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

Defaults on loans to small and medium enterprises (SME) by finance companies in India are expected to rise in the coming quarters since hardening interest rates are increasing the repayment burden, rating agency Moody’s has said. Also, options to refinance such loans for SMEs are limited, it added.

Rising interest rates, increasing costs amid high inflation and a muted operations environment for small businesses have weighed on SME borrowers’ ability to meet debt repayments over the past year.

Moody’s, in a statement, said delinquencies for loans against properties (LAP) extended to SMEs in securitised portfolios will continue to increase. A securitised paper is termed as asset-backed security (ABS).

India’s economy will remain vulnerable to bouts of heightened financial market volatility, while interest rates remain restrictive in advanced economies, which will add to the risk of LAP delinquencies.

Despite rising delinquencies, ABS are well-protected due to the deals’ structural protections. Indian LAP ABS have cash reserves and substantial excess spread, which provide deals with liquidity and buffers against losses.

The cash collateral coverage for LAP ABS, which Moody’s rates, is improving and averages between 41.5 per cent and 69.2 per cent of the outstanding principal on the deals’ pass-through certificates, depending on the deal origination year. To put it simply, the amount of cash buffer is increasing. This gives confidence to investors that even if the defaults in underlying SME loans may rise, it will not harm the payments to them.

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

A slowing property price growth is curtailing prospects of recovery. The pace of property price growth has slowed in major Indian cities because of rate hikes over the past year. This has reduced the prospects of recovery for defaulted LAP, which is negative for Indian ABS backed by these loans, Moody’s said.

Since May 2022, the RBI has increased its policy repo rate by 250 basis points, to 6.5 per cent, 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 signalled that it will remain vigilant about inflation in future rate decisions. At 5.66 per cent in March, inflation was at the upper limit of the RBI’s medium-term target band of 2.0-6.0 per cent, though it moderated from 6.44 per cent in February.