Fund-raising for NBFCs
NBFCs meet their funding requirements from a variety of sources but there are complexities. Ramesh Iyer, MD & CEO, Mahindra Finance, and V. Lakshmi Narasimha, ED, Shriram City Union Finance, explain the modalities:
NBFCs meet their funding requirements from a variety of sources but there are complexities. Ramesh Iyer, MD & CEO, Mahindra Finance, and V. Lakshmi Narasimha, ED, Shriram City Union Finance, explain the modalities
Rating company ICRA has said in a note recently that non-banking finance companies (NBFCs) would face hardships in raising funds in FY201819 in view of the prevailing higher costs of borrowing and decreasing funding options. It is estimated that NBFCs as a whole would need about `4000 billion in the fiscal as they eye a growth of 20% in their loan portfolio and ICRA is of the view that the weighted average cost of funds for these entities would increase to about 9.5% in 20182019 compared to 8.4%-8.5% in 2017-2018. They are also facing constraints as banks have put sectoral caps because of various reasons and ICRA said the share of NBFC credit increased to 10.5% of the banking system credit to corporates in March 2018 as compared with 8.7% in March 2017.
Foreign portfolio investors too are shying away because of certain recent developments and this can obviously impact private placement funding to NBFCs.
Another factor is the weakening rupee which is likely to have an adverse effect on prospects of foreign investors.
However, NBFCs have taken up strategic initiatives like improved market presence and effective marketing schemes, better loan products and care for customers, which are likely to improve prospects of capital infusion.
They have some relief as private equity (PE) investments have seen an upswing in the past few years and PE firms provide not just funds for NBFCs, but they are also seen as participants in creating global standards and processes in these organizations.
But, NBFCs do not have the ability to raise funds at a low rate like banks, and they are forced to evolve alternative strategies so that the funding they get are deployed in such a manner that it brings in higher returns. However, this is at a cost - they need to take higher risks.
Today, they have 3 primary sources of funds: For long term fund needs, they get term loans from banks, after deciding on the amount of funds to be deployed in normal operations. Bonds are another common route to reduce the interest rate on the sources of funds. For short term fund needs, they raise funds through commercial paper (CPs), which are short term unsecured promissory notes with a tenure of 3 months to 12 months.
Ramesh Iyer, vice chairman & MD, Mahindra Finance, one of India’s leading NBFCs with a rural focus, says the company raises funds through multiple borrowing sources with a diversified set of investor base. “Banks have always been a significant source of borrowing for us. During the years with debt capital markets maturing, the
share of issuance of NCDs has risen. Apart from these two major sources, we also raise funds through fixed deposits and public issuance of debentures as well as short term funds through commercial paper and inter corporate deposits. We also have a mechanism of raising funds through the securitization route as well. In addition, we are exploring funding from offshore market through masala bonds and ECB route,” he explains.
For Shriram City Union Finance, one of the country’s premier financial services company specializing in retail finance, bank borrowings constitute the highest share of resources, and were at 59% of the funding mix as of June 2018. According to V. Lakshmi Narasimhan, ED of the company, while deposits are integral to its plans as a resource base, “their share in the mix has been declining. We have been making the most opportune use of the money market, however.”
TERM LOANS, BONDS
As regards meeting long term fund requirements and the natural preference of NBFCs for term loans from banks and the option of bonds, Lakshmi Narasimhan says there are merits in tapping both avenues. “While bank borrowings currently comprise a major source of funds for us, we have floated bonds in the past and would continue to explore this route subject to the pricing being acceptable to us,” says he.
Iyer too says Mahindra Finance uses a mix of both these sources for long term funds along with fixed deposits depending on market liquidity and yield. “However for periods higher than 5 years, issuance of non-convertible debentures is more prevalent,” he adds.
Bank borrowings comprise approximately 30% to 35% of the overall borrowings of the company while debentures (excluding public issue of debentures) comprise ~ 40%. Public issue of debentures is ~ 5%.
CP, ICD COMMONLY USED
To what extend do they depend of CPs?
Iyer says CPs and inter corporate deposits are more commonly used as sources of short term funding. Apart from these, the company also has lines available with banks as part of consortium to avail working capital facilities. “We maintain a strong ALM policy to maintain liquidity. Approximately 10% to 15% of our overall borrowings is raised through short term source,” says he.
He adds that the company in general uses all borrowing sources so as to benefit from both a healthy mix of instruments as well as benefitting from its pricing. However, these usually does not exceed 2% of the overall borrowings.
For Shriram City Union Finance, as of now, CPs make up around 14% of its liabilities. However, debentures do not make the fit for the company as a shortterm funding mode because debentures are issued for tenors greater than 12 months. As of June 2018, the company does not have any inter-corporate deposits in its resource mix.
Iyer maintains that insurance companies and provident/ pension funds have the ability to invest for longer term compared to other market participants. “Insurance sector is one of the market participants in NCD placements and in the last few years their participation levels have increased, and these comprised ~ 15% of the total borrowings of Mahindra Finance. “We raise funds from such institutions as they are competitive considering their long term nature, which strengthens ALM,” he adds.
Shriram City Union Finance’s borrowings from the insurance sector are quite insignificant at present, being less than 1% of the total liabilities.
What is the role of ALCO in deciding the mode of securing funding?
Says Lakshmi Narasimhan: “Our Asset Liability Management Committee meets regularly (and as prescribed) to formulate, review, monitor and recommend policies on investment, asset-liability management, private placement of NCDs, securitization, interest rate approach and gradation of risks and other related matters as well as to formulate business strategy in line with the budget and to provide a framework for assessing and managing liabilities and associated risks. Our finance team works closely with and reports to the ALCO on all resource-raising initiatives.”
Iyer maintains that the ALCO helps in providing broader objective of raising funds through diversified borrowing sources to reduce dependency on any one single source. The company depends on sourcing mix on floating versus fixed based on business model. In addition, it also guides on maturity profile of liability and sourcing based on asset maturity mix.
ROLE OF PE FUNDING
Can NBFCs attract PE funding? Is this mode advantageous?
Iyer says usually PE firms invest in instruments which have the ability to provide them higher returns than pure debt instruments. Hence, they largely participate in structured instruments / equity. However in event of surplus funds available, they participate by investing in bonds/ CPs. But these investments comprise a very small portion of the total debt requirement.
“However,” says he, “they do participate in enhancing the capital base of the company by investing in the equity capital thereby enabling such companies to enhance their leverage and grow. Further, they may also participate in growth opportunities which an NBFC may evaluate. PE funding is useful for entities which are unable to raise capital and whose promoter reputation is weak. The cost of borrowings from PEs shall be higher compared to other market participants,” he elaborates.
Lakshmi Narasimhan says NBFCs, including Shriram City Union Finance, have attracted and continue to attract PE funding. “This route of capital raising is definitely mutually advantageous for wellrun NBFCs like ours since it helps us build up scale and we an offer targeted returns to the investors. Long-term PE investors look for certain minimum returns over a set investment horizon, and we at Shriram City Finance would like to believe that we have helped our PE investors add immense value to their investments placed with us,” says he.
SIGNIFICANCE OF FDI
He also explains the significance of FDI: “We understand 100% FDI in NBFCs is permitted under the Automatic Route, subject to sector conditions. There exists a reasonable number of prominent NBFCs either with substantial FDI in them or which operate as subsidiaries of entities based outside India.”
Iyer too says FDI’s can be a significant source of funding. However since NBFCs are not eligible to take forex exposure, such options get limited on account of the conversion pricing risk being transferred to FDIs. “Further, opportunities like masala bonds / ECB which could open up such investments get reduced on account of the incremental cost levied for withholding tax,” he says.
According to him one of the factors that can help NBFCs to attract funding from various sources is the removal/reduction of the WHT on masala bonds. This, he says, could help in enhancing funds from foreign investors. Further developing the bond market will also improve funding options. The other factors are strong parentage, liquidity back up, rating.
Lakshmi Narasimhan says it is advisable for NBFCs to possess a diversified mix of funding in order to cope with interest rate risks and other contingencies. “Well-run NBFCs with longevity, niche positioning, sustained profitability, scale and aboveaverage asset quality would always be better-placed to attract funding from multiple sources,” says he.
The cost of funding of NBFCs are higher than that of banks. How can they get over this problem apart from using the right rate of lending? Says Lakshmi Narasimhan: “Funding costs of NBFCs are not ordinarily comparable with those of banks since banks will always tend to have access to cheaper funds because of factors such as the ability to raise deposits on a much wider scale, open and operate CASA, maintain lower capital adequacy requirements etc. We at Shriram City Union Finance have always enjoyed the confidence of both institutional and retail lenders and depositors, and this, combined with positive events such as our recent credit rating upgrade should enable us to continue to raise money at acceptable pricing levels and to continue to deliver high NIMs, among other key metrics.”
Says Iyer: “NBFC’s have a nimble operating environment and are flexible in creating new products as per customers’ requirements. Such customized products put NBFCs in an advantageous position to fund entities/ products. The customer segments addressed by NBFCs are niche and not serviced by many banks due to uneven cash flow and limited credit history.”
The ICRA note had also said it will be challenging for NBFCs to raise funds in view of higher borrowing costs and narrowing options.
Iyer responds saying his company continues to source funds from all avenues including banks and market participants like mutual funds, FIs, PFs, corporates and insurance companies. “Given that the G-Sec rates have gone up partly on account of the policy rates increasing and also because of general inflationary trends, we believe that NBFCs shall continue to be among the prime sectors to be preferred by such investing communities given the growth opportunities and improved pricing,” says he.
Says Lakshmi Narasimhan: “NBFCs will have to contend with a higher cost of funds in FY2019, given the current interest rate trends. However, we reiterate that for efficiently-managed NBFCs, availability of adequately-priced resources should not be difficult, even with a growth target of 20% or more.”
Ramesh Iyer maintains that banks have always been a significant source of funds for Mahindra Finance, but NCDs too have gain prominence
V. Lakshmi Narasimhan is of the view that funding through the PE route is mutually advantageous for the NBFC as well as the PE since it helps build up scale