Rating Methodology for Non-Banking Finance Companies*

Transcription

1 ICRA Indnesia Rating Feature September 2011 Rating Methdlgy fr Nn-Banking Finance Cmpanies* Nn-Banking Finance Cmpanies (NBFCs) r mre-knwn as Multi-Finance cmpanies play an imprtant rle in the Indnesian financial market. Cmpared t banks, NBFCs have greater flexibility in gvernance structure and peratinal matters, and are allwed t lend independent f pririty-sectr targets and f statutry reserve requirements. Hwever, at the same time, there are regulatry restrictins n the buquet f services that NBFCs can ffer and n their funding ptins. NBFCs are nt allwed t take depsits. Typically, NBFCs in Indnesia extend the fllwing types f lans: Cnsumer Financing (fr purchase f vehicles, electrnics, etc) Leasing (Finance and Operating Leases) Factring Credit Cards Venture Capital and Infrastructure Financing In rating an NBFC, ICRA Indnesia evaluates the cmpany s business and financial risks, and uses this evaluatin t prject the level and stability f its future financial perfrmance in varius likely scenaris. The ratings are determined n a ging cncern basis rather than being based n a mere assessment f the cmpany s assets and debt levels as n a particular date. The brad parameters fr assessing the business and financial risks f an NBFC (as in the bullet list belw) are discussed at length in the next tw sectins. This methdlgy nte des nt purprt t be an exhaustive discussin n all the rating parameters invlved in the credit rating f NBFCs, but presents a brad framewrk fr the exercise. Business Risk Operating Envirnment Ownership Structure Franchise and Size, Cmpetitive Psitin Management, Systems and Strategy, Gvernance Structure Financial Risk Asset Quality Liquidity Prfitability Capital Adequacy While several parameters are used t assess an NBFC s business and financial risks, the relative imprtance f each f these parameters can vary acrss cmpanies, depending n its ptential t change the verall risk prfile f the cmpany cncerned. Fr instance, in a benign perating envirnment, a relatively new cnsumer finance cmpany may shw very gd prfitability, but may be unable t sustain the same thrugh several life cycles. Therefre, in this case, higher weight wuld be attached t the cmpany s business risk prfile than t its financial perfrmance. Further, an NBFC with a strng business prfile and stable financial perfrmance wuld be viewed mre favurably than anther with cmparable r better financial numbers, but with a weaker business risk prfile. ICRA Indnesia

2 BUSINESS RISK ICRA Indnesia makes an assessment f an NBFC s business risk by analysing, amng ther factrs, the cmpany s perating envirnment, franchise, wnership structure, and management and systems. As many f these parameters are qualitative, ICRA Indnesia tries t remve the subjectivity in its analysis by capturing and assessing infrmatin n defined sub-parameters, and using these t make a cmparisn acrss varius cmpanies. This analysis als incrprates ICRA Indnesia s assessment f the perfrmance f varius sectrs, its utlk n the ecnmy, and its views n issues related t the perating envirnment. Operating Envirnment The perating envirnment has a significant bearing n an NBFC s credit rating as it can impact its grwth prspects and asset quality quite cnsiderably. In assessing the perating envirnment, ICRA Indnesia lks at the verall ecnmic cnditins, prspects f the industry related t the asset class being financed, and the regulatry envirnment. Fr instance, in the case f a cnsumer financing fr cmmercial vehicles, the level f ecnmic activity and freight rates are very imprtant, just as the utlk n real estate is imprtant fr a hme finance cmpany, frm the perspective f bth asset creatin and asset quality. Fr an NBFC, regulatry changes can significantly impact (either psitively r negatively) credit lsses. Fr instance, the establishment f the Debtrs Infrmatin Systems (Credit Infrmatin Bureau) by Bank Indnesia was meant t help lenders take infrmed credit decisins. Hwever, in practice NBFCs still experience technical challenges due t inaccuracy f ppulatin data (there is still a pssibility f debtrs wning mre than ne registered Identificatin Number). This f curse weakens the validity f infrmatin prvided by the Debtrs Infrmatin Systems. Intensity f cmpetitin has a significant bearing n the credit prfile f an NBFC, given that the prevailing r anticipated cmpetitive intensity wuld influence the cmpany s grwth prspects, earnings and management strategy. ICRA Indnesia s evaluatin fcuses n the current level f cmpetitin as well as the attractiveness f the segment fr ptential cmpetitin by assessing several factrs including grwth ptential, entry barriers and risk-adjusted returns. Ownership Structure Ownership structure culd have a key influence n an NBFC s credit prfile in that a strng prmter and strategic fit with the parent can benefit an NBFC s earning, liquidity and capitalisatin, and hence its credit prfile. In assessing an NBFC s wnership structure, the parameters examined include, amng thers: the credit prfile f the prmter, sharehlding pattern f the NBFC, peratinal synergies f the NBFC with its prmter, level f invlvement f prmter in the NBFC and level f cmmitment, and track recrd f the prmter in prviding fund supprt. Gvernance Structure ICRA Indnesia believes that an apprpriate gvernance structure is imprtant t ensure that the pwers given t line managers at an NBFC are exercised in accrdance with the established prcedures and that these prcedures are in harmny with the brad plicy guidelines and strategic bjectives f the NBFC. ICRA Indnesia s evaluatin f an NBFC s gvernance structure invlves an assessment f the structural aspects f the Bard f Directrs and Bard f Cmmissiners, and Bard level cmmittees and f the functining f the varius Bard cmmittees. Franchise and Size Fr an NBFC, its franchise strength determines its capacity t grw while maintaining reasnable riskadjusted returns, and t maintain resilience f earnings, thereby facilitating predictability f its future financial perfrmance. It may be nted that an NBFC with a significant market share and a niche player can bth have a defensible franchise 1, which culd in turn benefit their credit prfile. As fr size, typically it is seen in relatin t an NBFC s lan mix and has a bearing n the cmpany s cmpetitive psitin, diversity, credit risk cncentratin, stability f earnings, and financial flexibility. 1 The bigger cmpany n the strength f its standing in the verall market and the smaller ne n accunt f its unique ffering r its strng relatinship with the key participants in the credit chain f the target segment. ICRA Indnesia Page 2 f 5

3 Management, Systems and Strategy Quality f management, systems and plicies, sharehlder expectatins and the strategy fllwed t manage these expectatins, and accunting quality are the fundatin stnes n which an NBFC s credit risk prfile is built. The imprtance f these factrs is even higher fr a new NBFC, ne with a shrter track recrd, r ne with a changing business prfile. In evaluating an NBFC s management, systems and strategy, ICRA Indnesia assesses the cmpany s cmpetitive psitin (ability t change lending nrms and/r yields), reliance n utsurcing, pace f grwth and respnsiveness t market changes, track recrd, and management experience (in relatin t grwth plans and the lifecycle f the lans extended), besides the extent f diversificatin in its lan bk. As fr track recrd, this is evaluated in relatin t cmpleted business cycles. Thus, while a five- t sixyear-ld cnsumer finance cmpany is cnsidered t have a reasnable track recrd (the typical lan tenure being three t fur years), a hme finance cmpany f the same vintage wuld be said t have an average track recrd (the typical lan tenure being 15 t 20 years). Further, if an NBFC is expanding int new prducts and gegraphies, its track recrd and management experience may nt prvide the same level f cmfrt as thse f anther NBFC with a stable grwth rate and grwing within existing gegraphies with the same lan mix. All credit ratings, including thse in the NBFC sectr, necessarily incrprate an assessment f the quality f the issuer s management, as well as the strengths/weaknesses arising frm the issuer s being a part f a grup. This part f the exercise is mstly subjective, althugh the actual track recrd f the management is a supprting factr. Usually, a detailed discussin is held with the management f the issuer NBFC t understand its business bjectives, plans and strategies, and views n past perfrmance, besides the utlk n the industry. Sme f the ther factrs assessed are: Experience f the prmter/management in the NBFC s line f business. Cmmitment f the prmter/management t the NBFC s line f business. Attitude f the prmter/management t risk taking and cntainment. The NBFC s risk management plicies (credit risk and market risk). Strength f the ther cmpanies belnging t the same grup as the NBFC. The ability and willingness f the grup t supprt the NBFC cncerned thrugh measures such as capital infusin, if required. A careful evaluatin f the risk management plicies f the NBFC is dne as that prvides imprtant guidance fr assessing the impact f stress events n the liquidity, prfitability, and capitalisatin f the cmpany cncerned. ICRA Indnesia cmpares the underwriting plicies f the NBFC cncerned with the best practices in the industry t make an assessment f the cmpany s risk prfile. The prcess f risk prfiling als invlves evaluating the NBFC s business surcing practices (in-huse vs. utsurced), besides its recvery and mnitring systems. ICRA Indnesia als evaluates the strategy and business plans f the NBFC, alng with the sharehlders expectatins frm the cmpany. Althugh ICRA Indnesia-assigned ratings are fr debt hlders, meeting sharehlders expectatins is imperative as therwise the cmpany s strategy itself culd underg a change (t meet sharehlders expectatins), which in turn culd alter its credit prfile. FINANCIAL RISK Asset Quality Asset quality plays an imprtant rle in indicating the future financial perfrmance f an NBFC. The fcus f asset quality evaluatin is n lifetime lsses, variability in lsses under varius scenaris, the impact f likely credit csts n prfitability, and the cushins available (in the frm capital r prvisins) t prtect the debt hlders frm unexpected deteriratin in asset quality. In evaluating an NBFC s asset quality, ICRA Indnesia assesses the quality f the cmpany s credit appraisal prcess and lending nrms, the riskiness f its lan mix, its risk appetite, the availability f data t facilitate credit decisin making, and its track recrd in managing its lan bk thrugh lifecycles. Assessment is als made f credit risk cncentratin, trend in viability f custmers, trend in delinquencies ICRA Indnesia Page 3 f 5

4 (adjusted fr vintage f the bk), Grss NPL percentage, Net NPL percentage, and Net NPL in relatin t Net Wrth. Further, the extent f diversificatin is als an imprtant indicatr f an NBFC s asset quality. In assessing diversificatin, the factrs generally lked at include lan mix, credit risk, prtfli granularity, gegraphical diversificatin, and brrwer prfile. High levels f diversificatin can shield an NBFC frm the impact f dwnturn in any ne segment. At the same time, diversificatin int riskier segments may nt imprve resilience and therefre may nt translate int superir ratings. Hwever, an NBFC s ability t manage diversificatin, especially in multiple businesses and/r new gegraphies is a very imprtant issue, just as management depth and the ability t adpt the skills and techniques needed t run different businesses are. As asset quality indicatrs can vary, depending n the asset class, brrwer prfile, NPL recgnitin nrms, and the accunting plicy n write-ffs, cmparing these indicatrs acrss NBFCs perating in different asset classes may nt yield meaningful results. ICRA Indnesia therefre makes a cmparisn f the delinquency levels (at 30days+, 60days+, 90days+) fr the same asset class and brrwer prfile acrss players, adjusted fr write-ffs. When available, static pl analysis is dne as this gives a meaningful estimate f the lsses at varius stages in the lan cycle as well as f the verall lifetime lsses, and is free frm the distrtins caused by a high grwth rate. Liquidity It is imprtant fr an NBFC t maintain a favurable liquidity prfile fr the smth functining f its funding activity (fresh asset creatin) and t hnur its debt cmmitments in a timely manner. It is als imprtant that an NBFC manage its interest rate risk, as the same culd impact its future prfitability. In assessing an NBFC s liquidity prfile, ICRA Indnesia evaluates the cmpany s plicy n liquidity, the maturity prfiles f its assets and liabilities, the asset-liability maturity gaps, and the backups available t plug such gaps. The evaluatin als fcuses n the diversity f the NBFC s funding surces and their quality (i.e. availability f these surces in a stress situatin). Prfitability An NBFC s ability t generate adequate returns is imprtant frm the perspective f bth its sharehlders and debt hlders. The purpse f ICRA Indnesia s evaluatin here is t assess the level f future earnings and the quality f earnings f the NBFC cncerned, which is dne by lking clsely at the building blcks: interest spreads, fee incme, perating expenses, and credit csts. The evaluatin f an NBFC s prfitability starts with the interest spreads (yields minus cst f funds) and the likely trajectry f the same in the light f the changes in the perating envirnment, the cmpany s liquidity psitin, and its strategy. The ability f the NBFC t cmplement its interest incme with fee incme is als assessed. A large fee incme allws greater diversificatin, which in turn can imprve the resilience f earnings, thereby imprving an NBFC s risk prfile. After assessing the incme stream, ICRA Indnesia evaluates the NBFC s perating efficiency (perating expenses in relatin t ttal assets, and cst t incme rati) and cmpares the same with that f its peers. Finally, the credit csts are estimated n the basis f the cmpany s asset quality prfile, and the prfitability indicatrs 2 cmpared acrss peers. Imprtantly, a very high return n equity may nt necessarily translate int a high credit rating, given that the underlying risk culd be very high as well, and being s it culd be mre vlatile r difficult t predict. Accunting Quality Cnsistent and fair accunting plicies are a prerequisite fr financial evaluatin and peer grup cmparisns. In evaluating an NBFC s accunting quality, ICRA Indnesia reviews the cmpany s accunting plicies, ntes t the accunts, and auditrs cmments in detail. Deviatins frm the Generally Accepted Accunting Practices are nted and the financial statements f the NBFC are adjusted t reflect the impact f such deviatins. Capital Adequacy An NBFC s capital prvides the secnd level f prtectin t debt hlders (earnings being the first) and therefre its adequacy (in relatin t the embedded credit, market, and peratinal risk) is an imprtant cnsideratin fr ratings. Riskiness f the prduct and granularly f the prtfli are factrs that have a Nn Perfrming Lans 2 Prfit after Tax as a percentage f Average Ttal Assets, and Prfit after Tax as a percentage f Average Net Wrth ICRA Indnesia Page 4 f 5

5 significant bearing n the amunt f capital required t prvide the desired degree f prtectin t an NBFC s debt hlders. The requirement f risk capital varies with the cncentratin and the riskiness f the prduct mix, as the fllwing chart shws. Chart 1: Risk Capital Requirement Matrix Expected credit lsses and variability Lw High Prtfli Cncentratin High Mderate High Lw Lw Mderately high ICRA Indnesia starts with the adjusted capital (as discussed in the sectin n Accunting Quality) and cnsiders the internal capital generatin and pssible supprt frm a strng parent/grup cmpany while evaluating the adequacy f an NBFC s risk capital fr a particular rating categry. ICRA Indnesia als evaluates the quality f an NBFC s capital, apart frm the level f capital. A higher percentage f Tier I capital is viewed mre favurably, given its greater permanence. Besides, an NBFC s ability t meet regulatry capital adequacy (such as in relatin t ttal brrwings) requirement is als evaluated. If necessary, ICRA Indnesia als makes adjustment n an NBFC s capital t truly reflect the underlying risks frm certain transactins that it undertakes, fr example lan channelling. Summing up The credit ratings assigned by ICRA Indnesia are a symblic representatin f its current pinin n the relative credit risk assciated with the instruments rated. This pinin is arrived at fllwing a detailed evaluatin f the issuer s business and financial risks and n using such evaluatin t prject the level and stability f its future financial perfrmance in varius likely scenaris. While several parameters are used t assess an NBFC s risk prfile, the relative imprtance f each f these parameters (qualitative as well quantitative) can vary acrss cmpanies, depending n its ptential t change the verall risk prfile f the cmpany cncerned. Cpyright, 2011, ICRA Indnesia. All Rights Reserved. All infrmatin cntained herein has been btained by ICRA Indnesia frm surces believed by it t be accurate and reliable. Althugh reasnable care has been taken t ensure that the infrmatin herein is true, such infrmatin is prvided as is withut any warranty f any kind, and ICRA Indnesia in particular, makes n representatin r warranty, express r implied, as t the accuracy, timeliness r cmpleteness f any such infrmatin. All infrmatin cntained herein must be cnstrued slely as statements f pinin and ICRA Indnesia shall nt be liable fr any lsses incurred by users frm any use f this publicatin r its cntents. * Adpted and mdified frm ICRA Ltd. s Credit Rating Methdlgy fr Nn-Banking Finance Cmpanies. ICRA Indnesia Page 5 f 5