RBI dividend cap proposal for NBFCs: Kotak report gives key insights

Dividend payout caps for NBFCs are based on CAR (Capital Adequacy Ratio) and net NPLs. RBI has released a draft circular on dividend payout ratio caps for NBFCs. The final guidelines will be introduced in due course; the current draft suggests that the guidelines will likely be applicable from FY2021E itself even though NPL ratio in FY2021E will likely be high due to the pandemic. The circular is addressed to NBFCs and not explicitly to HFCs. However, since HFCs are reckoned as NBFCs under the recent HFC guidelines, we believe that these guidelines will be applicable to HFCs (Aavas, HDFC and LIC Housing Finance) as well. RBI proposes to cap dividend payout ratio for NBFCs at a maximum of 50%.

The dividend payout ratio will be based on:

(1) capital adequacy ratio (CAR)

(2) net NPL for large players

LIC Housing Finance (due to low CAR), Mahindra and Mahindra Financial Services (high net NPLs) and Shriram Transport Finance (high net NPLs) will not be eligible for dividend payouts, if the norms apply to the previous year. Kotak awaits the final set of guidelines and implementation timelines on the same.

NBFCs that have CAR below 15% or net NPLs above 6% are not eligible for paying dividend. NBFCs have to comply with the requirement for three consecutive years (including the current fiscal) to be eligible for dividend payouts. The payout ratio caps range from 15-50% based on the aforesaid two ratios.

Most NBFCs comfortably placed excluding LIC Housing Finance, Mahindra and Mahindra Finance and Shriram Transport:

Several covered companies well placed:

Most large NBFCs under our coverage are well placed to meet the proposed dividend caps excluding LIC Housing Finance, Mahindra and Mahindra Finance and Shriram Transport Finance, if the guidelines are made applicable from the previous year.

Low CAR for LIC Housing Finance:

All covered NBFCs excluding LIC Housing Finance comply with CAR requirements of >15%, most NBFCs need to maintain high capitalization levels to provide comfort to rating agencies and debt capital markets.

High net NPLs in vehicles finance:

Select vehicle financiers like Mahindra & Mahindra Finance and Shriram Transport Finance have net stage 3 loans of >6% over the past three (or at least in one of these years) thereby making them ineligible for dividend payments. While Shriram Transport’s dividend payout ratios have been low at ~5-10% over the past few years, Mahindra Finance has reported 20-25% payouts in FY2018 and FY2019.

A couple of tools for non-compliance on margin:

NBFCs can manage these ratios (CAR and net NPLs) by raising tier II capital in case of non-compliance on the former or adjusting write-offs in case of deficit for the latter. NBFCs and HFCs can toggle between NPL provisions and write-offs or increase coverage on GNPLs in order to comply with net NPL requirements.

More to come for large players:

RBI has proposed to tighten regulations for NBFCs post the IL&FS crises. The regulator introduced LCR guidelines in the past year, capped HFC leverage and has now prescribed dividend caps. RBI will likely tighten regulations for large NBFCs further; a ‘scale-based regulatory approach linked to the systemic risk contribution of NBFCs’ will be proposed in the next one month.