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Asia-Pacific's Nonbanks Brace For Funding Squeeze

Chart 1

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Asia-Pacific's nonbanks navigated the pandemic well, only to encounter a set of risks that may prove more onerous and operationally disruptive. Nonbank financial institutions (NBFIs) face escalating funding costs as wholesale capital markets close to speculative-grade entities. S&P Global Ratings believes a dramatic reversal in sentiment that locks such institutions out of typical financing channels could dent ratings.

Many regional NBFIs rely on short-term borrowings, and the mismatch of tenors vis-à-vis their assets could quickly become problematic in a funding crunch.

This is confidence-sensitive sector. Its reliance on wholesale markets makes it vulnerable to occasional capital squeezes triggered by a generalized loss in confidence. In 2018-2019, the defaults of Infrastructure Leasing & Financial Services Ltd. and Dewan Housing Finance Ltd. saw liquidity slide for the Indian NBFI sector.

We recently downgraded many Mexican NBFIs after defaults by Unifin Financiera S.A.B. de C.V. and Credito Real, S.A.B. de C.V., SOFOM, E.N.R. eroded investor confidence, curtailing entities' access to international debt markets. Mexican NBFIs will also likely find financing conditions in domestic capital markets more restrictive (see "Various Rating Actions Taken On Six Mexican Nonbank Financial Institutions On Increasing Financing Risks," Aug. 17, 2022).

In a climate of war, surging energy costs, economic weakening, radical central bank tightening, persistent COVID disruptions, and routine confrontations among superpowers, markets can be unforgiving. NBFIs need steady, predictable access to funding. Some of the weaker finance companies face increased refinancing risk and strained liquidity.

This may pose contagion risks in some jurisdictions. The failure of a mid and large-sized finance company would hit the asset quality of lenders and stress the liquidity of peers. While this is not our base case, it is very similar to recent events in Mexico and India.

Securitized pools could also get hit as the bankruptcy of an originator could hinder collections. This would be the state of play at least until substitute servicers were appointed and operational issues sorted. This may be a more material issue in emerging markets.

Such effects vary widely. An NBFI will be more or less vulnerable depending on the lumpiness of an institution's liabilities, the extent of its reliance on short-term borrowing, its dependence on securitization, and entity-specific earnings or asset-quality stress.

Asia-Pacific Economic Prospects Still Strong

Asia-Pacific's economic recovery from COVID is still largely going strong outside of China. Robust growth is likely in 2022–2023 in economies that are largely driven by domestic demand, such as India, Indonesia, and the Philippines. With an estimated 4.8% GDP expansion in Asia-Pacific in 2023–2025, the region will once again be the fastest growing in the world.

However, sticky inflation and rapid monetary policy normalization in the U.S. and Europe have increased the downside risks for the region. Barring China and Japan, central banks in Asia-Pacific will continue to raise policy rates, on our view. Tapering by the U.S. Fed could drive capital outflows and intensify currency pressures if regional rate hikes fail to match those of the Fed. This is a key risk to emerging economies.

Table 1

Policy Rates Are Set To Climb Across Asia-Pacific
Policy rate (year end)
% 2021 2022e 2023e 2024e 2025e
Australia 0.10 1.75 2.50 2.75 2.50
India 4.00 5.65 5.25 5.00 5.00
Indonesia 3.50 4.00 4.75 5.25 5.50
Japan -0.10 -0.10 0.00 0.00 0.10
Malaysia 1.75 2.50 3.00 3.25 3.25
New Zealand 0.75 3.00 3.25 3.25 3.00
Philippines 2.00 3.00 3.25 3.75 3.75
South Korea 1.00 2.25 2.50 2.50 2.50
Taiwan 1.13 1.75 1.88 2.00 2.00
Thailand 0.50 1.00 1.50 1.75 2.00
Note: For India, 2021 = FY 2021 / 22, 2022 = FY 2022 / 23, 2023 = FY 2023 / 24, 2024 = FY 2024 / 25, 2025 = FY 2025 / 26. e--Estimate. Source: S&P Global Economics.

Finance Companies Have Navigated Choppy Waters Well

Solid profitability and capital buffers have helped regional finance companies withstand credit downcycles, as apparent most recently during COVID. The high provisioning buffers and healthy margins will likely carry most NBFIs through the challenging operating conditions of 2022.

Chart 2

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Of the finance companies we rate in Asia-Pacific, about three-quarters are investment grade. Some 77% have a stable rating outlook and 5% have a positive outlook.

Chart 3

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These ratings reflect stand-alone strength in entities' business models and finances. It also matches our expectation that the group or government would support many of these NBFIs in times of stress. Just 14% of our ratings have a negative outlook, or are on CreditWatch with negative implications.

But Weaker Companies May Yet Struggle

Most Asia-Pacific finance companies have benefited from excess liquidity in the past couple of years, and financing costs have dropped sharply for some. But with the external turbulence, this liquidity situation could reverse.

Risk premiums for weaker finance companies or those with perceived governance issues will rise more sharply, in our view. Stronger finance companies or those with strong parentage will see a more measured increase. This will be especially true in India, Japan, and Taiwan.

Financing costs for speculative-grade entities have risen sharply and the risk premiums for these entities should continue at high levels. This makes them vulnerable to market dislocations.

Finance Companies With Lumpy Liabilities Are Most At Risk

Among the rated finance companies, we assess as weak the liquidity profile of Zhongrong International Holdings Ltd. (ZRH). We revised the rating outlook on ZRH to negative to reflect the company's heightened investment risk, persistently weak liquidity, and the slow development of its asset management business (see "Zhongrong International Holdings Outlook Revised To Negative; 'BB-/B' Ratings Affirmed," May 23, 2022).

ZRH faces a series of lumpy refinancings, underpinning our weak liquidity assessment. Nevertheless, it has sufficient cash to meet its US$81.7 million 364-day notes due in November 2022.

Some finance companies have highly concentrated liabilities. For example, the bank warehouse facilities of Avanti Finance accounted for about 56% of the finco's funding base as of June 30, 2021, with the Westpac group (Westpac New Zealand Ltd. and Westpac Banking Corp.) providing about 95% of the warehouse funding. While Avanti has a long-standing relationship with the Westpac group, the reliance of any NBFI on a single funding provider is a potential source of risk.

Short-Term Borrowings Expose NBFIs To Swings In Sentiment

Some finance companies rely on short-term borrowings, which exposes them to refinancing risk and to market volatility. Among rated finance companies, we assess the funding of Muthoot Finance Ltd. and Manappuram Finance Ltd. as moderate, largely due to refinancing risk. About one-third of both firms' liabilities are short-term.

A handful of mitigating factors should hold the entities in good stead, namely:

  • Positive asset-liability management: A large portion of their assets are short-term gold loans. These are of a short tenor (of up to one year), are self-liquidating, and are a constant source of liquidity.
  • A high level of equity capital, at a tad over one-quarter of their total liabilities; and
  • Ample liquid assets, about 5%-10% of total assets.

Many NBFIs in Japan and Taiwan also rely on short-term bank borrowings and commercial papers and have mismatches when funding their medium-term account receivables. If these funding sources disappeared in an extreme stress scenario, this reliance could prove problematic.

Diverse counterparties offset such risks, as does potential funding support from parents that are part of large bank or corporate group.

Asset Quality, Earnings Stress May Also Hit Refinancing

Persistent inflation could hit the borrowers of the fincos we rate. Debt-service coverage and asset quality might weaken if rising costs exceeded wage growth for consumer lenders. Distorted risk pricing and the buildup of asset bubbles, particularly in the property market, may become more problematic in the longer term.

As interest rates rise, it will be difficult for some NBFIs to transfer rising funding costs to their borrowers. This could compress margins, particularly for finance companies that lend at a fixed rate. The profitability of many NBFIs will likely be squeezed this year because of this dynamic and the hit of weakening asset quality due to higher provisions.

Intense competition in certain relatively safe asset classes will also likely strain the earnings of finance companies. For example, lending backed with gold collateral in India generates strong risk-adjusted margins, bringing in many competitors. While margins may shrink, we as yet do not see any refinancing challenges for India's market leaders in this segment, Muthoot and Mannapuram

The fincos in Taiwan in general have satisfactory asset quality given most of their exposure is collateralized and the economy in Taiwan is healthy. Some Taiwan-based NBFIs may experience a spike in problem loans in their China operations due to COVID-related disruptions to the operations of some of their borrowers. However, the contribution of such entities to the total consolidated book is small, and this asset quality has been stabilizing in recent quarters.

Some Japanese fincos rely on nonlocal currency to operate their business globally. Prudent asset-liability management, especially in a nonlocal currency, underpins confidence in these fincos' funding and liquidity in times of market turbulence.

Chart 4

image

China's big four Chinese asset managers have significant property concentrations. These firms are China Cinda Asset Management Co. Ltd., China Great Wall Asset Management Co. Ltd., China Huarong Asset Management Co. Ltd., and China Orient Asset Management Co. Ltd. In particular, their loan-like exposure to developers' increased impairment expenses contributes to their recent profit warnings.

China's property market will likely follow an L-shaped recovery, and this profit pressure could linger for a while yet. Lowering regulatory barriers to entry for the distressed asset management sector is another driver for the negative outlooks and downside trends on these four asset managers.

Volatile Securitization Markets Creates Risks For NBFIs

Those NBFIs heavily reliant on securitization will likely find volatile markets and spiking funding costs will disrupt operations. Avanti's residential mortgage-backed securities (RMBS) funding accounted for about one-third of its funding base in fiscal 2019. Turbulent markets forced the finco to halt term issuance during the first half of 2020.

Avanti's experience demonstrates the market-sensitive nature of securitization funding, in our view. Its experience may well be repeated by other institutions in 2022.

Sentiment is fickle and the mood can change quickly. Indian securitization volumes sank in 2020, amid strict mobility lockdowns and large-scale moratoriums on loan repayments. Securitization volumes increased by nearly half to Indian rupee (INR) 1.3 trillion in the fiscal year ending March 2022, but volumes still trail pre-COVID levels.

Shriram Transport Finance Co. Ltd. (STFC) also has a material reliance on confidence-sensitive wholesale funding sources such as securitization, which could lead to higher volatility in funding costs. This dependence could restrain STFC's business growth should investors become more concerned about its asset-quality profile.

Chart 5

image

Cash, And Confidence, Is King

NBFIs refinancing risk will be greatest for issuers with concentrated near-term debt. Companies with weak operating performance over the next one to two years would be required to refinance at higher interest rates and wider spreads, which would strain debt-service coverage ratios and creditworthiness. Institutions with longer-maturity debt and healthy liquidity can wait for market turbulence to subside. But this is a very confidence-sensitive sector, and the mood of markets changes often these days. Much can go right, or wrong, for the NBFIs very quickly.

Appendix

Table 2

Funding And Liquidity Ratios

PT Perusahaan Pengelola Aset (Persero)

Zhongrong International Holdings Ltd.

Yulon Finance Corp.

Shriram Transport Finance Co. Ltd.

Muthoot Finance Ltd.

Mongolian Mortgage Corp. HFC LLC*

Manappuram Finance Ltd.

Kings Town Bank International Lease Corp.

Fortune Motors Co. Ltd.

Avanti Finance Ltd.

Hero FinCorp Ltd.

Bajaj Finance Ltd.

Stable funding ratio (%)
2018 53.48 45.08 16.90 71.08 45.30 119.80 38.40 32.67 35.98 61.42 69.02
2019 49.24 165.83 17.40 84.93 64.56 116.10 63.34 67.22 42.10 83.01 59.08 71.26
2020 51.79 124.86 20.18 85.33 61.63 126.25 61.83 48.13 40.96 85.06 68.76 71.50
2021 70.96 13.44 12.83 89.10 N.A. N.A. N.A. 41.45 41.24 91.20 62.78 63.30
Liquidity coverage metric (x)
2018 0.00 0.30 0.04 0.12 0.01 67.49 0.10 0.06 0.10 0.08 0.23
2019 0.00 2.96 0.05 0.38 0.29 3.14 0.30 0.12 0.14 0.20 0.00 0.34
2020 0.02 20.68 0.06 0.55 0.28 4.74 0.24 0.08 0.19 0.18 0.31 0.40
2021 0.03 0.45 0.04 0.62 N.A. N.A. N.A. 0.39 0.28 0.37 0.16 0.22
Deposits to total financial liabilities (%)
2018 N.A. N.A. N.A. 11.76 0.87 N.A. 0.01 N.A. N.A. N.A. N.A. 12.99
2019 N.A. N.A. N.A. 12.62 0.63 N.A. 0.00 N.A. N.A. N.A. N.A. 16.46
2020 N.A. N.A. N.A. 15.24 0.51 N.A. 0.00 N.A. N.A. N.A. N.A. 19.55
2021 N.A. N.A. N.A. 19.11 N.A. N.A. N.A. N.A. N.A. N.A. N.A. 18.64
Borrowings to total financial liabilities (%)
2018 100.00 100.00 100.00 88.24 99.13 100.00 99.99 100.00 100.00 N.A. 100.00 87.01
2019 100.00 100.00 100.00 87.38 99.37 100.00 100.00 100.00 100.00 100.00 100.00 83.54
2020 100.00 100.00 100.00 84.76 99.49 100.00 100.00 100.00 100.00 100.00 100.00 80.45
2021 100.00 100.00 100.00 80.89 N.A. N.A. N.A. 100.00 100.00 100.00 100.00 81.36
Secured debt/debt + deposits (%)
2018 100.00 100.00 100.00 88.45 97.69 100.00 78.11 100.00 100.00 N.A. 73.01 85.14
2019 100.00 100.00 100.00 93.54 87.07 100.00 89.78 100.00 100.00 100.00 84.11 91.74
2020 100.00 100.00 100.00 95.23 90.40 100.00 93.93 100.00 100.00 100.00 86.40 86.83
2021 100.00 100.00 100.00 95.91 N.A. N.A. N.A. 100.00 100.00 100.00 86.33 87.26
Note: See Glossary (after Appendix) for a clarification of terms. *2021 actuals are estimates based on unaudited results. N.A.--Not available. Source: S&P Global Ratings.

Table 3

Rating Score Snapshot Of Finance Companies
SACP Anchor Business position Capital and earnings Risk position Funding and liquidity Support Additional Factors Rating

Avanti Finance Ltd.

bb bb Adequate (0) Very strong (+2) Constrained (-2) Adequate/Adequate (0) 0 0 BB/Stable/B

Bajaj Finance Ltd.

bb+ bb- Strong (+1) Strong (+1) Adequate (0) Adequate/Adequate (0) 0 0 BB+/Positive/B

Hero Fincorp Ltd.

b bb- Moderate (-1) Adequate (0) Moderate (-1) Adequate/Adequate (0) 3 0 BB/Stable/B

Manappuram Finance Ltd.

bb- bb- Moderate (-1) Very strong (+2) Moderate (-1) Moderate/Adequate (-1) 0 0 BB-/Stable/B

Mongolian Mortgage Corp. HFC LLC

b- b- Strong (+1) Constrained (0) Moderate (-1) Adequate/Adequate (0) 0 0 B-/Stable/B

Muthoot Finance Ltd.

bb bb- Adequate (0) Very strong (+2) Moderate (-1) Moderate/Adequate (-1) 0 0 BB/Negative/B

PT Perusahaan Pengelola Aset (Persero)

b+ bb- Adequate (0) Strong (+1) Constrained (-2) (-2) Adequate/Adequate (0) 2 0 BB/Stable/B

Shriram Transport Finance Co. Ltd.

bb- bb- Strong (+1) Strong (+1) Moderate (-1) Moderate/Adequate (-1) 0 0 BB-/Stable/B

Zhongrong International Holdings Ltd.

b- bb Moderate (-1) Moderate (-1) Moderate (-1) Moderate/Weak (-3 or more) 3 0 BB-/Negative/B
Note: Data as of August 24, 2022. SACP--Stand-alone credit profile. Source: S&P Global Ratings.

Glossary

Liquidity coverage metric:  The ratio of broad liquid assets plus available committed unsecured lines to short-term wholesale funding.

Stable funding ratio:  Available stable funding sources relative to stable funding needs. Available stable funding includes the sum of total equity net of intangibles, customer deposits, and long-term interbank and debt market funding including hybrid instruments with no equity content maturing in one year or more.

Stable funding needs:  Includes customer loans, a proportion of short-term reverse repurchase agreements with nonbanks, interbank loans and all reverse repurchase agreements with banks and nonbanks maturing in one year or more, potentially more risky and/or less liquid securities holdings depending on their asset type, restricted cash, all other nonderivative assets, and a proportion of off-balance-sheet credit equivalents.

We apply this definition unless a financial institution's available financial reporting includes maturities of exactly one year in the same category as maturities of less than one year. When this occurs, we may classify maturities of exactly one year in the "less than one year" category for that financial institution.

See "Financial Institutions Rating Methodology," published Dec. 9, 2021, for further clarification on the above terms.

Editor: Jasper Moiseiwitsch

Digital designer: Tim Hellyer

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Geeta Chugh, Mumbai + 912233421910;
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Research Assistant:Priyal Shah, CFA, Mumbai

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