September 24, 2022

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CRISIL Ratings: Why delinquencies for unsecured loans may go up regardless of asset classes

While there will be an impact on collections and delinquencies, the impact should be lower than what we saw in Q1 of last year, says Krishnan Sitaraman, Senior Director, Crisil Ratings.

The second Covid wave is intensifying and a challenge definitely lies in the unsecured loan segment. What is the total quantum of industry loans to unsecured books and is the underlying stress increasing or has it increased significantly?
The second wave will bring forth challenges on the asset quality front and this is something which we were indicating a few months back as well. At that time, the collection efficiencies were improving from August-September onwards on a month-on-month basis across asset classes. But if there was a rise in the intensity of cases accompanied by containment measures and restrictions, that could have an impact on collections.

But I still think that compared to what we saw a year back, the restrictions announced so far are lower in trajectory or intensity. So while there will be an impact on collections and delinquencies, the impact should be lower than what we saw in Q1 of last year. That said, what I am looking at is an increase in delinquencies across asset classes.

If I consider NBFCs specifically, I feel gold loan and home loan NBFCs will be least impacted whereas unsecured loans, MSME loans and wholesale loans will be more impacted given the vulnerability of the underlying borrower class. Coming to unsecured loans, our sense is that stressed assets in that space is in the region of around 9-10{de3fc13d4eb210e6ea91a63b91641ad51ecf4a1f1306988bf846a537e7024eeb} and that includes some element of restructured assets.

We will have to see the spread intensity and duration of the pandemic, how long the accompanied lockdown measures last and if they come over with the increasing vaccination trajectory and if we get a control over that in the next couple of months, I do not see much of an increase beyond that.

But if this lasts for six or seven months, then we could see a further upside. On the unsecured side, this is the most stressful scenario that we are seeing in the last 10-12 years. The high stress building up was in the wake of the global financial crisis where we saw subprime loans and credit card receivables rack up 10-12{de3fc13d4eb210e6ea91a63b91641ad51ecf4a1f1306988bf846a537e7024eeb} NPAs. Subsequent to that, we have seen unsecured loans perform reasonably well.

What is the total quantum of industry loans to unsecured books? Is the underlying stress increasing or has it increased significantly?
The second wave will bring forth challenges on the asset quality front and we had been indicating this a few months back as well. At that time, the collection efficiencies were improving from August-September onwards on month-on-month basis across asset classes. But if there was a rise in the intensity of cases accompanied by containment measures, we are seeing delinquencies move up.

What is the future outlook of NPAs going forward for unsecured loans and the quantum of NPAs and provisions that may be needed at the industry level with this spike in Covid cases?
We are seeing stressed assets in unsecured books in the region of 9.5{de3fc13d4eb210e6ea91a63b91641ad51ecf4a1f1306988bf846a537e7024eeb} to 10{de3fc13d4eb210e6ea91a63b91641ad51ecf4a1f1306988bf846a537e7024eeb} and it will vary from company to company. In certain entities, it is lower and in certain entities, it is higher and a number of NBFCs have enhanced or improved their credit appraisal and underwriting processes and that has also enabled them to have a control over the extent of NPAs moving up. There has been an increasing element of digitisation and technology enablement in the business processes as well. That is also helping to some extent.

If the spread intensity and duration of the pandemic and the containment measures extends or prolongs, we could see delinquencies go up beyond the 9.5{de3fc13d4eb210e6ea91a63b91641ad51ecf4a1f1306988bf846a537e7024eeb} to 10{de3fc13d4eb210e6ea91a63b91641ad51ecf4a1f1306988bf846a537e7024eeb}. Here the underlying borrower profile is very important. So whether salaried or self-employed, we are seeing bulk of the customer segments getting impacted because of the underlying situation. However, there is a small section in each of these segments which has not been impacted that much.

For instance, a large segment of IT professionals come within the salaried class. Their salary levels and jobs have not been impacted while their discretionary expenditure has come down. So they are not going to 5-star hotels, they are not going on vacations, they are not going to multiplexes. So, they have higher savings. So, that customer profile is not impacted that much. But a bulk of the salaried segments are facing salary cuts and job losses as well. They are impacted.

Among the self-employed, if they are in the essential segment like agrochemicals, pharmaceuticals, there the impact has not been much but for the bulk of the other segments, we are seeing vulnerabilities in business cash flows. So what this will result in is an impact on collection efficiencies and delinquencies as far as NBFCs go. In unsecured loans — the recovery levels or retrievals — once the default goes into a large delinquency bucket is not very high. So if you look at 10{de3fc13d4eb210e6ea91a63b91641ad51ecf4a1f1306988bf846a537e7024eeb} stressed assets or NPAs, bulk of that will need to get written off whereas if you look at home loan or a gold loan, the element of recovery will be very high there.

So in unsecured loans, once there is delinquency, recovery levels will be low and the provisioning has to be in a large proportion. That is something we will need to monitor. But the key is how long the situation gets prolonged.

Amidst banks, NBFCs and MFIs — which category do you see getting hit most?
I would say it is dependent on the underlying borrower behaviour and borrower profile rather than specific segments within unsecured loans. For instance, if there is a very high quality private sector bank and they are choosing their customer profile very selectively and if they are looking at salaried professionals and self-employed guys, they are not much hit. So then irrespective of whichever segment they are in, their asset quality will not get much impacted. But as you move down the spectrum of either private sector banks or even public sector banks or NBFCs, the typical customer profile on the unsecured side will not be the blue chip clients. In that situation, their income profile will get impacted and there will be delinquencies.

If I look at unsecured as an asset class in terms of the repayment priority for the borrower, that will come lower in the hierarchy of loans than say a home loan or a car loan. He will pay off the home loan first, then the car loan and then unsecured loan. So because the unsecured loan is lower in the hierarchy of repayment for his loans, they will be more impacted. I see delinquencies going up in case of unsecured loans regardless of asset classes. There may be minor variations, but there may not be any material variations.