SME delinquencies will continue to rise despite RBI’s rate pause: Moody’s
Higher interest rates in India have increased repayment amounts and limited refinancing options for SME borrowers with LAP (loans secured by mortgages over residential or commercial real estate), heightening the risk of delinquencies and defaults. This situation is credit negative for Indian asset-backed securities (ABS) backed by Loan Against Properties (APS), says a report by Moody’s Investor Service.
The Reserve Bank of India (RBI) has increased its policy repo rate by 2.5 percentage points to 6.5% in a series of rate rises since May 2022 to combat inflation. Indian 10-year government bond yields and the Marginal Cost of Fund based Lending Rate (MCLR), which is the benchmark rate that banks mostly use to set lending rates for NBFCs, have increased as the RBI’s repo rate has risen.
At its monetary policy meeting in April, the RBI kept the repo rate unchanged to assess the cumulative effect of past rate hikes, but signaled it will remain vigilant about inflation in future rate decisions. At 5.66% in March, inflation was at the upper limit of the RBI’s medium-term target band of 2%-6%, though it moderated from 6.44% in February.
According to Moody’s, the higher repo rate, bond yields and MCLR have pushed up the cost of both market and bank funding for NBFCs, compressing their net interest margins and prompting them to raise rates for LAP. LAP securitized in India ABS have floating interest rates, so repayment amounts for these loans have increased as lenders have raised borrowing costs. Even if the RBI were to keep rates on hold from here, the repayment amounts will weigh on SME borrowers’ capacities to repay debt.
Furthermore, the rate increases over the past year have reduced the likelihood that LAP borrowers will be able to refinance their debt on more affordable terms if they can no longer meet repayment amounts, says Moody’s.
Slowing property price growth is curtailing recovery prospects
The pace of property price growth has slowed in major Indian cities as a result of the rate rises over the past year. The slower price growth has reduced recovery prospect for defaulted LAP when NBFCs sell the underlying properties to recoup outstanding debt amounts, which is negative for Indian ABS backed by these loans. Additionally, slower price growth could erode lenders’ willingness to refinance LAP. Large cities and metropolitan areas are key markets for medium and large LAP.
Delinquencies will increase, but structural protections will curb losses
With interest rate rises over the past year increasing repayment amounts and limiting refinancing options, we expect loan delinquencies for LAP ABS we rate to continue to increase. We also expect that 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.
Delinquency rates have increased since last year and remain elevated. Rising interest rates, increasing costs amid high inflation and a muted operation environment for small businesses have weighed on SME borrowers’ abilities to meet debt repayments over the past year.
Despite rising delinquencies, LAP ABS are well protected, because of the deals’ structural protections. Indian LAP ABS have non-amortizing cash reserves and substantial excess spread, which provide deals with liquidity and buffers against losses. The cash collateral coverage for LAP ABS we rate is improving and averages between 41.5% and 69.2% of the outstanding principal on deals’ pass-through certificates, depending on the deal origination year.
Also Read: Securitisation volumes in Q4FY23 at Rs 61,000 cr: ICRA
