Thematic | July 2018
NBFC
Ind-AS
A new, contemporary look
Sandeep Gupta
(S.Gupta@MotilalOswal.com), +91 22 3982 5544;
Alpesh Mehta
(Alpesh.Mehta@MotilalOswal.com); +91 22 3982 5415
Mohit Baheti
(Mohit.Baheti@motilaloswal.com), +9122 3846 2492;
Somil Shah
(Somil.Shah@MotilalOswal.com), +9122 3312 4975
 Motilal Oswal Financial Services
NBFC
Contents: NBFC – Ind-AS: A new, contemporary look
Summary ............................................................................................................................. 3
NBFCs – a paradigm shift in financial reporting..................................................................... 7
HFCs to witness gains, Corporate financiers impacted ........................................................ 24
Opportunities and key challenges ....................................................................................... 28
Investors are advised to refer through important disclosures made at the last page of the Research Report.
Motilal Oswal research is available on www.motilaloswal.com/Institutional-Equities, Bloomberg, Thomson Reuters, Factset and S&P Capital.
July 2018
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Thematic | July NBFC
2018
NBFC
Ind-AS: A new, contemporary look
Entering an era of transparent reporting and enhanced disclosure practices
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Indian NBFCs are all set to adopt IFRS-converged Indian Accounting Standards (Ind-AS)
from FY19. This will bring in more transparency in the system and ensure disclosures
are in line with global standards. Moreover, it will change the way companies conduct
their business in terms of structuring their loans (upfront fees v/s yields), liabilities,
employee compensation, and securitization/assignment, amongst others.
In the absence of any circular from the RBI, NBFCs will follow accounting policies
based on Ind-AS, but continue with older norms for regulatory reporting.
We believe the impact on reserves for most NBFCs will be neutral to positive, given (a)
largely mono-line businesses with a proven track record, near-zero any other form of
stressed loans (besides NPA) and high provisioning and (b) reversal of DTL recognized
on special reserves.
Companies having ZCBs, structured debt, preference shares, a higher share of lumpy
fees and higher ESOP cost would be adversely impacted.
We believe that HFCs are best placed to face the transition, while corporate lenders
will be adversely impacted.
Transition to Ind-AS means much more than just accounting change
Ind-AS will bring more transparency in accounting and disclosures. It will also
change the way companies conduct their business in terms of employee
compensation, structuring of loans, securitization/assignment of loans, issuance
of liabilities, etc.
In our view, the migration to the new norms will lead to major differences in the
presentation of financials on account of recognition of (a) fee income/loan
origination expenses, (b) interest income on impaired assets, (c) impairment
provision, (d) fair valuation of ESOP, (e) interest expense on ZCBs/deep discount
bonds/preference shares, (f) securitized loans, (g) gains on assignment, (h) DTL
on special reserve and (i) investment classification and valuation, as well as
consolidation of entities based on control.
HFCs will see a benefit in the form of provisioning and reversal of DTL. Most
large HFCs have a proven track record of low LGDs and PDs, and carry
additional/contingent provisioning on balance sheet. Processing fees on core
housing loans may be replaced by legal and other charges, and thus, not impact
the income statement. DSA expense amortization and a reduction in credit cost
are added benefits for HFCs. However, companies in the affordable housing
segment with a limited track record and a higher share of fee income could see
some impact. Companies with ZCCBs/structured liabilities/ESOPs are likely to
see higher expenses getting charged through the income statement.
Corporate financers may witness higher provisioning, deferment of fee income
and a rise in employee expenses. Vehicle financers may see an impact on their
securitization activity (awaiting final regulation on this) and a minimal impact on
provisioning.
Overall, the impact of Ind-AS convergence on our NBFC coverage universe will
be neutral to positive.
3
HFCs to witness gains; corporate financiers most impacted
July 2018
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Several opportunities, but challenges remain
Ind-AS is likely to bring in more transparency in the system and ensure
disclosures are in line with global standards. Since Ind-AS is based on the
principle of ‘substance over form’ and ‘fair valuation’, it is likely to present a
more contemporary picture of the state of affairs of the companies.
Under Ind-AS, companies would need to (a) prepare an opening balance sheet
on the transition day, (b) recognize assets and liabilities based on the new
norms and (c) route the difference through the reserves. This will imply a
material change in networth. We believe that investors need to be watchful of
adjustments made by companies during the migration.
We believe that several migration-related challenges still remain. These include
(a) clarification from the regulators on implementation of ECL, securitization,
etc., (b) high dependence on management’s estimate, (c) lack of expertise on
fair valuation, (d) varying level of corporate preparedness and (e) a separate set
of financial statement required for filings with the regulator.
NBFC: Impact from Ind-AS transition
NBFCs
Deferment of
Fee Income
Amortization of
Interest on ZCCB Upfront gain Reversal of DTL
Expected Credit
Employee
loan origination
/ Deep Discount recognition on
on special
Loss (ECL) model Benefit Expenses
expenses
Bonds / Pref
direct
reserve
Dividend
assignment
HDFC
Indiabulls Housing Finance
PNB Housing Finance
Dewan Housing Finance
REPCO
LIC Housing Finance
Gruh Finance
L&T Finance Holdings
Mahindra Finance
Shriram Transport Finance
Shriram City Union Finance
Cholamandalam Investment
and Finance
Bajaj Finance
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Source: MOSL
Impact:
Positive
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l
Marginally Positive
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Neutral
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l
Marginally Negative
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l
Negative
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Exhibit 1:
Major changes and their impact on key metrics for NBFCs
Key difference areas
Revenue Recognition
Fee income on loans
extended
Investment income
IGAAP
Ind-AS
Impact due to Ind-AS
No specific guidelines. Generally
recognized on receipt basis.
Instruments classified as (a) non-
trade investment and (b) trade
investment carried at cost.
Fee income is amortized over life
of loan/period of service using
effective interest rate.
Instruments classified as (a)
amortized cost: carried at cost, (b)
FVTOCI: with MTM gains/losses in
reserve and (c) FVTPL: with MTM
gains/losses in P&L.
Interest income is recognized on
the basis of effective interest rate
on net carrying value of asset
(gross-impairment provision).
Temporary deferral of revenue
recognition leading to impact on
PPoP and earnings.
Higher volatility in treasury
income. Increase in networth on
one-time fair valuation on
transition.
RBI guideline under IGAAP was
conservative. Ind-AS would,
however, lead to regulation of
otherwise lumpy interest income
on NPA.
Interest income on NPA
Interest income on NPA to be
recognized on realization basis.
Gains on direct
assignment
Financial instruments
Loan impairment
provisioning
Gains are amortized over the tenure
Gains would be recognized upfront
Up-fronting of gains on
of assignment.
in income statement, as loans
assignment in income statement.
assigned would be de-recognized.
Impairment provision based on RBI
guidelines, which is more in line
with incurred loss model.
Discount on issue/premium on
redemption charged through
reserves.
Interest expenses for structured
bonds charged on accrual basis.
Expected credit loss (ECL)
framework to be applied for loan
impairment provision.
Charged through income
statement on EIM method.
Early recognition of impairment
provisioning on loan book based
on the three-stage ECL model
and variables of PDs/LGDs.
Decrease in NII.
Borrowing cost on deep
discount
bond/redemption
premium payable on
maturity
Interest expenses on
structured bonds
Interest expenses would be
recognized on EIR basis.
Substance rather than form drives
classification of financial
instrument.
Redeemable preference shares
treated as debt, and preference
dividend as finance cost.
Mandatory to account for ESOPs
cost on fair valuation.
Classification of Financial
Legal form of financial instrument
Assets and Financial
drives classification.
Liabilities
Preference dividend on
redeemable preference
shares
Employee benefits
ESOPs
Long-term employee
benefit plans
Termination benefits
Decrease in NII in the earlier
years compensated by increase
in subsequent years.
Existing financial instrument
would need reclassification, E.g.,
preference shares, perpetual
bonds.
Decrease in NII.
Preference dividend is shown as
appropriation to profits.
Optional to account for ESOP cost
on intrinsic basis or fair valuation.
Gains/ losses on change in actuarial
assumptions charged to income
statement.
Benefit expense to be recognized
when employer becomes legally
liable (e.g. employee accepts VRS).
Investments are carried at lower of
Cost or fair value with only losses
recognized in income statement.
Increase in employee costs.
Gains/losses on change in actuarial
Reduction in volatility of income
assumptions charged to reserves.
statement.
Benefit expense to be provided for
Upfront recognition of
on the basis of constructive
termination benefit-related
liability.
expenses.
Investment carried at FVTPL and
Increase in tax expenses (MAT)
FVOCI would be fair value, leading
due to unrealized MTM profits
to unrealized MTM gains subject to
on investments.
MAT. Also, transition gains would
be subject to MAT.
Reversal of DTL provisions as on
FY18 in networth and no
recurring charges in income
statement.
Income tax
MAT on unrealized
investment MTM gains
Reversal of DTL on
special reserve
Deferred tax liabilities to be
Ind-AS does not require creation of
accounted on special reserve, based
deferred tax on amount
on the NHB prudential guidelines
transferred to special reserve.
for HFCs.
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Key difference areas
Others
Loan processing
expenses
Recognition of
securitized loan assets
IGAAP
Ind-AS
Impact due to Ind-AS
Generally recognized on upfront
basis.
Transaction costs on loan
Deferral of cost recognition
origination are amortized over life
leading to expansion of PPoP.
of loan.
Loans securitized are de-recognized
True sale criteria to be fulfilled for
except for the MRR amount, based
the loans to be eligible for de-
on the IRACP guidelines.
recognition, i.e., only when all
contractual rights to cash flow
transfer to buyer.
New loans securitization would
not be de-recognized due to
non-fulfillment of ‘True sale
criteria’, leading to an impact on
RoA.
Exhibit 2:
Ind-AS changes to impact income statement and networth
Particulars
Revenue
recognition
Fee income on loans
Interest income on NPAs
Investment Income
Gains on direct assignment
Financial
Instruments
Impairment provision- expected credit Loss model
Borrowing cost on deep discount bond/redemption premium payable
on maturity
Interest expenses on structured bonds
Classification of Financial Assets and Financial Liabilities
Preference dividend on redeemable preference shares
Employee Benefit
Income Tax
Others
Actuarial gain / loss
Fair valuation of ESOPs
MAT impact on MTM gain on fair valuation
DTL on special reserve
Loan processing fee
Transition t o Ind AS – one-time impact
Income Statement
Net-worth
Source: MOSL
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NBFCs – a paradigm shift in financial reporting
Indian NBFCs are undergoing a big shift in the way they report financials after
migrating to Ind-AS from April 2018. Ind-AS, which is based on the principle of
‘substance over form’ and ‘fair valuation,’ differs materially from IGAAP, which is
focused on ‘legal form’ and ‘conservatism.’ Migration to the new norms will lead to
major differences in the presentation of financials on account of recognition of (a)
fee income/loan origination expenses, (b) interest income on impaired assets , (c)
impairment provision, (d) fair valuation of ESOP, (e) interest expense on ZCBs/deep
discount bonds/preference share capital, (f) securitized loans , (g) gains on
assignment, (h) DTL on special reserve, and (i) investment classification and
valuation, as well as consolidation of entities basis control. .
Ind-AS, based on the
principle of (a) substance
over form and (b) fair
valuation, would
significantly impact NBFCs
Transition to Ind-AS – much more than just accounting change
NBFCs will transition to Ind-AS from FY19 based on the timeline specified by the
Ministry of Corporate Affairs (MCA). However, for banks, the RBI has given a
one-year extension for transition to the new accounting norms, considering the
significant impact and the lack of preparedness.
We believe that the transition to Ind-AS involves much more than just a
technical challenge. It will be one of the biggest fundamental changes to affect
the non-banking and financial services industry for many years.
The transition will lead to some changes in the way businesses are being
conducted today in terms of employee compensation, structuring of loans
(upfront fees v/s yields), and securitization, among others.
Beyond accounting, Ind-AS requires companies to make extensive disclosures.
This will ensure greater transparency and efficient decision making.
Phase I
Phase II
FY19
FY18
Exhibit 3:
Roadmap for implementation of Ind-AS for NBFCs
Year of adoption
Comparative year
Companies covered
Listed companies
Unlisted companies
Group companies
NBFCs with net worth
Companies listed or in the process of being listed
> = INR5b
NBFCs with net worth
Companies having net worth
> = INR5b
> = INR2.5b
Applicable to holding, subsidiaries, JVs or associates of companies covered above
Source: MCA, MOSL
FY18
FY17
HFCs to adopt Ind-AS, but continue with IRACP for compliance reporting
National Housing Bank (NHB), in its circular dated 14
th
June 2018, reiterated that
HFCs are required to adopt and implement Ind-AS based on the accounting
standards and guidance notes issued by ICAI and as notified by the MCA.
However, HFCs, for regulatory and supervisory purposes, are required to
continue following the existing norms, including prudential norms, and other
related circulars, etc.
HFCs, thus, would need to maintain dual books of financial accounts with
financial results. We expect the RBI will come out with similar guidelines for
other NBFCs (Click
here for circular).
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Earnings and networth to be impacted under new norms
Our analysis highlights that significant differences lie in financial instruments,
revenue recognition, employee benefits and income taxes in the NBFC sector.
Besides this, accounting changes related to business combinations and
consolidation would be necessary.
Such changes are likely to impact both earnings and networth of companies.
KEY IMPACT AREAS FOR NBFCs WHILE TRANSITIONING TO IND-AS
01
FINANCIAL
INSTRUMENTS
02
REVENUE
RECOGNITION
03
INCOME
TAXES
04
EMPLOYEE
BENEFITS
Impairment
provisioning - ECL
model
Classification,
measurement
and de-
recognition of
financial
instruments.
Fee income
recognized on EIR
basis
MTM gains to be
recognized
Interest income
recognition on
NPA
DTL on special
reserve
Deferred tax on
balance sheet
approach
Fair valuation of
ESOP
Actuarial impact
in OCI
IND-AS TO IMPACT NBFCS’ EARNINGS AND NETWORTH
INCOME STATEMENT
NPA impairment provision based on 'Expected Credit
Loss' model
Deferment of fee income on loans and guarantees
Deferment of loan origination expenses
Recognition of interest expenses through income
statement on ZCCB and deep discount bonds.
Recognition of interest cost on structured bonds on EIR
basis.
Recognition of issue expenses on raising structured
products through income statement
Early recognition of gains on direct assignment of loans
No requirement of creation of DTL on special reserve
Gain/loss on fair valuation of investment portfolio (for
FVTPL and investments carried at amortized cost)
Recognition of interest income on NPAs
Actuarial gain/loss on long-term employee benefits to
get routed through reserves
Fair valuation of ESOPs
Recognition of employee terminal benefits on the basis
of constructive liability
Dividend on preference shares
NET WORTH
All adjustments that impact income statement.
All adjustments to be made in opening reserves while
transitioning to Ind-AS (primarily loan loss provisioning
and DTL on special reserves)
Transactions such as hedge accounting of derivatives,
actuarial gain/loss, etc., routed directly through OCI
reserves
Fair valuation of investment portfolio (for FVOCI
portfolio)
Classification and measurement of financial assets and
financial liabilities
Tax adjustment following the balance sheet approach
under Ind-AS
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Deferment of fee income/origination cost on loans
NBFCs derive a significant proportion of their earnings through fees and service
charges. Most of the NBFCs generally follow accrual methods to recognize fee
income.
Under the previous regime, loan processing fees were recognized upfront in the
profit, and loss account and costs relating to origination of loans (DSA expenses)
were debited to the profit and loss account.
Under Ind-AS, integral fees (loan linked fees) – such as origination fees – would
be adjusted in the effective interest rate (EIR) and amortized over loan maturity.
On the other hand, non-integral fees, such as specific services fees, would
continue to be accounted like under IGAAP.
Recognition of integral fee on amortized basis over the life of the loan using the
‘effective interest rate’ method will lead to time deferment in recognition of
revenue.
Exhibit 4:
Integral & non-integral fees to be recognized over different time horizons
Adjusted to
EIR:
Intregal
Fee
Not
Adjusted to
EIR:
Non-
Integral Fee
Specific service fees
Origination fees
received on creation of
financial asset
Orgination fees paid
on creation of financial
liability
Loan syndication fees
Commitment fees
(when loan is not
measured at FVPTL);
involves specific
lending arrangement
Commitment fees
(when loan is not
measured at FVPTL);
does not involves
specific lending
arrangement
Source: MOSL
Retail financiers to see
minimal impact (lower fee
income) relative to
corporate financiers (higher
fee income)
The impact of deferment of fee income will vary among NBFCs on the basis of
loan book. Further, the impact will be offset by amortization of loan origination
expenses, which are currently being expensed.
Retail financiers – vehicle financiers, housing financiers and MFIs
derive fee
income typically in the range of 0.5-2% of the loan amount, followed by
consumer financiers
(0.25% of the loan amount).
Retail financers have higher loan origination expenses, which will be deferred
and recognized over the tenure of the loan, offsetting the impact of deferral of
fee income.
Among NBFCs, companies having a higher share of developer and corporate
loans may be adversely impacted. Fees on corporate book are higher than
processing fees, which would be amortized over the tenure of loans, leading to a
net negative impact.
Also, fee income, which would have been already recognized on current
outstanding loan, will be reversed in opening transition. This reversed fee
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income would now be recognized using the effective interest rate on the
remaining part of loans.
Since this provision will be applicable retrospectively, this would impact
companies with a high-growth portfolio relative to those with a steady-growth
portfolio.
NII to be impacted on factoring in redemption premium as interest cost
Companies issuing deep
discount bonds/structured
bonds to see increase in
interest cost
A few NBFCs issue deep discount coupon bonds redeemable at a premium.
Currently, the issue expenses, discount and redemption premium are charged
directly through reserves. Ind-AS requires the discount/premium payable on
such bonds to be charged off to the profit and loss statement on an EIR basis,
impacting NII.
Also, for the structured bonds (such as one with a step up in interest payments
over the life of the bond) issued by the companies, interest expenses will now
be factored on the EIR basis rather than the accrual basis. This will lead to higher
interest recognition during the earlier years, with an offsetting impact in the
later years.
Under the erstwhile regime debenture/bond issue, expenses were permitted to
be charged off through the reserves. Under Ind-AS, the same needs to be routed
through the income statement.
Exhibit 5:
NBFCs: Interest cost on ZCCB to impact earnings (INR m)
Company
HDFC
Indiabulls Housing Finance
Dewan Housing Finance
Punjab National Housing Finance
*FY18 Annual Report NA
#On Standalone Financial Statements
#
Amount
3,038
2,621
1,147
-
FY17
NII %
3.1%
6.6%
7.6%
-
PAT %
4.1%
9.0%
12.4%
-
Amount
3,840
*
989
127
FY18
NII %
3.4%
*
4.1%
0.8%
PAT %
4.5%
*
8.4%
1.5%
Source: Company, MOSL
Exhibit 6:
IBHF currently routes debenture issue expenses and premium through reserves
Particulars
Debenture issue expenses (Net of tax)
Premium on redemption of NCD (Net of tax)
*For FY17, FY18 Annual Report NA
INR m*
1,253
1,368
2,621
Source: Company, MOSL
Forward-looking ECL approach to impact loss provisioning
Three-stage ECL model
would lead to early
recognition of loan loss
provisioning
The forward-looking expected credit loss (ECL) approach for loan impairment
provisioning is significantly different from the current provisioning norms under
the RBI-prescribed income recognition, asset classification and provisioning
(IRACP).
ECL model follows a three-stage approach, under which loan impairment
provisioning is measured either on ‘12-month ECL’ or ‘Lifetime ECL,’ depending
on the credit quality assessment of the financial instrument.
NBFCs will have to provide for loss allowance, not only based on their portfolio’s
historical loss experience, but also by factoring in their future expectations and
the macro-economic environment.
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In contrast, under the IRACP norms, the provisioning is based on the objective
criteria fixed by the RBI, which are based on the 90-day past-due concept for
both banks and NBFCs. These IRACP norms waited for actual impairment to be
incurred before requiring a loss allowance thereon, and hence, it is criticized for
being a ‘too little, too late’ approach.
Furthermore, as a prudent measure to build a cushion against the build-up of
non-performing assets (NPA), the RBI has prescribed a provision on standard
assets.
Exhibit 7:
Ind-AS prescribes a three-stage asset classification model
Default Timeline
0 - 30 Days
31 - 60 Days
61 - 90 Days
More than 90 Days
NPA <= 1 year
NPA <= 1 year
Sub-Standard <= 1 year
>1 year Sub-Standard <= 3 year
Sub-Standard > 3 year
IRACP
SMA 0
SMA 1
SMA 2
NPA
Sub-Standard: Secured
Sub-Standard: Unsecured
Doubtful: Up to 1 year
Doubtful: 1 - 3 year
Doubtful: more than 3 year
IRACP – Provision
0.4%
ECL
Stage I
Stage II
15.0%
25.0%
25.0%
40.0%
100.0%
Source: MOSL
Stage III
Exhibit 8:
Overview of the ECL model
Change in credit quality since intial recognition
Stage 1:
Performing assets (initial
recognition)
Stage 2:
Underperforming (assets
with significant increase in
credit risk since initial
recognition)
Stage 3:
Non-
performing
(credit
impaired
assets)
12 month
expected
credit
losses
Effetctive
interest on
gross carrying
amount
Lifetime
expected
credit
losses
Effective
interest on
gross carrying
amount
Lifetime
expected
credit
losses
Effective interest
on amortised
cost carrying
amount (that is,
net of credit
allowance)
Source: MOSL
Stage 1: Performing assets with low credit risk
This stage involves the performing financial instruments, which include
originated/purchased financial instruments or low-credit-risk financial
instruments.
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For these assets, 12-month expected credit losses (ECL) are recognized and
interest revenue is calculated on gross carrying amount of the asset (i.e.,
without deduction for credit allowance).
12-month ECLs are the expected credit losses that result from default events
that are possible within 12 months after the reporting date.
Stage 2: Underperforming assets with significant increase in credit risk
This stage involves the underperforming financial instruments that have had a
significant increase in credit risk since initial recognition (unless they have low
credit risk at the reporting date) but that do not have objective evidence of
impairment.
For these assets, lifetime ECL are recognized, but interest revenue is still
calculated on gross carrying amount of the asset.
Lifetime ECLs are the expected credit losses that result from all possible default
events over the expected life of the financial instrument. Expected credit losses
are the weighted average credit losses, with the probability of default (‘PD’) as
the weight.
Stage 3: Non-performing assets (NPA) with objective evidence of
impairment
This stage involves non-performing financial instruments that have objective
evidence of impairment at the reporting date. For these assets, lifetime ECLs are
recognized, and interest revenue is calculated on the net carrying amount (that
is, net of credit allowance). Financial instrument in this stage will generally be
individually assessed.
Key observation:
The ECL model relies on relative assessment of credit risk. This means that a loan with the same characteristic could be
included in stage 1 for one NBFC and in stage 2 for another, depending on the credit risk at initial recognition of the loan
for each entity.
Moreover, a NBFC could have different loans with the same counterparty that are included in different stages of the
model, depending on the credit risk that each loan had at origination.
Conclusion:
The application of ECL framework would largely vary across NBFCs depending upon risk management strategies adopted,
and historical performance.
Exhibit 9:
Provision requirement to increase as assets shift to a higher stage
Particulars
Asset categorization
Credit quality
Credit risk
Basis of provisioning recognition
Interest
Stage 1
Performing
Not deteriorated significantly since
its initial recognition
Low
12 month ECL
On gross basis
Stage 2
Under performing
Deteriorated significantly since
its initial recognition
Moderate to high
Life time ECL
On gross basis
Stage 3
Non-performing
Objective evidence of
impairment
Very high
Life time ECL
On net basis (gross carrying
value minus loss allowance)
Source: MOSL
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Change in stage of asset classification under ECL model remains critical
ECL model prescribes ‘significant increase in credit risk’ as a catalyst leading to
downgrading of financial assets from stage I to stage II and ultimately to stage
III.
Significant increase in credit risk depends on quantitative as well as qualitative
factors of financial assets. Ind-AS 109 provides list of events (such as financial
difficulty of borrower, breach of contract and disappearance of an active market
for that financial assets) which may solely or collectively indicate a significant
increase in credit risk.
Further, the Ind-AS provides for certain rebuttable presumptions, which set
certain backstops to the continuation of the asset/ loan exposure in a particular
stage of asset classification.
Exhibit 10:
Significant increase in credit risk
Change in forward-looking marginal lifetime Pds, guided by credit
scores, ratings, risk categories and collective assessment of effects
of forward-looking information (most sophisticated approach)
It may be possible to use changes in 12months Pds, for certain loans
Challenge to define significance thresholds
Yes
Yes
Watch lists (Wholesale)
Ratings / credit scores
Changes in behavior
Death, divorce, unemployment or bankruptcy
Expectations of forbearance
Market indicators, e.g. credit spreads, bond spreads
Business environment, technological changes, market prices
Yes
>30 days past due presumption
Forbearance
Covenant breaches
Source: MOSL
Rebuttable presumption – a BACKSTOP
Significant increase in initial credit risk (migration from stage I to stage II)
Regardless of the way in which an entity assesses significant increase in
credit risk, there is a rebuttable presumption that the credit risk on a
financial asset has increased significantly since initial recognition when
contractual payments are more than 30 days past due.
This presumption can be rebutted only if there is reasonable and
supportable evidence that there has been no significant increase in the
credit risk. For example, where non-payment is due to administrative
oversight, instead of resulting from financial difficulty of the borrower.
Objective evidence of impairment /default (migration from stage II to stage III)
Ind-AS 109 states that when defining default for the purposes of
determining the risk of a default occurring, an entity shall apply a default
definition as used for internal credit risk management purposes.
July 2018
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However, there is a rebuttable presumption that default does not occur
later than when a financial asset is 90 days past due unless an entity has
reasonable and supportable information to demonstrate that a more lagging
default criterion is more appropriate.
Key observation:
The rebuttable presumption of 30-90 day by Ind-AS 109 may bring consistency at some level. It would also strengthen
credit risk management and facilitate better repayment discipline. Also, the 90-day threshold is consistent with the IRB
approach under the Basel framework as well as with the extant RBI guidelines.
The transition to ECL is subjective framework based on management judgment,
which will make it difficult for various stakeholders such as the RBI and auditors
to exercise audit and make comparison across banks.
Although the ECL model is forward-looking, historical information is always
considered to be an important anchor or base to measure the expected credit
losses. However, historical data should be adjusted on the basis of current
observable data to reflect the effects of current conditions and forecasts of
future conditions.
Calculating Expected Credit Loss (ECL)
ECL = PD * LGD * EAD * DF
Where,
Probability of Default (PD):
PD is the probability of borrowers defaulting on their obligation in the future
based on historical experience and future estimation. Each financial institution
would define its own terms of default depending on internal credit risk
management for relevant loan portfolio, historical experience, and future
estimation, among others.
PD is representative of asset quality, and thus, varies across different stages of
loan portfolio. We believe that a parallel analogy could be drawn from loan
portfolio and historical slippage rate to estimate PDs. For instance, housing
financiers with lower historical slippage ratios (like GRUH) in the past would
typically have lower PDs than financiers with higher slippage (like MMFS).
NBFCs would need to categorize loan portfolios based on different borrower
class (such as corporate, retail and agricultural) and further sub group into
different tranches based on the homogenous pattern. Corporate loan book
could be further categorized into different sectors such as cement, power and
infrastructure. Retail loan book could be categorized depending on the product
category, the target customer profile, geography and so forth.
Loss Given Default (LGD)
LGD is the estimated loss from a transaction once a default has been incurred.
As LGD is independent of asset quality, it is applied uniformly across various
stages.
LGD depends on the type and amount of collateral and is exposure specific, i.e.,
different exposures to the same borrower may have different LGDs.
14
PDs varies across stages of
loan portfolio and depends
on internal credit risk and
historical experience
LGDs applies uniformly
across stages of loans and
depends on type and
amount of collateral
July 2018
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NBFC
Exposure at default (EAD):
EAD is an estimation of exposure of banks in the event of default.
Provision coverage ratio – critical to access the impact
To understand the company-wise impact of ECL provision, one needs to also
factor in the provision coverage ratios and outstanding provisions that
companies have been maintaining. A company carrying a higher provision
coverage ratio is less susceptible to the one-time impact on provisioning and is
also less likely to witness a steep increase in the credit cost on migration to
IndAS.
Exhibit 11:
Higher GNPA for vehicle financiers and corporate financiers (INR b)
GNPL
NPL
53.9
39.2
23.0
11.4
2.9
BAF
For FY18
12.8
7.1
8.1 5.0
DHFL
9.4
0.7 -
GRUH
HDFC
13.0
4.1
7.1
LTFH
MMFS
33.4
19.7
1.9 1.4
PNBHF
2.8 1.3
REPCO
24.6
9.4
21.3
47.0
73.8
CIFC
IBHFL
LICHF
SCUF
SHTF
Source: Company, MOSL
Exhibit 12:
Higher GNPA for vehicle financiers and corporate financiers (%)
GNPL %
NPL %
6.5
1.4 0.3
BAF
For FY18
3.0
1.7
0.8 0.5
DHFL
0.5 -
GRUH
1.0 0.6
HDFC
0.8 0.3
IBHFL
0.8 0.4
LICHF
4.0
LTFH
8.5
3.6
MMFS
0.3 0.2
PNBHF
2.9 1.3
REPCO
9.0
3.4
SCUF
7.7
2.2
SHTF
CIFC
Source: Company, MOSL
Determining impact of ECL
The impact of ECL depends on critical variables of quality of loan book (loss
given default), historical rate of default (Probability of default) and provision
coverage ratio.
Although assessing the PDs would be a dynamic task, we have tried to quantify
the LGDs on the basis of loan portfolio and derive at an approximate loss
provision required on GNPAs (stage III) and assessing the remaining provision
that will be available for standard assets (stage I & stage II).
While we expect LGDs for HFCs to range from 20% to 30%, those for VFCs and
Consumer finance are likely to range from 30% to 50%. We expect corporate
financiers like LTFH to have higher LGD of 65%, given the restructured loan
book.
July 2018
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Low historical asset slippage
and existing adequate
provisioning result in
minimal impact on HFCs
Accordingly, we find that:
Most HFCs have adequate provision available for stage I and stage II assets
in the range of 1.2% to 1.6%. While, GRUH and LICHF despite having lower
provision available (at 0.8% and 0.6% respectively) for stage I and stage II
loan assets, based on the lower historical slippages, we expect minimal
impact.
For VFCs, although LGDs for SHTF is relatively high at 50%, higher provision
available could mitigate the impact of additional provision on stage I and
stage II loan assets. We expect LGDs for CIFC to be at 35% as ~30% of loan
book being non vehicle finance.
Among NBFCs, we expect LTFH to require additional provisioning
requirements while migrating to Ind-AS.
Exhibit 13:
Corporate financing companies may witness a provisioning shortfall under Ind AS (INRb)
NBFCs
Loan Book
Standard
Assets
(a)
Housing Finance Companies
DHFL
GRUH
HDFC
IBHF
LICHF
PNBHF
REPCO
CIFC
MMFS
SHTF
BAF
SCUF
LTFH
905.2
155.7
3,594.4
1,220.5
1,663.2
570.1
98.6
366.5
510.0
796.7
771.3
273.7
835.1
897.1
155.0
3,555.2
1,211.1
1,650.2
568.3
95.7
353.7
463.1
723.0
759.8
249.0
781.2
8.1
0.7
39.2
9.4
13.0
1.9
2.8
12.8
47.0
73.8
11.4
24.6
53.9
30%
20%
20%
30%
20%
20%
20%
35%
40%
50%
50%
50%
65%
2.4
0.1
7.8
2.8
2.6
0.4
0.6
4.5
18.8
36.9
5.7
12.3
35.0
16.4
1.3
50.0
17.6
12.5
7.0
2.0
7.1
29.1
55.3
11.5
16.3
23.6
14.0
1.2
42.2
14.7
9.9
6.6
1.4
2.6
10.3
18.5
5.8
3.9
(11.4)
1.6%
0.8%
1.2%
1.2%
0.6%
1.2%
1.5%
0.7%
2.2%
2.6%
0.8%
1.6%
-1.5%
Source: Company, MOSL
GNPA
(b)
LGD* %
(c)
GNPA
Loss
(d) = (b) * (c)
Total Provision Remaining Provision available
on Loan Book Provision
on Std Assets
(e)
(f) = (e) - (d)
(g) = (f) / (a)
Vehicle Finance Companies
Consumer Finance Companies
Corporate Finance Companies
*Based on our estimates
July 2018
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NBFC
Employee benefits costs may rise
Employee costs under Ind-AS may vary from IGAAPs primarily on account of: (a)
share-based payments and (b) long-term employee benefits. Also, the
recognition of terminal liabilities will be required to be made on the basis on
constructive liability rather than the contractual liability, which will lead to early
recognition of provisioning (expenses) in the income statement.
Exhibit 14:
Employee cost recognition varies under Ind-AS
Long-term employee benefits
•Actuarial loss / gain
Share based payments
• Fair valuation of ESOPs
Source: MOSL
Fair valuation of ESOPs to impact earnings
Indian GAAP permits an option of accounting for ESOP using either the intrinsic
value method or the fair value method. Most NBFCs grant ESOPs to employees
and have opted to account at intrinsic cost.
Ind-AS, on the contrary, mandates employee share-based payments to be
accounted using the fair value method.
Fair valuation of ESOP is likely to increase employee cost and will have a
significant impact on key indicators such as earnings per share.
Exhibit 15:
ESOP fair valuation to impact profitability (INR m)
NBFC
BAF
CIFC
DHFL
GRUH
HDFC
IBHF
LTFH
PNBHF
* FY18 Annual Report NA
FY16
FV Net Impact
% of PAT
265
2.1%
-
-
(1)
0.0%
107
4.4%
-
-
352
1.2%
216
2.5%
NA
NA
FY17
FV Net Impact
% of PAT
305
1.7%
-
-
87
0.3%
62
2.1%
-
-
201
0.9%
85
0.8%
180
3.4%
FY18
FV Net Impact
% of PAT
484
1.5%
98
1.0%
176
1.5%
26
0.70%
6,017
7.1%
*
*
*
*
154
1.9%
Source: Company, MOSL
Actuarial-led volatility in employee cost to reduce in income statement:
Existing Indian GAAP requires actuarial gains/losses on re-measurement of net
defined liability (asset) to be charged through the income statement, which
leads to volatility in earnings. Ind-AS 19 Employee Benefits requires the impact
of re-measurement in net defined benefit liability (asset) to be recognized in
other comprehensive income, reducing volatility in the income statement.
July 2018
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NBFC
Exhibit 16:
Actuarial assumption changes have led to volatility in earnings for NBFC (INRm)
2016
NBFC
BFIN
CIFC
DHFL
GRUH
HDFC
IBHF
LICHF
LTFH
MMFS
PNBHF
REPCO
STFC
Actuarial
(Gain)/Loss
43
29
60
7
218
82
22
1
(141)
1
(2)
31
% of PAT
0.3%
0.5%
0.8%
0.3%
0.3%
0.4%
0.1%
0.0%
-2.1%
0.0%
-0.2%
0.3%
% of PPOP
0.2%
0.2%
0.5%
0.2%
0.3%
0.2%
0.1%
0.0%
-0.7%
0.0%
-0.1%
0.1%
Actuarial
(Gain)/Loss
122
96
26
10
172
29
196
2
95
13
(9)
20
2017
% of PAT
0.7%
1.3%
0.3%
0.3%
0.2%
0.1%
1.0%
0.0%
2.4%
0.3%
-0.5%
0.2%
% of PPOP
0.4%
0.7%
0.2%
0.2%
0.2%
0.1%
0.6%
0.0%
0.5%
0.1%
-0.3%
0.0%
Actuarial
(Gain)/Loss
119
(2)
30
3
96
*
*
*
243
(1)
*
20
2018
% of PAT
0.4%
0.0%
0.3%
0.1%
0.1%
*
*
*
2.9%
0.0%
*
0.1%
% of PPOP
0.2%
0.0%
0.1%
0.0%
0.1%
*
*
*
1.0%
0.0%
*
0.0%
* FY18 Annual Report NA
Source: Company, MOSL
Timing of recognition of termination benefits
Under Indian GAAP, termination benefits are required to be provided for based
on legal liability (rather than constructive liability) when an employee signs up
for the voluntary retirement scheme (VRS). This is generally a timing issue for
creating a provision. Under Ind-AS, termination benefits are required to be
provided for when the scheme is announced and management is demonstrably
committed to it. This will lead to up-fronting of termination benefits in the
income statement.
Securitization of assets
may not lead to de-recognition under Ind-AS
RBI guidelines currently provide explicit criteria such as ‘true sale’, ‘minimum
holding period’ (MHP) and ‘minimum retention requirement’ (MRR) for
De-recognition of assets
securitization of asset and subsequent de-recognition. This is significantly
would depend on meeting
different from the Ind AS de-recognition criteria, which provide for de-
the true sale criteria
recognition of assets when entities transfer or relinquish rights to collect cash
flow.
Currently, the originator retains a certain portion of the loan book to fulfill the
criteria of MRR – which if continued under Ind-AS would not result in de-
recognition, and hence, the originator would continue holding securitized loan
on its books.
Failing true sale criteria
This will result in an increase in loan book, and thus, make the balance sheet
more asset heavy for NBFCs. However, there would be no material impact on
would lead to recognition of
securitized assets ‘on
revenue recognition of gain on securitization, which is currently recognized on
books’
an amortized basis. Under Ind-AS, the gain would be recognized over the period
of securitization based on the effective interest method.
In the absence of any guidance, we expect (a) current RBI guidelines to continue
for securitization and (b) PSL classification norms for reporting purposes.
These provisions would be applicable for new loan securitized post Ind-AS
regime. Loan book securitized until FY18 would continue to be off-balance-
sheet, in line with the exemption provided under Ind-AS 101.
July 2018
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Exhibit 17:
Criteria under extant RBI regulations for de-recognition of assets
Type of loan
Minimum Holding period
(MHP)
Minimum Retention ration
(MRR)
Loans with original
maturity up to 2 years
Minimum number of
installment to be
received - 3/2 on
monthly/quartely loan
5% of the book value of
loan securitized
Loans with original
maturity of more than 2
years up to 5 years
Minimum number of
installment to be
received - 6/3 on
monthly/quartely loan
10% of the book value
of loan securitized
Loans with original
maturity of more than 5
years
Minimum number of
installment to be
received - 12/4 on
monthly/quartely loan.
10% of the book value
of loan securitized.
Source: MOSL
Exhibit 18:
NBFCs actively securitize loan book (INRb)
Securitization O/s as at FY18
15.2%
% of Loan Book
19.5%
10.2%
1.4%
55.6
CIFC
6.9
MMFS
124.2
155.7
IBHF
STFH
Source: Company, MOSL
Early recognition of gains on assignment of loans
De-recognition of loan
under direct assignment will
lead to upfronting of gains
on assignment
Over the past few quarters, NBFCs have been increasingly opting for the
assignment route, which leads to derecognize of loan under current norms. It
will continue to do so under Ind-AS (due to absence of MRR/MHP criteria).
Currently, NBFCs have to amortize the gain on assignment over the period of
loans. Under Ind-AS, as loans would be derecognized from the assignee’s book,
it would lead to front-ending of gains in the income statement.
July 2018
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NBFC
Exhibit 19:
Assignment a common practice amongst NBFCs (INR b)
Assignment O/s as at FY18
12.7%
% of loan book
1.8%
115.0
64.5
HDFC
DHFL
5.5%
31.3
PNBHF
2.8%
21.6
BAF
1.8%
6.7
CIFC
Source: Company, MOSL
Interest income on NPA to be recognized on EIR basis
Recognition of interest
income on NPA on EIR basis
would positively impact
NBFCs with higher GNPAs
The RBI guidelines require interest income on non-performing assets (NPAs) to
be recognized on a realization basis only.
Under Ind-AS 109, interest income is generally recognized on the effective
interest rate on the gross carrying amount of financial assets, depending on the
stage of the loan. In cases where a loan or an asset is considered impaired, (i.e.,
stage III), the interest income will be accounted for at the net amount (i.e., gross
carrying amount less provisions made).
This, in our view, will lead to upfront recognition of interest income on NPAs on
EIR basis. This will offer a reprieve to companies with a higher proportion of
GNPAs.
Recognition of gains/losses on investments
The extant guidelines provide for classification of investments as trade and non-
trade, and are carried at cost or fair value, whichever is lower. Under Ind-AS, all
financial assets initially have to be recorded in balance sheet at fair value. After
initial recognition based on Ind-AS 109, financial assets may be classified
subsequently measured at:
Fair valuation of investment
on transition date would
lead to positive impact on
networth
Amortized cost:
A financial asset is subsequently measured at amortized cost if
the asset is held within a business model whose objective is to collect
contractual cash flows that are solely payments of principal and interest (SPPI).
Fair valuation through other comprehensive income (FVOCI):
A financial asset
is subsequently measured at FVOCI if it meets the SPPI criterion and is held in a
business model whose objective is achieved by both collecting contractual cash
flows and selling financial assets. At initial recognition of an equity investment
that is not held for trading, an entity may present the subsequent changes in fair
value in other comprehensive income (OCI).
Fair valuation through profit and loss (FVTPL):
All other financial assets are
classified as being subsequently measured at FVTPL.
July 2018
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Exhibit 20:
Classification of Financial Assets
DEBT
DERIVATIVES
EQUITY
Contractual cash flow characteristics test
(at instrument level)
No
Yes
Business model test
(at an aggregate level)
Hold to
collect
contract
ual cash
flow
BM with obj. of
collecting
contractual
cash flow and
selling FA
Neither
of one
Held for trading
Yes
No
No
No
Conditional fair value option
(FVO) elected?
No
Amortized
cost
No
FVOCI (with
recycling)
Yes
No
FVOCI option
elected?
Yes
FVTPL
FVOCI (with
recycling)
Source: MOSL
NBFCs holding investment in financial assets, subsidiary, associate and joint
venture would need to classify these investments as carried at FVOCI or FVTPL
depending on the business model. Fair valuation of these investments would
lead to substantial gain in net worth and income statement (in case of FVTPL).
Also, Ind-AS provides an option to carry investment in subsidiary and associate
at cost. However, any option exercised to classify equity investment is
irrevocable.
While non-trade investments in debenture, government bonds and treasury
notes will have to be fair valued on the transition date, this would also lead to
one-time gain on networth.
MTM P&L gains and losses on investments carried at FVTPL would lead to
volatility in the income statement.
July 2018
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FAIR VALUE PRINCIPLE PRESCRIBED UNDER IND-AS
INVESTMENTS
AMORTISED
COST
FAIR VALUE
THROUGH
PROFIT & LOSS
(FVTPL)
FAIR VALUE
FAIR VALUE
THROUGH OTHER
COMPREHENSIVE
INCOME (FVTPL)
VALUATION
AMORTISED COST
FAIR VALUE
MTM Loss
NA
DEBITED TO P&L
DEBITED TO OCI
MTM GAIN
NA
CREDITED TO P&L
CREDITED TO OCI
REALISED GAIN
CREDITED TO P&L*
IGNORE
TRANSFER FROM
OCI TO P&L
*Amortized based on Effective Interest Rate (EIR) method
Source: MOSL
Deferred tax to witness significant changes on migration
Transition to Ind-AS would
lead to reversal of DTL
created on special reserve
as mandated by erstwhile
NHB circular
HFCs have provided for deferred tax liability in respect of special reserve created
based on the prudential guidelines issued by National Housing Bank (NHB) in
2014.
Managements of HFCs, however, believe that this special reserve created will
never be utilized, and thus, the tax liability will never be utilized. Under Ind-AS,
this guideline will thus become void.
We expect HFCs to maintain their stance of non-utilization of DTL, which would
lead to reversal of DTL in opening net worth, resulting in a positive impact for
most HFCs.
Exhibit 21:
DTL reversal on special reserve to positively impact HFCs (INRb)
DTL on Special Reserve
13.6%
% of Net Worth
11.7%
8.1%
39.2
4.8%
2.7%
1.7
HDFC
PNBHF
4.1
DHFL
1.9
GRUH
3.1%
3.8
IHFL*
0.9
Repco*
13.0
LICHF*
6.4%
Source: Company, MOSL
July 2018
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NBFC
Income tax on fair valuation gain:
Any fair valuation gain or loss on transition to
Ind-AS has to be included in book profit over a period of five years and
subjected to a minimum alternative tax. Also, any subsequent MTM gain or loss
will have to be included in book profits. This will lead to several financial entities
having significant investment book to pay tax under MAT.
Balance sheet approach under play:
Under Ind-AS, deferred taxes are
computed using a balance sheet approach for temporary differences between
the carrying amount of an asset or liability in the statement of financial position
and its tax base. Under IGAAP, taxes are computed using the profit/loss
statement approach for timing differences in respect of recognition of items of
profit or loss for the purposes of financial reporting and for income taxes.
No requirement for virtual certainty for recognizing DTA:
Where an entity has a
history of tax losses, the entity recognizes a deferred tax asset arising from
unused tax losses or tax credits only to the extent that it has sufficient taxable
temporary differences, or there is other convincing unabsorbed depreciation, all
deferred tax assets are recognized only to the extent that there is virtual
certainty supported by convincing evidence that sufficient future taxable income
will be available against which such deferred tax assets can be realized. Ind-AS
12 does not lay down any requirement for consideration of virtual certainty in
such cases.
Fixed assets revaluation:
On transition to Ind-AS, entities can measure all fixed
assets at fair value and can consider fair value as a deemed cost. The upward
revaluation can significantly boost revaluation reserves, and thus, net worth.
Land leases:
Ind-AS 17 deals specifically with land leases. Land leases are
classified as finance or operating leases based on the general criteria laid down
in the standard. When a lease includes both land and building elements, an
entity assesses the classification of each element as a finance lease or an
operating lease separately. Under Indian GAAP, no accounting standard deals
with land leases. According to an Expert Advisory Committee (EAC) opinion,
long-term land lease may be treated as finance lease.
Business combinations accounted under ‘purchase method’:
Ind-AS 103
requires all business combinations within its scope to be accounted under the
purchase method, excluding business combinations of entities or businesses
under common control, which are to be accounted using the pooling of interest
method. Current Indian GAAP permits both the purchase method and the
pooling of interest method in the case of amalgamation. However, the pooling
of interest method is allowed only if the amalgamation satisfies certain specified
conditions.
Consolidation:
IGAAPs require the preparation of financial statements only
when a company has one or more subsidiaries. However, Ind-AS requires
consolidated financials to be prepared even when an entity has one or more
joint ventures or associates and no subsidiaries.
Segmental disclosures made more robust:
Ind-AS requires segmental
information to be provided on how the chief operating decision-maker (CODM)
evaluates financial information for allocating resources and assessing
performance. This may require certain companies to change segment
disclosures consistent with internal reporting.
23
Other differences
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HFCs to witness gains, Corporate financiers impacted
HFCs will see a benefit in the form of provisioning and reversal of DTL. Most
large HFCs have a proven track record of low LGDs and PDs, and carry
additional/contingent provisioning on balance sheet. Processing fees on core
housing loans may be replaced by legal and other charges, and thus, not impact
the income statement. DSA expense amortization and a reduction in credit cost
are added benefits for HFCs. However, companies in the affordable housing
segment with a limited track record and a higher share of fee income could see
some impact. Companies with ZCCBs/structured liabilities/ESOPs are likely to
witness higher expenses getting routed through the income statement.
Corporate financers may witness higher provisioning, deferment of fee income
and a rise in employee expenses. Vehicle financers may see an impact on their
securitization activity (awaiting final regulation on this) and a minimal impact on
provisioning.
Consumer financers are likely to witness an adverse impact on their employee
cost and securitization activity, while they may benefit in terms of upfront
recognition of gains on assignment. We expect the impact of loan provisioning
to be neutral to slightly negative.
Overall, the impact of Ind-AS convergence on our NBFC coverage universe will
be neutral-to-positive.
Impact
Exhibit 22:
Material implications for many companies
Company
HDFC
Remarks
(a)
Fee recognition:
HDFC has ~27% corporate loan book, wherein fee income is
Marginally Negative
high and its amortization will impact earnings. Fee on retail loans is minimal and
could be offset against initial costs or deferred.
(b)
Loan origination expenses:
DSA charge amortization on retail loans will lead to
Marginally Positive
higher profitability in earlier years.
(c)
Fair valuation of ESOPs:
HDFC issued ESOPs in FY18. Annual fair valuation
Negative
impact for the same is ~INR12.0b (impact due to fair valuation of ESOPs for part
of FY18 stood at INR6.0b, 7.1% of PAT).
(d)
Expected credit loss:
HFCs have low LGD in the range of 10%-30% for GNPA,
Positive
which, in our view, will lead to adequate balance provision available (at ~1.2%)
for standard assets.
(e)
DTL reversal on special reserve:
Will increase FY18 networth by 6%.
Positive
(f)
Gain on direct assignment to be front-ended:
Assigned book as at FY18 stood at
Marginally Positive
INR64.5b, 1.8% of total loan book.
(g)
Redemption premium on ZCCB to be routed through income statement:
Negative
Interest cost amortized through reserve stood at INR3.8b, 4.5% of FY18 PAT.
(h)
Fair valuation of investment portfolio:
Fair valuation on investments will
Positive
positively impact networth on transition.
(a)
Loan origination expenses:
DSA charge amortization on retail loans will lead to
Marginally Positive
higher profitability in earlier years.
(b)
Expected credit loss:
HFCs have LGD in the range of 10%-30% for GNPA. For
Neutral
LICHF, balance available provision for standard assets stands low at 0.6%.
However, on the basis of lower historical slippages, we expect impact to be
neutral.
(c)
DTL reversal on special reserve:
Will positively impact FY17 networth by 12%.
Positive
LIC Housing
Finance
July 2018
24
 Motilal Oswal Financial Services
NBFC
Company
REPCO
Remarks
Impact
(a)
Loan origination expenses:
DSA charge amortization on retail loans will lead to
Marginally Positive
higher profitability in earlier years.
(b)
DTL reversal on special reserve:
Will positively impact FY17 networth by 8%.
Positive
(c)
Expected credit loss:
HFCs have low LGD in the range of 10%-30% for GNPA,
Positive
which, in our view, leads to adequate balance provision available (at ~1.5%) for
standard assets.
(a)
Fee recognition:
DHFL has ~35% non-retail loan book, wherein fee income is
Marginally Negative
high and its amortization will impact earnings. Fee on retail loans is minimal and
could be offset against initial costs or deferred.
(b)
Loan origination expenses:
DSA charge amortization on retail loans will lead to
Marginally Positive
higher profitability in earlier years.
(c)
Expected credit loss:
HFCs have LGD in the range of 10%-30% for GNPA, which,
Positive
in our view, leads to adequate balance provision available for standard assets at
~1.6%.
(d)
Fair valuation of ESOPs:
Further, DHFL issued fresh ESOPs in FY18. Its FV
Marginally negative
will adversely impact FY18 earnings by 1.5%.
(e)
DTL reversal on special reserve:
Will positively impact FY18 networth by 5%.
Marginally Positive
(f)
Gain on direct assignment to be front-ended:
Assigned book as at FY18 stood at
Marginally Positive
INR115.0b, 12.7% of loan book.
(g)
Redemption premium on ZCCB to be routed through income statement:
Negative
Interest cost amortized through reserve stood at 8.4% of FY18 PAT.
(a)
Fee recognition:
PNBHF has ~16% construction finance wherein fee income is
Marginally Negative
high and its amortization will impact earnings. Fee on retail loans is minimal and
could be offset against initial costs or deferred.
(b)
Loan origination expenses:
DSA charge amortization on retail loans will lead to
Marginally Positive
higher profitability in earlier years.
(c)
Expected credit Loss:
HFCs have LGD in the range of 10%-30% for GNPA, which,
Positive
in our view, leads to adequate balance provision available for standard assets at
~1.2%.
(d)
Fair valuation of ESOPs:
Will adversely impact FY18 earnings by 1.9%.
Marginally Negative
(e)
DTL reversal on special reserve:
Will positively impact FY18 networth by 3%.
Marginally Positive
(f)
Gain on direct assignment to be front-ended:
Assigned book as at FY18 stood at
Marginally Positive
INR31.3b, 5.5% of total loan book.
(g)
Redemption premium on ZCCB to be routed through income statement:
Marginally Negative
Interest cost amortized through reserve stood at 1.5% of FY18 PAT.
(a)
Fee recognition:
IBHFL has ~40% non-retail loan book, wherein fee income is
Marginally Negative
high and its amortization will impact earnings. Fee on retail loans is minimal and
could be offset against initial costs or deferred.
(b)
Loan origination expenses:
DSA charge amortization on retail loans will lead to
Marginally Positive
higher profitability in earlier years.
(c)
Expected credit loss:
HFCs have low LGD in the range of 10%-30% for GNPA,
Positive
which, in our view, leads to adequate balance provision available for standard
assets at ~1.2%.
(d)
Fair valuation of ESOPs:
Will adversely impact FY17 earnings by 0.9%.
Neutral
(e)
DTL reversal on special reserve:
Will positively impact FY17 networth by 3%.
Marginally Positive
(f)
Securitization:
Securitized book as at FY18 stood at INR124.2b, 10.2% of loan
Marginally Negative
book. Recognition of asset securitized (in future) could adversely impact ROAs.
(g)
Redemption premium on ZCCB to be routed through income statement:
Negative
Interest cost amortized through reserve stood at INR2.6b, 9.0% of FY17 PAT.
Dewan Housing
Finance
PNB Housing
Finance
Indiabulls
Housing Finance
July 2018
25
 Motilal Oswal Financial Services
NBFC
Company
GRUH Finance
Remarks
Impact
(a)
Loan origination expenses:
DSA charge amortization on retail loans will lead to
Marginally Positive
higher profitability in earlier years.
(b)
Expected credit loss:
HFCs have low LGD in the range of 10%-30% for GNPA. In
Neutral
case of GRUH, we expect balance provision available for standard assets to be at
0.8%. However, with low historical slippages.
(c)
Fair valuation of ESOPs:
Will adversely impact FY18 earnings by 0.7%.
Neutral
(d)
DTL reversal on special reserve:
Will positively impact FY18 networth by 14%.
Positive
Marginally Negative
Mahindra Finance (a)
Fee recognition:
Vehicle financiers derive typically 0.5-2.0% fee income, which
would be deferred over the period of loan/rendering service. ~88% of loan
disbursed is vehicle finance.
(b)
Loan origination expenses:
DSA charge amortization on retail loans will lead to
higher profitability in earlier years.
(c)
Expected credit Loss:
VFCs have higher LGD in the range of 40%-50% for GNPA.
However, given adequacy of balance provision available for standard assets at
~2.2%, we expect marginally positive impact.
(d)
Income recognition on NPA
:
Since MMFS has high GNPAs, it will be positively
impacted.
Shriram Transport (a)
Fee recognition:
Vehicle financiers derive typically 0.5-2.0% fee income, which
would be deferred over the period of loan/rendering service.
(b)
Loan origination expenses:
DSA charge amortization on retail loans will lead to
higher profitability in earlier years.
(c)
Expected credit Loss:
VFCs have higher LGD in the range of 40%-50% for GNPA.
However, given the adequacy of balance provision available standard assets at
~2.6%, we expect marginally positive impact.
(d)
Securitization:
Securitized book as at FY18 stood at INR155.7b, 20% of loan
book. Recognition of assets securitized (in future) could adversely impact ROAs.
(e)
Income recognition on NPA
:
Since SHTF has high GNPAs, it will be positively
impacted.
Cholamandalam
Investment
and Finance
Marginally Positive
Marginally Positive
Marginally Positive
Marginally Negative
Marginally Positive
Marginally Positive
Marginally Negative
Marginally Positive
(a)
Fee recognition:
Vehicle financiers derive typically 0.5-2.0% fee income, which
Marginally Negative
would be deferred over the period of loan/rendering service.
(b)
Loan origination expenses:
DSA charge amortization on retail loans will lead to
Marginally Positive
higher profitability in earlier years.
(c)
Expected credit loss:
We expect marginally low LGD at ~35% for GNPA as non-
Marginally Negative
vehicle portfolio constitutes ~30% of loan book. However, in case of CIFC, we
expect a marginally negative impact, given that the balance provision available
for standard assets stands low at ~0.6%.
(d)
Securitization:
Securitized book as at FY18 stood at INR55.6b, 15.2% of loan
Marginally Negative
book. Recognition of asset securitized (in future) could adversely impact ROAs.
(e)
Gain on direct assignment to be front-ended:
Assigned book as at FY18 stood at
INR6.7b, 1.8% of total loan book.
Marginally Positive
(a)
Fee recognition:
Consumer financiers have low (0.25%) fee income and tenure
for loan. Hence, deferment will not have any meaningful impact.
(b)
Loan origination expenses:
Consumers financiers incur DSA charges. However,
tenure of loan is low; its deferment will not have a meaningful impact.
(c)
Fair valuation of ESOPs:
Will adversely impact FY18 earnings by 1.8%.
(d)
Expected credit loss:
Consumer Financiers have higher LGD in the range of 50%
for GNPA, which will lead to lower balance provision available for standard
assets provisioning at ~0.8%.
Neutral
Neutral
Marginally Negative
Marginally Negative
Bajaj Finance
July 2018
26
 Motilal Oswal Financial Services
NBFC
Company
Remarks
Impact
(e)
Gain on direct assignment to be front-ended:
Assigned book as at FY18 stood at
Marginally Positive
INR21.6b, 2.8% of total loan book.
Shriram City Union (a)
Fee recognition:
Consumer financiers have low (0.25%) fee income and tenure
Finance
for loan. Hence, deferment will not have any meaningful impact.
(b)
Loan origination expenses:
Consumers financiers incur DSA charges. However,
tenure of loan is low; its deferment will not have any meaningful impact.
(c)
Expected credit loss.
We expect LGD in the range of 40%-50% for GNPA. While
SCUF has high GNPA at 9%, we believe that provisions made of ~INR16.3b will
be slightly lower than those required under Ind-AS.
(d)
Income recognition on NPA:
Since SCUF has high GNPAs, it will be positively
impacted.
L&T Finance
Holdings
Neutral
Neutral
Neutral
Marginally Positive
(a)
Fee recognition:
Corporate financiers derive high fee income, but LTFH currently
Neutral
amortizes fee, which is in line with Ind-AS.
(b)
Fair valuation of ESOPs:
will adversely impact FY17 earnings by 0.8%.
Neutral
(c)
Expected credit loss:
Corporate financiers have higher LGD in the range of 65%
Negative
for GNPA. LTFH has GNPA of ~INR54b, 6.5% of loan book (including restructured
loans of ~INR21b). We believe that provision made of ~INR24b may be lower
than required under Ind-AS. It would be interesting to see how LTFH provides
for its legacy book (Pre 2012).
(d)
Dividend on preference shares:
Will impact earnings (FY17: INR1.1b, 10.2% of
Negative
PAT).
July 2018
27
 Motilal Oswal Financial Services
NBFC
Opportunities and key challenges
New financials to present a more contemporary picture
Ind-AS is likely to bring in much more transparency in the system and ensure
disclosures are in line with global standards. Under Ind-AS, companies would need
to (a) prepare an opening balance sheet on the transition day, (b) recognize assets
and liabilities based on the new norms and (c) route the difference through the
reserves. This will imply a material change in networth. We believe that investors
need to be watchful of interpretations/adjustments made by companies during the
migration.
Extensive disclosures:
Ind-AS demands additional disclosures (e.g., on segment
reporting, qualitative and quantitative disclosure of ECL impairment and risk
assumptions) in line with global standards. This will not only enhance
transparency, but also provide vital information to various stakeholders.
More appropriate representation:
Since the new accounting standards are
based on the principle of ‘substance over form’ and ‘fair valuation,’ they are
likely to present a more contemporary picture of the state of affairs of the
companies, as against the conservative approach followed under IGAAP.
Facilitate comparability:
Ind-AS will present a more comparable picture of the
peer set. Under IGAAPs, there is no specific guidance, and thus, corporates
follow different policies, making their financials incomparable.
Appealing to foreign investors:
Ind-AS is not the same as IFRS, but it will bring
the accounting standards in India much closer to international standards that
investors are familiar with and have confidence in. This, in turn, should improve
the appeal of Indian companies among foreign investors.
Several challenges as we migrate
First-time adoption:
Although first-time adoption of Ind-AS is an opportunity for
all entities to align their accounting policies to best practices, it is also offers
room for cleaning up of books, the interpretation of which is a challenge for
investors.
Extensive disclosures:
These are required so that shareholders are aware of
every change in estimate, accounting policy, reclassification or recognition/de-
recognition of assets and liabilities. However, companies will have to decide
how much to disclose so as to meet the regulatory requirements and at the
same time maintain a competitive edge.
Dividend distribution policies:
Companies may need to review and, if necessary,
amend their dividend distribution policies in light of their changed financial
situation post Ind-AS adoption.
Management estimates:
A lot of accounting in Ind-AS is based on management
estimates. It would be challenging in initial periods to maintain accuracy and
consistency in estimates.
Fair value:
Use of fair value approach will bring in a lot of volatility in
accounting. Also, we believe that since this concept is new to India, there is a
lack of knowledge and technical expertise to determine fair value.
July 2018
28
 Motilal Oswal Financial Services
THEMATIC/STRATEGY RESEARCH GALLERY
 Motilal Oswal Financial Services
Explanation of Investment Rating
Investment Rating
BUY
SELL
NEUTRAL
UNDER REVIEW
NOT RATED
Expected return (over 12-month)
>=15%
< - 10%
> - 10 % to 15%
Rating may undergo a change
We have forward looking estimates for the stock but we refrain from assigning recommendation
NBFC
*In case the recommendation given by the Research Analyst becomes inconsistent with the investment rating legend, the Research Analyst shall within 28 days of the inconsistency, take appropriate measures to make the recommendation consistent with the investment rating legend.
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specific recommendations and views expressed by research analyst(s) in this report.
Disclosure of Interest Statement
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Companies where there is interest
No
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www.nseindia.com, www.bseindia.com.
Research Analyst views on Subject Company may vary based on Fundamental research and Technical Research. Proprietary trading desk of MOSL or
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The Research Analysts contributing to the report may not be registered /qualified as research analyst with FINRA. Such research analyst may not be associated persons of the U.S. registered broker-dealer, MOSIPL, and therefore, may not be subject
to NASD rule 2711 and NYSE Rule 472 restrictions on communication with a subject company, public appearances and trading securities held by a research analyst account.
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views expressed in the report. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alternations to this statement as may be required from time to time without any prior approval.
MOSL, its associates, their directors and the employees may from time to time, effect or have effected an own account transaction in, or deal as principal or agent in or for the securities mentioned in this document. They may perform or seek to perform
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Registered Office Address: Motilal Oswal Tower, Rahimtullah Sayani Road, Opposite Parel ST Depot, Prabhadevi, Mumbai-400025; Tel No.: 022-3980 4263; www.motilaloswal.com. Correspondence Address: Palm Spring Centre, 2nd Floor, Palm
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Contact No.:022-30801085.
Registration details of group entities.: MOSL: SEBI Registration: INZ000158836 (BSE/NSE/MSE); CDSL: IN-DP-16-2015; NSDL: IN-DP-NSDL-152-2000; Research Analyst: INH000000412. AMFI: ARN 17397. Investment Adviser: INA000007100.
Motilal Oswal Asset Management Company Ltd. (MOAMC): PMS (Registration No.: INP000000670) offers PMS and Mutual Funds products. Motilal Oswal Wealth Management Ltd. (MOWML): PMS (Registration No.: INP000004409) offers wealth
management solutions. *Motilal Oswal Securities Ltd. is a distributor of Mutual Funds, PMS, Fixed Deposit, Bond, NCDs, Insurance and IPO products. * Motilal Oswal Commodities Broker Pvt. Ltd. offers Commodities Products. * Motilal Oswal Real
Estate Investment Advisors II Pvt. Ltd. offers Real Estate products. * Motilal Oswal Private Equity Investment Advisors Pvt. Ltd. offers Private Equity products
July 2018
29