(Source: BloombergQuint)

BQ Explains: Does SBI’s Purchase Of NBFC Loans Make Business Sense?

State Bank of India’s decision to step up purchases of loan portfolios from non-banking financial companies brought relief to the beaten down stock prices of non-bank lenders.

Shares of all NBFCs closed higher. Bajaj Finance Ltd. gained 10 percent, Indiabulls Housing Finance Ltd. rose 3.6 percent and Dewan Housing Finance Ltd. was up 16 percent.

The gains followed a Tuesday evening announcement from SBI, in which the country’s largest lender said it could purchase up to Rs 45,000 crore in loans from NBFCs this year. Earlier, it had set this target at Rs 15,000 crore. By selling their loan portfolios, NBFCs can get liquidity and free up capital for fresh lending. The government in a statement said as much. “The measure should alleviate liquidity concerns to a great extent,” said Economic Affairs Secretary Subhash Chandra Garg.

Is this a case of SBI bailing out a stressed NBFC sector? Or does the step make business sense for the lender?

This is an opportunity for us to meet the priority sector targets and also to get a quality book. At the same time, our credit-deposit ratio as of now is about 66 percent. So, there is adequate headroom available to us to ramp up our credit. So it’s a win-win for everybody.
Dinesh Khara, MD, SBI.

Analysts, too, believe that if done prudently, such purchases of NBFC loan portfolios could work well for SBI. The lender can use this route to expand its loan book and add to its net interest margins, they said.

Direct Assignments vs Pass-Through-Certificates

Lenders like SBI can purchase NBFC loan portfolios through two routes—via ‘direct assignment’ and securitisation via ‘pass-through-certificates’.

In the case of ‘direct assignment’, the bank would buy a loan portfolio from a specific NBFC. It would do due diligence, negotiate a price and move forward accordingly. Portfolios purchased through this route would reflect on the bank’s loan book. The bank would also bear the credit risk that may emerge out of these portfolios.

In the case of pass-through-certificates, assets would be pooled together and rated by rating agencies. The pool would then be opened up for investment by banks. Banks who invest in these certificates would show them as part of the investment book.

Transactions via both routes have been rising of late.

According to data from rating agency ICRA, the total securitisation volume in the Q1 2018-19 stood at Rs. 32,300 crore, an increase of 128 percent over the volumes during the same period previous year. The volume of transactions via pass-through-certificated increased by 69 percent to Rs. 11,300 crore. Direct assignment transactions increased by around 180 percent to Rs. 21,000 crore, shows the ICRA data.

Does It Make Sense For Banks?

Anil Gupta, head of financial sector ratings at ICRA, explained that banks can benefit in a few ways should they decide to buy loan portfolios from NBFCs.

Firstly, a bank, through the purchase of an NBFC portfolio, can shore up its loan book. While the bank could do this by originating its own assets, the purchase of a loan portfolio allows for the loan book to grow without much effort on the part of the bank, explained Gupta. The portfolio would also come to the bank at a good yield since NBFC loans would have been given out at a higher rate of interest than bank loans.

NBFCs, in return for the sale of the portfolio, will get funding at the base rate of the bank with a certain spread built in.

Such securitisation transactions could continue to rise in the second half of the year, said brokerage house CLSA in a report. The number of sellers, however, may outweigh the number of buyers, making the market more lucrative for banks.

While NBFCs/HFCs are eager to sell, it will be a buyers’ market. Those with larger retail books and a track record of securitisation relationships will find better demand. Those with better capitalisation, higher-credit ratings and balanced ALMs have lesser urgency to sell and hence have better bargaining power relative those with larger wholesale books and capital-market related loans.
CLSA Report.

Banks with a relatively low credit-deposit ratio may be in a better place to purchase loan portfolios, added Gupta.

Also read: Will Strains Within The NBFC Sector Hurt The Flow Of Funds To The Economy?

Could It Be Risky For Banks?

When a bank purchases a loan portfolio via the ‘direct assignment’ route, it bears the credit risk associated with that portfolio. As such, the risk in such purchases depends on the ability of the bank to assess the quality of the loan pool that it hopes to purchase.

However, there are some regulatory safeguards built in to the regulations for such transactions. For instance, the RBI guidelines say that if an NBFC is selling a portfolio of loans with original maturity of 24 months or less, it must retain a minimum of 5 percent of the book value of the loans being securitised. This is known as the minimum retention requirement. For loans with original maturity of more than 24 months, the MRR is set at 10 percent.

The MRR is primarily designed to ensure that the originating NBFCs have a continuing stake in the performance of securitised assets so as to ensure that they carry out proper due diligence of loans to be securitised.
RBI Guidelines.

Banks may see this route as less risky than increasing exposure directly to NBFCs, said CLSA. “Banks are also preferring to buy out loans rather than direct lending to NBFCs, given the reasonably higher exposure and risk-aversion to taking additional exposure and asset quality risk.”

Gupta adds that he would expect most loan portfolio sales to happen in segments like microfinance loans, mortgage loans and tractor or commercial vehicle loans, where there is some visibility of asset quality trends and performance. Portfolios with personal loans, unsecured loans and loans against property may be muted interest though due to concerns about asset quality, Gupta said.