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  • Why market may be overdoing its fear of Ind-AS impact on NBFC stocks

    Publish Date: September 14, 2018

    You may have read about how the Indian Accounting Standards (Ind-AS) are having an impact on the earnings and net worth of non-banking financial companies (NBFCs). For instance, Magma Fincorp reported a 17% decline in net worth due to large provisions. For L&T Finance Holdings, this decline in net worth was 12%. Reliance Capital reportedly posted disappointing results due to Ind-AS norms, even with operational businesses doing good.

    Adhering to these norms became mandatory for certain NBFCs effective 1 April 2018. With one quarter of reporting, NBFCs already show the effect of following the standards. For some of these companies, the Ind-As adjustment has hit where it matters the most: bottom line or profit after tax (PAT). As a result, NBFC stocks have received some negative treatment due to the fear of Ind-AS effects. Yet, the market may be too pessimistic in its assessment. Read on to know why.

    Low impact on net worth

    The applicable NBFCs today report financial results by complying with Ind-AS compared to the Indian Generally Accepted Accounting Principles (IGAAP) earlier. If you ignore the headlines and look deeper, you will see that most NBFCs have reported a low impact of transition to Ind-AS on their net worth.

    We feel this phenomenon is likely due to two reasons. First, there was already a high amount of non-performing loans (NPL) coverage or large extra provisions on the balance sheet. Second, the credit cycle is improving, leading to a decline in provisioning requirements. If the GDP growth picks up further pace, expect the credit cycle to improve further. Of course, companies like Magma and L&T Finance have seen some adverse impact, but they are exceptions.

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    Provisions impact varies

    The stock market fails to see that the overall quantum of provisions has remained similar between IGAAP and Ind-AS for NBFCs. Also, the composition of provisions varies.

    On the other hand, provisions/loss given default (LGD) on stage 3 loans are 33–43% for these companies under Ind-AS. This stands in contrast to 21–70% NPL coverage under IGAAP, shows our analysis. Clearly, the general perception that Ind-AS will force NBFCs to post more losses is misplaced.

    Related read: What’s in store for markets in September?

    Procyclicality remains unchanged

    Investors must also understand that, while upfront recognition of loan assignment poses a risk to NBFCs, new accounting norms do not affect the procyclicality. In business cycle theory, an economic quantity that is positively correlated with the overall state of the economy is considered procyclical. Ind-AS may not increase procyclicality for NBFCs, we feel. Earnings under Ind-AS tend to be more procyclical than under older accounting norms, but don’t expect a significant difference for NBFCs.

    NBFCs of our listed universe have already reported high procyclicality over the last few years. This means, the NBFCs have made high NPL provisions under IGAAP. Also, Ind-AS allow NBFCs to have income recognition on delinquent loans. This is because the same is provided for under the ECL calculations. So, interest reversals are not expected to greatly affect quarterly earnings. This situation was similar under the IGAAP regime.

    Related : What the Q1 numbers say about the health of Indian banks

    Still early days

    We also feel that the stock market is arriving at conclusions rather too quickly. While it is true that NBFCs have enjoyed a ramp-up in valuations, Ind-AS should not be used as a fear factor to beat down the stocks unreasonably.

    Any comparison between NBFCs under the Ind-AS regime needs to be done with care. There is disparity in the accounting treatment of several line items and more. To have an effective comparison, standardisation needs to set in. We feel that would happen over the next few quarters.

    Also, it is still early days for Ind-AS to affect business strategy and performance. Evidence shows that most NBFCs reported a negligible difference in net worth under IGAAP and restated net worth under Ind-AS. Yes, there are exceptions, but they only prove the rule, as the adage goes.

    What our research team says

    NBFC stocks have received some negative treatment on the basis of Ind-AS impact fears. Such concerns may be unfounded. So far, earnings reported based on those norms have not seen a big impact on networth. While typically earnings under Ind-AS tend to be more procyclical than older accounting norms, we don’t expect a significant difference for NBFCs. This is because NBFCs have already reported high procyclicality over the last few years, making high provisions under IGAAP during the transition to 90 day pass due (dpd) NPLs.


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