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Investor optimism in vehicle financiers will be put to margin test

While the outlook for the automobile industry seems to be turning for the better, the rising interest rate cycle could hit margins for non-bank lenders

June 29, 2022 / 11:21 AM IST

Shares of non-bank lenders predominantly into auto loans have seen a rare level of confidence from investors amid a broad market meltdown driven by global factors.

Such optimism is not without reason as disbursements have improved sharply in recent months and earnings for the fourth quarter of FY22 were robust.

Even as the Nifty 50 dropped 10 percent year-to-date, shares of used-vehicle financier Shriram Transport Finance Corporation held on to their early gains. Those of Cholamandalam Investment and Finance Company and Mahindra & Mahindra Financial Services are up roughly 20 percent in this period.

Analysts said the optimism is on the back of strong disbursements and an uplifting outlook for the automobile industry. Mahindra Finance’s disbursements more than tripled in May year-on-year, the company said in a recent business update on the exchanges. Shriram Transport Finance head Umesh Rewankar has indicated a loan growth target of 12 percent for FY23 and expects commercial vehicles to show quicker growth over the next three years.

More importantly, the outlook for the automobile industry seems to be turning for the better. Management commentary from auto companies about growth in the coming quarters has been upbeat. Beyond the pain in two-wheelers that continues, the expectations are that both commercial and passenger vehicle sales could rebound.

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Channel checks by brokerage houses indicate that sales in June could bounce back in most vehicle segments. Jefferies India analysts pointed out that even two-wheeler sales could recover.

“We see a strong case for 2W revival and factor 15%/20%/15% growth in FY23/FY24/FY25,” they said in a note. This augurs well for lenders in terms of growth.

Key lenders in the vehicle finance segment such as rural-focused Mahindra Finance, used-vehicle focused Shriram Transport Finance and even a more diversified Cholamandalam have weathered the pandemic to a great extent.

Stress triggered by the pandemic has been dealt with and fresh troubles are less likely, according to analysts. This is another important reason for investors to stick with these companies in a hostile market. The outlook for asset quality is optimistic.

That brings us to potential trouble spots that investors need to keep an eye on.

Margin trouble

One key concern is the effect of a rising interest rate cycle. Analysts anticipate a hit on margins for almost all non-bank lenders, and vehicle financiers are no exception. Vehicle financiers are among the most vulnerable to borrowing costs, unlike housing finance companies that enjoy competitive rates.

Most non-bank lenders have a large portion of borrowings in the form of bonds. Corporate bond yields have surged more than 100 basis points in the past two months, even for the best rated companies. Crisil expects the borrowing cost of non-bank lenders to increase by 85-105 bps for FY23.

“The interest rate scenario has turned for NBFCs, with the Reserve Bank of India hiking the repo rate by 90 bps in two tranches… with bank floating loans now benchmarked to external gauges such as the repo since October 2019, the passthrough is relatively quicker compared with loans linked to the marginal cost of funds-based lending rate,” the rating company said in a recent note.

Analysts at Motilal Oswal Financial Services also expect FY23 to be a challenging year on margins.

“Just as vehicle financiers benefitted from a declining interest rate cycle over FY21-22, with a few of them even reporting historically higher spreads and NIM (net interest margin), we believe that FY23 will be a real acid test of liability strength and the mix of respective franchises,” Motilal Oswal said in a recent note.

As such, margins have declined for Shriram Transport Finance over the past three years. The lender’s margins were down to 7.9 percent in FY22 from 8.4 percent in FY19. Cholamandalam and Mahindra Finance have fared well, though. Spreads for both lenders have improved marginally, although analysts said this could be short-lived.

Companies are likely to rejig their borrowing book by going in for more commercial paper in the wake of an uptick in disbursements. Cholamandalam fares well among the three due to a more diversified borrowing book.

Vehicle financiers have a sanguine growth outlook, manageable stress and a general improving market on their side. All they need to do is stave off a sharp increase in borrowing costs for investors to keep their faith in them.
Moneycontrol News
first published: Jun 29, 2022 11:21 am
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