover at least another 25-30 basis points (bps) increase in yield during the next six months.
The third is that the growth is coming from cars and UVs (utility vehicles). However, in the pre-owned vehicle segment, demand is very high, but availability continues to remain a challenge. Not too many pre-owned vehicles are easily available in the market, and therefore, the growth in this segment requires more aggression, and this is where yields are high. In the next six months, we will see a yield improvement of at least 35-40 basis points. We expect the 6.6 percent of NIM to go up to 6.8 percent and then eventually reach that 7 percent level. By March, we will start to see NIM go closer to 7 percent. Reaching 7 percent will be based on whether borrowing costs come down by at least 10 to 15 basis points.
Do you see the need for capital to achieve your target of doubling your asset book by 2025?
Our current capital adequacy ratio is 18 percent plus and Tier-1 is around 16 percent. Until we reach a level of 12 percent for Tier-1, we may not need capital, and we are making adequate profits. For our goal of 2025, we don't see a need for capital.
What is your outlook on the recovery in rural demand for the rest of the year?
In the last few years, especially after COVID-19, rural needs have been redefined. There is an aspirational need, and then there is a need-based need. Demand for need-based products remains steady, but for aspirational products, there is caution. Also, aspirational needs have changed. The aspirations could be health, education, or consumer durables. Within these, we have seen rural people prioritising health over consumer durables. This might explain why some of the FMCG companies are telling a different rural story. But if you talk to insurance, health, or pharma companies, the story is different. Some consumers are willing to take out a personal loan, pay health insurance premiums, or maybe higher education for kids. There is a pickup in the education loans. I think our aspirational spending has undergone a dynamic change.
Given this optimism about the rural economy, what kind of growth and asset quality are you expecting for Mahindra Finance?
We continue to believe that our AUM (assets under management) will continue to grow upward of 20 percent for the next six months. We believe that in the next six months, with rural cash flow at its best, the credit cost will settle down to about 1.5-1.7 percent.
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