SME loan defaults to rise for NBFCs in coming quarters: Moody’s

Loan defaults to small and medium-sized enterprises (SMEs) by finance companies in India are expected to rise in coming quarters as interest rate tightening is increasing the repayment burden, ratings agency Moody’s said. Also, options for refinancing such loans for SMEs are limited, he added.

Rising interest rates, rising costs amid high inflation and a subdued operating environment for small businesses have affected the ability of SME borrowers to meet debt payments over the past year .

Moody’s, in a statement, said that loan-against-property (LAP) delinquencies granted to SMEs in securitized portfolios will continue to rise. A securitized paper is called an asset-backed security (ABS).

India’s economy will remain vulnerable to bouts of increased financial market volatility, while interest rates will remain tight in advanced economies, increasing the risk of defaults in the LAP.

Despite the increase in delinquencies, ABS are well protected thanks to the structural protections of the agreements. Indian LAP ABS has cash reserves and substantial excess margin, providing liquidity and cushioning losses.

Cash collateral coverage for LAP ABS, which is rated by Moody’s, is improving and averages between 41.5% and 69.2% of principal outstanding on the transfer certificates of operations, depending on the year of origin of the operation. . Simply put, the amount of cash reserve is increasing. This gives investors confidence that even if defaults on the underlying SME loans may increase, it will not hurt the payments made to them.

While the Reserve Bank of India (RBI) halted its rate hike cycle in April, rate hikes over the past year have increased the cost of funding for non-bank finance companies (NBFCs). Given this, NBFCs have increased interest rates for LAP loans to SME borrowers.

The slowdown in property price growth is reducing prospects for recovery. The pace of property price growth has slowed in major Indian cities due to rate hikes over the past year. This has reduced the recovery prospects for the defaulted LAP, which is negative for the Indian ABSs backed by these loans, Moody’s said.

Since May 2022, the RBI has raised its policy repo rate by 250 basis points, to 6.5 percent, in a series of rate hikes to combat inflation.

In April, RBI’s Monetary Policy Committee (MPC) kept the repo rate unchanged to assess the cumulative effect of past rate hikes, but said it will remain attentive to inflation in future rate decisions. At 5.66 percent in March, inflation was at the upper end of the RBI’s medium-term target band of 2.0 to 6.0 percent, though it eased from 6.44 percent in February.