Motilal Oswal Financial Services

7/19/2019 Motilal Oswal Financial Services
Thema c | July 2018
NBFC
Ind-AS
A new, contemporary look

Sandeep Gupta (S.Gupta@Mo lalOswal.com), +91 22 3982 5544; Alpesh Mehta (Alpesh.Mehta@Mo lalOswal.com); +91 22 3982 5415
Mohit Bahe (Mohit.Bahe @mo laloswal.com), +9122 3846 2492; Somil Shah (Somil.Shah@Mo lalOswal.com), +9122 3312 4975
NBFC
Contents: NBFC – Ind-AS: A new, contemporary look
https://www.motilaloswal.com/site/rreports/HTML/636669825011460493/index.htm 1/27
Summary ............................................................................................................................. 3
NBFCs – a paradigm shi in financial repor ng..................................................................... 7
HFCs to witness gains, Corporate financiers impacted ........................................................ 24
Opportuni es and key challenges ....................................................................................... 28
Investors are advised to refer through important disclosures made at the last page of the Research Report.
Mo lal Oswal research is available on www.mo laloswal.com/Ins tu onal-Equi es, Bloomberg, Thomson Reuters, Factset and S&P Capital.
July 2018 2
Thema c | July NBFC

2018
NBFC
Ind-AS: A new, contemporary look
Entering an era of transparent repor ng and enhanced disclosure prac ces
Indian NBFCs are all set to adopt IFRS-converged Indian Accoun ng Standards (Ind-AS)
from FY19. This will bring in more transparency in the system and ensure disclosures
are in line with global standards. Moreover, it will change the way companies conduct
their business in terms of structuring their loans (upfront fees v/s yields), liabili es,
employee compensa on, and securi za on/assignment, amongst others.
In the absence of any circular from the RBI, NBFCs will follow accoun ng policies
based on Ind-AS, but con nue with older norms for regulatory repor ng.
We believe the impact on reserves for most NBFCs will be neutral to posi ve, given (a)
largely mono-line businesses with a proven track record, near-zero any other form of
stressed loans (besides NPA) and high provisioning and (b) reversal of DTL recognized
on special reserves.
Companies having ZCBs, structured debt, preference shares, a higher share of lumpy
fees and higher ESOP cost would be adversely impacted.
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support in the Asiamoney We believe that HFCs are best placed to face the transi on, while corporate lenders
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Transi on to Ind-AS means much more than just accoun ng change
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Ind-AS will bring more transparency in accoun ng and disclosures. It will also
change the way companies conduct their business in terms of employee
compensa on, structuring of loans, securi za on/assignment of loans, issuance
of liabili es, etc.
In our view, the migra on to the new norms will lead to major differences in the
presenta on of financials on account of recogni on of (a) fee income/loan
origina on expenses, (b) interest income on impaired assets, (c) impairment
provision, (d) fair valua on of ESOP, (e) interest expense on ZCBs/deep discount
bonds/preference shares, (f) securi zed loans, (g) gains on assignment, (h) DTL
on special reserve and (i) investment classifica on and valua on, as well as
consolida on of en es based on control.
HFCs to witness gains; corporate financiers most impacted

HFCs will see a benefit in the form of provisioning and reversal of DTL. Most
large HFCs have a proven track record of low LGDs and PDs, and carry
addi onal/con ngent provisioning on balance sheet. Processing fees on core
housing loans may be replaced by legal and other charges, and thus, not impact
the income statement. DSA expense amor za on and a reduc on in credit cost
are added benefits for HFCs. However, companies in the affordable housing
segment with a limited track record and a higher share of fee income could see
some impact. Companies with ZCCBs/structured liabili es/ESOPs are likely to
see higher expenses ge ng charged through the income statement.
Corporate financers may witness higher provisioning, deferment of fee income
and a rise in employee expenses. Vehicle financers may see an impact on their
securi za on ac vity (awai ng final regula on on this) and a minimal impact on
provisioning.
Overall, the impact of Ind-AS convergence on our NBFC coverage universe will
be neutral to posi ve.
July 2018 3
NBFC
Several opportuni es, but challenges remain

Ind-AS is likely to bring in more transparency in the system and ensure
disclosures are in line with global standards. Since Ind-AS is based on the
principle of ‘substance over form’ and ‘fair valua on’, it is likely to present a
more contemporary picture of the state of affairs of the companies.
Under Ind-AS, companies would need to (a) prepare an opening balance sheet
on the transi on day, (b) recognize assets and liabili es based on the new
norms and (c) route the difference through the reserves. This will imply a
material change in networth. We believe that investors need to be watchful of
adjustments made by companies during the migra on.
We believe that several migra on-related challenges s ll remain. These include
(a) clarifica on from the regulators on implementa on of ECL, securi za on,
etc., (b) high dependence on management’s es mate, (c) lack of exper se on
fair valua on, (d) varying level of corporate preparedness and (e) a separate set
of financial statement required for filings with the regulator.
NBFC: Impact from Ind-AS transi on

Deferment of Amor za on of Interest on ZCCB Upfront gain Reversal of DTL
Expected Credit Employee
Fee Income loan origina on / Deep Discount recogni on on on special
NBFCs Loss (ECL) model Benefit Expenses
expenses Bonds / Pref direct reserve
Dividend assignment
HDFC ●● ●● ●●● ●●● ●●● ●● ●●●
Indiabulls Housing Finance ●● ●● ●●● ● ●●● ● ●●
PNB Housing Finance ●● ●● ●●● ●● ●● ●● ●●
Dewan Housing Finance ●● ●● ●●● ●● ●●● ●● ●●
REPCO ● ●● ●●● ● ● ● ●●●
LIC Housing Finance ● ●● ● ● ● ● ●●●
Gruh Finance ● ●● ● ● ● ● ●●●
L&T Finance Holdings ● ● ●●● ● ●●● ● ●
Mahindra Finance ●● ●● ●● ● ● ● ●
Shriram Transport Finance ●● ●● ●● ● ● ● ●
Shriram City Union Finance ● ● ● ● ● ● ●
Cholamandalam Investment
and Finance
●● ●● ●● ● ● ●● ●
Bajaj Finance ● ● ●● ●● ● ●● ●
Impact: Posi ve ●●● l Marginally Posi ve ●● l Neutral ● l Marginally Nega ve ●● l Nega ve ●●● Source: MOSL
July 2018 4
NBFC
Exhibit 1: Major changes and their impact on key metrics for NBFCs
Key difference areas IGAAP Ind-AS Impact due to Ind-AS
Revenue Recogni on
Fee income on loans No specific guidelines. Generally Fee income is amor zed over life Temporary deferral of revenue
extended recognized on receipt basis. of loan/period of service using recogni on leading to impact on
effec ve interest rate. PPoP and earnings.
Investment income Instruments classified as (a) non- Instruments classified as (a) Higher vola lity in treasury
trade investment and (b) trade amor zed cost: carried at cost, (b) income. Increase in networth on
investment carried at cost. FVTOCI: with MTM gains/losses in one- me fair valua on on
reserve and (c) FVTPL: with MTM transi on.
gains/losses in P&L.
Interest income on NPA Interest income on NPA to be Interest income is recognized on RBI guideline under IGAAP was
recognized on realiza on basis. the basis of effec ve interest rate conserva ve. Ind-AS would,
on net carrying value of asset however, lead to regula on of
(gross-impairment provision). otherwise lumpy interest income
on NPA.
Gains on direct Gains are amor zed over the tenure Gains would be recognized upfront Up-fron ng of gains on
assignment of assignment. in income statement, as loans assignment in income statement.
assigned would be de-recognized.
Financial instruments
Loan impairment Impairment provision based on RBI Expected credit loss (ECL) Early recogni on of impairment
provisioning guidelines, which is more in line framework to be applied for loan provisioning on loan book based
with incurred loss model. impairment provision. on the three-stage ECL model
and variables of PDs/LGDs.
Borrowing cost on deep Discount on issue/premium on Charged through income Decrease in NII.
discount redemp on charged through statement on EIM method.
bond/redemp on reserves.
premium
maturity payable on
Interest expenses on Interest expenses for structured Interest expenses would be Decrease in NII in the earlier
structured bonds bonds charged on accrual basis. recognized on EIR basis. years compensated by increase
in subsequent years.
Classifica on of Financial Legal form of financial instrument Substance rather than form drives Exis ng financial instrument
Assets and Financial drives classifica on. classifica on of financial would need reclassifica on, E.g.,
Liabili es instrument. preference shares, perpetual
bonds.
Preference dividend on Preference dividend is shown as Redeemable preference shares Decrease in NII.
redeemable preference appropria on to profits. treated as debt, and preference
shares dividend as finance cost.
Employee benefits
ESOPs Op onal to account for ESOP cost Mandatory to account for ESOPs Increase in employee costs.
on intrinsic basis or fair valua on. cost on fair valua on.
Long-term employee Gains/ losses on change in actuarial Gains/losses on change in actuarial Reduc on in vola lity of income
benefit plans assump ons charged to income assump ons charged to reserves. statement.
statement.
Termina on benefits Benefit expense to be recognized Benefit expense to be provided for Upfront recogni on of
when employer becomes legally on the basis of construc ve termina on benefit-related
liable (e.g. employee accepts VRS). liability. expenses.
Income tax
MAT on unrealized Investments are carried at lower of Investment carried at FVTPL and Increase in tax expenses (MAT)
investment MTM gains Cost or fair value with only losses FVOCI would be fair value, leading due to unrealized MTM profits
recognized in income statement. to unrealized MTM gains subject to on investments.
MAT. Also, transi on gains would
be subject to MAT.
Reversal of DTL on Deferred tax liabili es to be Ind-AS does not require crea on of Reversal of DTL provisions as on
special reserve accounted on special reserve, based deferred tax on amount FY18 in networth and no
on the NHB pruden al guidelines transferred to special reserve. recurring charges in income
for HFCs. statement.
July 2018 5
NBFC
Key difference areas IGAAP Ind-AS Impact due to Ind-AS

Others
Loan processing Generally recognized on upfront Transac on costs on loan Deferral of cost recogni on
expenses basis. origina on are amor zed over life leading to expansion of PPoP.
of loan.
Recogni on of Loans securi zed are de-recognized True sale criteria to be fulfilled for New loans securi za on would
securi zed loan assets except for the MRR amount, based the loans to be eligible for de- not be de-recognized due to
on the IRACP guidelines. recogni on, i.e., only when all non-fulfillment of ‘True sale
contractual rights to cash flow criteria’, leading to an impact on
transfer to buyer. RoA.
Exhibit 2: Ind-AS changes to impact income statement and networth

Par culars Income Statement Net-worth
Revenue Fee income on loans
recogni on
Interest income on NPAs
Investment Income
Gains on direct assignment
Financial Impairment provision- expected credit Loss model
Instruments
Borrowing cost on deep discount bond/redemp on premium payable
on maturity
Interest expenses on structured bonds
Classifica on of Financial Assets and Financial Liabili es
Preference dividend on redeemable preference shares
Employee Benefit Actuarial gain / loss
Fair valua on of ESOPs
Income Tax MAT impact on MTM gain on fair valua on
DTL on special reserve
Others Loan processing fee
Transi on t o Ind AS – one- me impact
Source: MOSL
July 2018 6
NBFC
NBFCs – a paradigm shi in financial repor ng
Indian NBFCs are undergoing a big shi in the way they report financials a er
migra ng to Ind-AS from April 2018. Ind-AS, which is based on the principle of
‘substance over form’ and ‘fair valua on,’ differs materially from IGAAP, which is
focused on ‘legal form’ and ‘conserva sm.’ Migra on to the new norms will lead to
Ind-AS, based on the
major differences in the presenta on of financials on account of recogni on of (a)
principle of (a) substance fee income/loan origina on expenses, (b) interest income on impaired assets , (c)
over form and (b) fair impairment provision, (d) fair valua on of ESOP, (e) interest expense on ZCBs/deep
valua on, would discount bonds/preference share capital, (f) securi zed loans , (g) gains on
significantly impact NBFCs assignment, (h) DTL on special reserve, and (i) investment classifica on and
valua on, as well as consolida on of en es basis control. .
Transi on to Ind-AS – much more than just accoun ng change

NBFCs will transi on to Ind-AS from FY19 based on the meline specified by the
Ministry of Corporate Affairs (MCA). However, for banks, the RBI has given a
one-year extension for transi on to the new accoun ng norms, considering the
significant impact and the lack of preparedness.
We believe that the transi on to Ind-AS involves much more than just a
technical challenge. It will be one of the biggest fundamental changes to affect
the non-banking and financial services industry for many years.
The transi on will lead to some changes in the way businesses are being
conducted today in terms of employee compensa on, structuring of loans
(upfront fees v/s yields), and securi za on, among others.
Beyond accoun ng, Ind-AS requires companies to make extensive disclosures.
This will ensure greater transparency and efficient decision making.
Exhibit 3: Roadmap for implementa on of Ind-AS for NBFCs
Phase I Phase II
Year of adop on FY18 FY19
Compara ve year FY17 FY18
Companies covered
NBFCs with net worth
Listed companies Companies listed or in the process of being listed
> = INR5b
NBFCs with net worth Companies having net worth
Unlisted companies
> = INR5b > = INR2.5b
Group companies Applicable to holding, subsidiaries, JVs or associates of companies covered above
Source: MCA, MOSL
HFCs to adopt Ind-AS, but con nue with IRACP for compliance repor ng
th
Na onal Housing Bank (NHB), in its circular dated 14 June 2018, reiterated that
HFCs are required to adopt and implement Ind-AS based on the accoun ng
standards and guidance notes issued by ICAI and as no fied by the MCA.
However, HFCs, for regulatory and supervisory purposes, are required to
con nue following the exis ng norms, including pruden al norms, and other
related circulars, etc.
HFCs, thus, would need to maintain dual books of financial accounts with
financial results. We expect the RBI will come out with similar guidelines for
other NBFCs (Click here for circular).
July 2018 7
NBFC
Earnings and networth to be impacted under new norms

Our analysis highlights that significant differences lie in financial instruments,
revenue recogni on, employee benefits and income taxes in the NBFC sector.
Besides this, accoun ng changes related to business combina ons and
consolida on would be necessary.
Such changes are likely to impact both earnings and networth of companies.
KEY IMPACT AREAS FOR NBFCs WHILE TRANSITIONING TO IND-AS
01 02 03 04
FINANCIAL REVENUE INCOME EMPLOYEE
INSTRUMENTS RECOGNITION TAXES BENEFITS
Impairment Fee income DTL on special Fair valua on of

provisioning - ECL recognized on EIR reserve ESOP
model basis Deferred tax on Actuarial impact
Classifica on, MTM gains to be balance sheet in OCI
measurement recognized approach
and de- Interest income
recogni on of recogni on on
financial NPA
instruments.
IND-AS TO IMPACT NBFCS’ EARNINGS AND NETWORTH
INCOME STATEMENT NET WORTH
NPA impairment provision based on 'Expected Credit All adjustments that impact income statement.
Loss' model All adjustments to be made in opening reserves while
Deferment of fee income on loans and guarantees transi oning to Ind-AS (primarily loan loss provisioning
Deferment of loan origina on expenses and DTL on special reserves)
Recogni on of interest expenses through income Transac ons such as hedge accoun ng of deriva ves,
statement on ZCCB and deep discount bonds. actuarial gain/loss, etc., routed directly through OCI
Recogni on of interest cost on structured bonds on EIR reserves
basis. Fair valua on of investment por olio (for FVOCI
Recogni on of issue expenses on raising structured por olio)
products through income statement Classifica on and measurement of financial assets and
Early recogni on of gains on direct assignment of loans financial liabili es
No requirement of crea on of DTL on special reserve Tax adjustment following the balance sheet approach
Gain/loss on fair valua on of investment por olio (for under Ind-AS
FVTPL and investments carried at amor zed cost)
Recogni on of interest income on NPAs
Actuarial gain/loss on long-term employee benefits to
get routed through reserves
Fair valua on of ESOPs
Recogni on of employee terminal benefits on the basis
of construc ve liability
Dividend on preference shares
July 2018 8
NBFC
Deferment of fee income/origina on cost on loans

NBFCs derive a significant propor on of their earnings through fees and service
charges. Most of the NBFCs generally follow accrual methods to recognize fee
income.
Under the previous regime, loan processing fees were recognized upfront in the
profit, and loss account and costs rela ng to origina on of loans (DSA expenses)
were debited to the profit and loss account.
Under Ind-AS, integral fees (loan linked fees) – such as origina on fees – would
be adjusted in the effec ve interest rate (EIR) and amor zed over loan maturity.
On the other hand, non-integral fees, such as specific services fees, would
con nue to be accounted like under IGAAP.
Recogni on of integral fee on amor zed basis over the life of the loan using the
‘effec ve interest rate’ method will lead to me deferment in recogni on of
revenue.
Exhibit 4: Integral & non-integral fees to be recognized over different me horizons
Not
Adjusted to
Adjusted to
EIR: Intregal
EIR: Non-
Fee
Origina on fees Integral Fee
received on crea on of Specific service fees
financial asset
Orgina on fees paid

on crea on of financial Loan syndica on fees
liability
Commitment fees
Commitment fees
(when loan is not
(when loan is not
measured at FVPTL);
measured at FVPTL);
does not involves
involves specific
specific lending
lending arrangement
arrangement
Source: MOSL
The impact of deferment of fee income will vary among NBFCs on the basis of
loan book. Further, the impact will be offset by amor za on of loan origina on
expenses, which are currently being expensed.
Retail financiers to see Retail financiers – vehicle financiers, housing financiers and MFIs derive fee
minimal impact (lower fee income typically in the range of 0.5-2% of the loan amount, followed by
income) rela ve to
consumer financiers (0.25% of the loan amount).
corporate financiers (higher
Retail financers have higher loan origina on expenses, which will be deferred
fee income)
and recognized over the tenure of the loan, offse ng the impact of deferral of
fee income.
Among NBFCs, companies having a higher share of developer and corporate
loans may be adversely impacted. Fees on corporate book are higher than
processing fees, which would be amor zed over the tenure of loans, leading to a
net nega ve impact.
Also, fee income, which would have been already recognized on current
outstanding loan, will be reversed in opening transi on. This reversed fee
July 2018 9
NBFC
income would now be recognized using the effec ve interest rate on the
remaining part of loans.
Since this provision will be applicable retrospec vely, this would impact
companies with a high-growth por olio rela ve to those with a steady-growth
por olio.
NII to be impacted on factoring in redemp on premium as interest cost

A few NBFCs issue deep discount coupon bonds redeemable at a premium.
Currently, the issue expenses, discount and redemp on premium are charged
directly through reserves. Ind-AS requires the discount/premium payable on
such bonds to be charged off to the profit and loss statement on an EIR basis,
impac ng NII.
Companies issuing deep Also, for the structured bonds (such as one with a step up in interest payments
discount bonds/structured
over the life of the bond) issued by the companies, interest expenses will now
bonds to see increase in
be factored on the EIR basis rather than the accrual basis. This will lead to higher
interest cost
interest recogni on during the earlier years, with an offse ng impact in the
later years.
Under the erstwhile regime debenture/bond issue, expenses were permi ed to
be charged off through the reserves. Under Ind-AS, the same needs to be routed
through the income statement.
Exhibit 5: NBFCs: Interest cost on ZCCB to impact earnings (INR m)

Company FY17 FY18
Amount NII % PAT % Amount NII % PAT %
#
HDFC 3,038 3.1% 4.1% 3,840 3.4% 4.5%
Indiabulls Housing Finance 2,621 6.6% 9.0% * * *
Dewan Housing Finance 1,147 7.6% 12.4% 989 4.1% 8.4%
Punjab Na onal Housing Finance - - - 127 0.8% 1.5%
*FY18 Annual Report NA
#On Standalone Financial Statements Source: Company, MOSL
Exhibit 6: IBHF currently routes debenture issue expenses and premium through reserves
Par culars INR m*
Debenture issue expenses (Net of tax) 1,253
Premium on redemp on of NCD (Net of tax) 1,368
2,621
*For FY17, FY18 Annual Report NA Source: Company, MOSL
Forward-looking ECL approach to impact loss provisioning

The forward-looking expected credit loss (ECL) approach for loan impairment
provisioning is significantly different from the current provisioning norms under
the RBI-prescribed income recogni on, asset classifica on and provisioning
(IRACP).
Three-stage ECL model
ECL model follows a three-stage approach, under which loan impairment
would lead to early provisioning is measured either on ‘12-month ECL’ or ‘Life me ECL,’ depending
recogni on of loan loss on the credit quality assessment of the financial instrument.
provisioning NBFCs will have to provide for loss allowance, not only based on their por olio’s
historical loss experience, but also by factoring in their future expecta ons and
the macro-economic environment.
July 2018 10
NBFC
In contrast, under the IRACP norms, the provisioning is based on the objec ve
criteria fixed by the RBI, which are based on the 90-day past-due concept for
both banks and NBFCs. These IRACP norms waited for actual impairment to be
incurred before requiring a loss allowance thereon, and hence, it is cri cized for
being a ‘too li le, too late’ approach.
Furthermore, as a prudent measure to build a cushion against the build-up of
non-performing assets (NPA), the RBI has prescribed a provision on standard
assets.
Exhibit 7: Ind-AS prescribes a three-stage asset classifica on model

Default Timeline IRACP IRACP – Provision ECL
0 - 30 Days SMA 0 Stage I

31 - 60 Days SMA 1 0.4%
Stage II
61 - 90 Days SMA 2
More than 90 Days NPA
NPA <= 1 year Sub-Standard: Secured 15.0%
NPA <= 1 year Sub-Standard: Unsecured 25.0%

Stage III
Sub-Standard <= 1 year Doub ul: Up to 1 year 25.0%
>1 year Sub-Standard <= 3 year Doub ul: 1 - 3 year 40.0%

Sub-Standard > 3 year Doub ul: more than 3 year 100.0%
Source: MOSL
Exhibit 8: Overview of the ECL model
Change in credit quality since in al recogni on
Stage 3:
Stage 2:
Stage 1: Non-
Underperforming (assets
performing
Performing assets (ini al with significant increase in (credit
recogni on) credit risk since ini al
impaired
recogni on) assets)
Effec ve interest
12 month Effetc ve Life me Effec ve Life me on amor sed
expected interest on expected interest on expected cost carrying
credit gross carrying credit gross carrying credit amount (that is,
losses amount losses amount losses net of credit
allowance)
Source: MOSL
Stage 1: Performing assets with low credit risk

This stage involves the performing financial instruments, which include
originated/purchased financial instruments or low-credit-risk financial
instruments.
July 2018 11
NBFC
For these assets, 12-month expected credit losses (ECL) are recognized and
interest revenue is calculated on gross carrying amount of the asset (i.e.,
without deduc on for credit allowance).
12-month ECLs are the expected credit losses that result from default events
that are possible within 12 months a er the repor ng date.
Stage 2: Underperforming assets with significant increase in credit risk

This stage involves the underperforming financial instruments that have had a
significant increase in credit risk since ini al recogni on (unless they have low
credit risk at the repor ng date) but that do not have objec ve evidence of
impairment.
For these assets, life me ECL are recognized, but interest revenue is s ll
calculated on gross carrying amount of the asset.
Life me ECLs are the expected credit losses that result from all possible default
events over the expected life of the financial instrument. Expected credit losses
are the weighted average credit losses, with the probability of default (‘PD’) as
the weight.
Stage 3: Non-performing assets (NPA) with objec ve evidence of

impairment
This stage involves non-performing financial instruments that have objec ve
evidence of impairment at the repor ng date. For these assets, life me ECLs are
recognized, and interest revenue is calculated on the net carrying amount (that
is, net of credit allowance). Financial instrument in this stage will generally be
individually assessed.
Key observa on:

The ECL model relies on rela ve assessment of credit risk. This means that a loan with the same characteris c could be
included in stage 1 for one NBFC and in stage 2 for another, depending on the credit risk at ini al recogni on of the loan
for each en ty.
Moreover, a NBFC could have different loans with the same counterparty that are included in different stages of the
model, depending on the credit risk that each loan had at origina on.
Conclusion:
The applica on of ECL framework would largely vary across NBFCs depending upon risk management strategies adopted,
and historical performance.
Exhibit 9: Provision requirement to increase as assets shi to a higher stage

Par culars Stage 1 Stage 2 Stage 3
Asset categoriza on Performing Under performing Non-performing
Not deteriorated significantly since Deteriorated significantly since Objec ve evidence of
Credit quality
its ini al recogni on its ini al recogni on impairment
Credit risk Low Moderate to high Very high
Basis of provisioning recogni on 12 month ECL Life me ECL Life me ECL
On net basis (gross carrying
Interest On gross basis On gross basis
value minus loss allowance)
Source: MOSL
July 2018 12
NBFC
Change in stage of asset classifica on under ECL model remains cri cal
ECL model prescribes ‘significant increase in credit risk’ as a catalyst leading to
downgrading of financial assets from stage I to stage II and ul mately to stage
III.
Significant increase in credit risk depends on quan ta ve as well as qualita ve
factors of financial assets. Ind-AS 109 provides list of events (such as financial
difficulty of borrower, breach of contract and disappearance of an ac ve market
for that financial assets) which may solely or collec vely indicate a significant
increase in credit risk.
Further, the Ind-AS provides for certain rebu able presump ons, which set
certain backstops to the con nua on of the asset/ loan exposure in a par cular
stage of asset classifica on.
Exhibit 10: Significant increase in credit risk
Change in forward-looking marginal life me Pds, guided by credit

scores, ra ngs, risk categories and collec ve assessment of effects
Yes of forward-looking informa on (most sophis cated approach)
It may be possible to use changes in 12months Pds, for certain loans
Challenge to define significance thresholds
Watch lists (Wholesale)

Yes Ra ngs / credit scores
Changes in behavior
Death, divorce, unemployment or bankruptcy
Expecta ons of forbearance
Market indicators, e.g. credit spreads, bond spreads
Business environment, technological changes, market prices
Yes
>30 days past due presump on
Forbearance
Covenant breaches
Source: MOSL
Rebu able presump on – a BACKSTOP

Significant increase in ini al credit risk (migra on from stage I to stage II)
Regardless of the way in which an en ty assesses significant increase in
credit risk, there is a rebu able presump on that the credit risk on a
financial asset has increased significantly since ini al recogni on when
contractual payments are more than 30 days past due.
This presump on can be rebu ed only if there is reasonable and
supportable evidence that there has been no significant increase in the
credit risk. For example, where non-payment is due to administra ve
oversight, instead of resul ng from financial difficulty of the borrower.
Objec ve evidence of impairment /default (migra on from stage II to stage III)

Ind-AS 109 states that when defining default for the purposes of
determining the risk of a default occurring, an en ty shall apply a default
defini on as used for internal credit risk management purposes.
July 2018 13
NBFC
However, there is a rebu able presump on that default does not occur
later than when a financial asset is 90 days past due unless an en ty has
reasonable and supportable informa on to demonstrate that a more lagging
default criterion is more appropriate.
Key observa on:

The rebu able presump on of 30-90 day by Ind-AS 109 may bring consistency at some level. It would also strengthen
credit risk management and facilitate be er repayment discipline. Also, the 90-day threshold is consistent with the IRB
approach under the Basel framework as well as with the extant RBI guidelines.
The transi on to ECL is subjec ve framework based on management judgment,

which will make it difficult for various stakeholders such as the RBI and auditors
to exercise audit and make comparison across banks.
Although the ECL model is forward-looking, historical informa on is always
considered to be an important anchor or base to measure the expected credit
losses. However, historical data should be adjusted on the basis of current
observable data to reflect the effects of current condi ons and forecasts of
future condi ons.
Calcula ng Expected Credit Loss (ECL)
ECL = PD * LGD * EAD * DF
Where,
Probability of Default (PD):
PD is the probability of borrowers defaul ng on their obliga on in the future
PDs varies across stages of
based on historical experience and future es ma on. Each financial ins tu on
loan por olio and depends
on internal credit risk and would define its own terms of default depending on internal credit risk
historical experience management for relevant loan por olio, historical experience, and future
es ma on, among others.
PD is representa ve of asset quality, and thus, varies across different stages of
loan por olio. We believe that a parallel analogy could be drawn from loan
por olio and historical slippage rate to es mate PDs. For instance, housing
financiers with lower historical slippage ra os (like GRUH) in the past would
typically have lower PDs than financiers with higher slippage (like MMFS).
NBFCs would need to categorize loan por olios based on different borrower
class (such as corporate, retail and agricultural) and further sub group into
different tranches based on the homogenous pa ern. Corporate loan book
could be further categorized into different sectors such as cement, power and
infrastructure. Retail loan book could be categorized depending on the product
category, the target customer profile, geography and so forth.
Loss Given Default (LGD)

LGDs applies uniformly LGD is the es mated loss from a transac on once a default has been incurred.
across stages of loans and As LGD is independent of asset quality, it is applied uniformly across various
depends on type and stages.
amount of collateral LGD depends on the type and amount of collateral and is exposure specific, i.e.,
different exposures to the same borrower may have different LGDs.
July 2018 14
NBFC
Exposure at default (EAD):

EAD is an es ma on of exposure of banks in the event of default.
Provision coverage ra o – cri cal to access the impact

To understand the company-wise impact of ECL provision, one needs to also
factor in the provision coverage ra os and outstanding provisions that
companies have been maintaining. A company carrying a higher provision
coverage ra o is less suscep ble to the one- me impact on provisioning and is
also less likely to witness a steep increase in the credit cost on migra on to
IndAS.
Exhibit 11: Higher GNPA for vehicle financiers and corporate financiers (INR b)
GNPL NPL 73.8
53.9
47.0
39.2
33.4
23.0 24.6
19.7 21.3
11.4 12.8 13.0
7.1 8.1 5.0 9.4 7.1 9.4
2.9 4.1 1.9 1.4 2.8 1.3
0.7 -
BAF CIFC DHFL GRUH HDFC IBHFL LICHF LTFH MMFS PNBHF REPCO SCUF SHTF
For FY18 Source: Company, MOSL
Exhibit 12: Higher GNPA for vehicle financiers and corporate financiers (%)
GNPL % NPL %
8.5 9.0
7.7
6.5
4.0 3.6 3.4
3.0 2.9 1.3 2.2
1.4 0.3 1.7 0.8 0.5 0.5 - 1.0 0.6 0.8 0.3 0.8 0.4 0.3 0.2
BAF CIFC DHFL GRUH HDFC IBHFL LICHF LTFH MMFS PNBHF REPCO SCUF SHTF
For FY18 Source: Company, MOSL
Determining impact of ECL

The impact of ECL depends on cri cal variables of quality of loan book (loss
given default), historical rate of default (Probability of default) and provision
coverage ra o.
Although assessing the PDs would be a dynamic task, we have tried to quan fy
the LGDs on the basis of loan por olio and derive at an approximate loss
provision required on GNPAs (stage III) and assessing the remaining provision
that will be available for standard assets (stage I & stage II).
While we expect LGDs for HFCs to range from 20% to 30%, those for VFCs and
Consumer finance are likely to range from 30% to 50%. We expect corporate
financiers like LTFH to have higher LGD of 65%, given the restructured loan
book.
July 2018 15
NBFC
Accordingly, we find that:

Low historical asset slippage Most HFCs have adequate provision available for stage I and stage II assets
and exis ng adequate in the range of 1.2% to 1.6%. While, GRUH and LICHF despite having lower
provisioning result in
provision available (at 0.8% and 0.6% respec vely) for stage I and stage II
minimal impact on HFCs
loan assets, based on the lower historical slippages, we expect minimal
impact.
For VFCs, although LGDs for SHTF is rela vely high at 50%, higher provision
available could mi gate the impact of addi onal provision on stage I and
stage II loan assets. We expect LGDs for CIFC to be at 35% as ~30% of loan
book being non vehicle finance.
Among NBFCs, we expect LTFH to require addi onal provisioning
requirements while migra ng to Ind-AS.
Exhibit 13: Corporate financing companies may witness a provisioning shor all under Ind AS (INRb)
Standard GNPA Total Provision Remaining Provision available

NBFCs Loan Book GNPA LGD* %
Assets Loss on Loan Book Provision on Std Assets
(a) (b) (c) (d) = (b) * (c) (e) (f) = (e) - (d) (g) = (f) / (a)
Housing Finance Companies
DHFL 905.2 897.1 8.1 30% 2.4 16.4 14.0 1.6%
GRUH 155.7 155.0 0.7 20% 0.1 1.3 1.2 0.8%
HDFC 3,594.4 3,555.2 39.2 20% 7.8 50.0 42.2 1.2%

IBHF 1,220.5 1,211.1 9.4 30% 2.8 17.6 14.7 1.2%
LICHF 1,663.2 1,650.2 13.0 20% 2.6 12.5 9.9 0.6%
PNBHF 570.1 568.3 1.9 20% 0.4 7.0 6.6 1.2%

REPCO 98.6 95.7 2.8 20% 0.6 2.0 1.4 1.5%
Vehicle Finance Companies
CIFC 366.5 353.7 12.8 35% 4.5 7.1 2.6 0.7%
MMFS 510.0 463.1 47.0 40% 18.8 29.1 10.3 2.2%
SHTF 796.7 723.0 73.8 50% 36.9 55.3 18.5 2.6%

Consumer Finance Companies
BAF 771.3 759.8 11.4 50% 5.7 11.5 5.8 0.8%
SCUF 273.7 249.0 24.6 50% 12.3 16.3 3.9 1.6%
Corporate Finance Companies
LTFH 835.1 781.2 53.9 65% 35.0 23.6 (11.4) -1.5%
*Based on our es mates Source: Company, MOSL
July 2018 16
NBFC
Employee benefits costs may rise

Employee costs under Ind-AS may vary from IGAAPs primarily on account of: (a)
share-based payments and (b) long-term employee benefits. Also, the
recogni on of terminal liabili es will be required to be made on the basis on
construc ve liability rather than the contractual liability, which will lead to early
recogni on of provisioning (expenses) in the income statement.
Exhibit 14: Employee cost recogni on varies under Ind-AS
Long-term employee benefits •Actuarial loss / gain
Share based payments • Fair valua on of ESOPs
Source: MOSL
Fair valua on of ESOPs to impact earnings

Indian GAAP permits an op on of accoun ng for ESOP using either the intrinsic
value method or the fair value method. Most NBFCs grant ESOPs to employees
and have opted to account at intrinsic cost.
Ind-AS, on the contrary, mandates employee share-based payments to be
accounted using the fair value method.
Fair valua on of ESOP is likely to increase employee cost and will have a
significant impact on key indicators such as earnings per share.
Exhibit 15: ESOP fair valua on to impact profitability (INR m)

FY16 FY17 FY18
NBFC FV Net Impact % of PAT FV Net Impact % of PAT FV Net Impact % of PAT
BAF 265 2.1% 305 1.7% 484 1.5%
CIFC - - - - 98 1.0%
DHFL (1) 0.0% 87 0.3% 176 1.5%
GRUH 107 4.4% 62 2.1% 26 0.70%
HDFC - - - - 6,017 7.1%
IBHF 352 1.2% 201 0.9% * *
LTFH 216 2.5% 85 0.8% * *
PNBHF NA NA 180 3.4% 154 1.9%
* FY18 Annual Report NA Source: Company, MOSL
Actuarial-led vola lity in employee cost to reduce in income statement:

Exis ng Indian GAAP requires actuarial gains/losses on re-measurement of net
defined liability (asset) to be charged through the income statement, which
leads to vola lity in earnings. Ind-AS 19 Employee Benefits requires the impact
of re-measurement in net defined benefit liability (asset) to be recognized in
other comprehensive income, reducing vola lity in the income statement.
July 2018 17
NBFC
Exhibit 16: Actuarial assump on changes have led to vola lity in earnings for NBFC (INRm)
2016 2017 2018
NBFC Actuarial Actuarial Actuarial
% of PAT % of PPOP % of PAT % of PPOP % of PAT % of PPOP
(Gain)/Loss (Gain)/Loss (Gain)/Loss
BFIN 43 0.3% 0.2% 122 0.7% 0.4% 119 0.4% 0.2%
CIFC 29 0.5% 0.2% 96 1.3% 0.7% (2) 0.0% 0.0%
DHFL 60 0.8% 0.5% 26 0.3% 0.2% 30 0.3% 0.1%
GRUH 7 0.3% 0.2% 10 0.3% 0.2% 3 0.1% 0.0%
HDFC 218 0.3% 0.3% 172 0.2% 0.2% 96 0.1% 0.1%
IBHF 82 0.4% 0.2% 29 0.1% 0.1% * * *
LICHF 22 0.1% 0.1% 196 1.0% 0.6% * * *
LTFH 1 0.0% 0.0% 2 0.0% 0.0% * * *
MMFS (141) -2.1% -0.7% 95 2.4% 0.5% 243 2.9% 1.0%
PNBHF 1 0.0% 0.0% 13 0.3% 0.1% (1) 0.0% 0.0%
REPCO (2) -0.2% -0.1% (9) -0.5% -0.3% * * *
STFC 31 0.3% 0.1% 20 0.2% 0.0% 20 0.1% 0.0%
* FY18 Annual Report NA Source: Company, MOSL
Timing of recogni on of termina on benefits

Under Indian GAAP, termina on benefits are required to be provided for based
on legal liability (rather than construc ve liability) when an employee signs up
for the voluntary re rement scheme (VRS). This is generally a ming issue for
crea ng a provision. Under Ind-AS, termina on benefits are required to be
provided for when the scheme is announced and management is demonstrably
commi ed to it. This will lead to up-fron ng of termina on benefits in the
income statement.
Securi za on of assets may not lead to de-recogni on under Ind-AS

RBI guidelines currently provide explicit criteria such as ‘true sale’, ‘minimum
holding period’ (MHP) and ‘minimum reten on requirement’ (MRR) for
De-recogni on of assets
securi za on of asset and subsequent de-recogni on. This is significantly
would depend on mee ng
the true sale criteria different from the Ind AS de-recogni on criteria, which provide for de-
recogni on of assets when en es transfer or relinquish rights to collect cash
flow.
Currently, the originator retains a certain por on of the loan book to fulfill the
criteria of MRR – which if con nued under Ind-AS would not result in de-
recogni on, and hence, the originator would con nue holding securi zed loan
on its books.
Failing true sale criteria This will result in an increase in loan book, and thus, make the balance sheet
would lead to recogni on of more asset heavy for NBFCs. However, there would be no material impact on
securi zed assets ‘on revenue recogni on of gain on securi za on, which is currently recognized on
books’ an amor zed basis. Under Ind-AS, the gain would be recognized over the period
of securi za on based on the effec ve interest method.
In the absence of any guidance, we expect (a) current RBI guidelines to con nue
for securi za on and (b) PSL classifica on norms for repor ng purposes.
These provisions would be applicable for new loan securi zed post Ind-AS
regime. Loan book securi zed un l FY18 would con nue to be off-balance-
sheet, in line with the exemp on provided under Ind-AS 101.
July 2018 18
NBFC
Exhibit 17: Criteria under extant RBI regula ons for de-recogni on of assets
Minimum Holding period Minimum Reten on ra on

Type of loan
(MHP) (MRR)
Minimum number of
Loans with original installment to be 5% of the book value of
maturity up to 2 years received - 3/2 on loan securi zed
monthly/quartely loan
Minimum number of
Loans with original
installment to be 10% of the book value
maturity of more than 2
received - 6/3 on of loan securi zed
years up to 5 years
monthly/quartely loan
Minimum number of
Loans with original
installment to be 10% of the book value
maturity of more than 5
received - 12/4 on of loan securi zed.
years
monthly/quartely loan.
Source: MOSL
Exhibit 18: NBFCs ac vely securi ze loan book (INRb)
Securi za on O/s as at FY18 % of Loan Book

19.5%
15.2% 10.2%
155.7
1.4% 124.2
55.6 6.9
CIFC MMFS IBHF STFH
Source: Company, MOSL
Early recogni on of gains on assignment of loans

Over the past few quarters, NBFCs have been increasingly op ng for the
assignment route, which leads to derecognize of loan under current norms. It
will con nue to do so under Ind-AS (due to absence of MRR/MHP criteria).
De-recogni on of loan
Currently, NBFCs have to amor ze the gain on assignment over the period of
under direct assignment will
lead to upfron ng of gains loans. Under Ind-AS, as loans would be derecognized from the assignee’s book,
on assignment it would lead to front-ending of gains in the income statement.
July 2018 19
NBFC
Exhibit 19: Assignment a common prac ce amongst NBFCs (INR b)
Assignment O/s as at FY18 % of loan book
12.7%
1.8%
115.0
5.5%
64.5 2.8% 1.8%
31.3 21.6 6.7
HDFC DHFL PNBHF BAF CIFC
Interest income on NPA to be recognized on EIR basis

The RBI guidelines require interest income on non-performing assets (NPAs) to
be recognized on a realiza on basis only.
Recogni on of interest Under Ind-AS 109, interest income is generally recognized on the effec ve
income on NPA on EIR basis interest rate on the gross carrying amount of financial assets, depending on the
would posi vely impact stage of the loan. In cases where a loan or an asset is considered impaired, (i.e.,
NBFCs with higher GNPAs stage III), the interest income will be accounted for at the net amount (i.e., gross
carrying amount less provisions made).
This, in our view, will lead to upfront recogni on of interest income on NPAs on
EIR basis. This will offer a reprieve to companies with a higher propor on of
GNPAs.
Recogni on of gains/losses on investments

The extant guidelines provide for classifica on of investments as trade and non-
trade, and are carried at cost or fair value, whichever is lower. Under Ind-AS, all
financial assets ini ally have to be recorded in balance sheet at fair value. A er
ini al recogni on based on Ind-AS 109, financial assets may be classified
subsequently measured at:
Amor zed cost: A financial asset is subsequently measured at amor zed cost if
Fair valua on of investment
on transi on date would the asset is held within a business model whose objec ve is to collect
lead to posi ve impact on contractual cash flows that are solely payments of principal and interest (SPPI).
networth Fair valua on through other comprehensive income (FVOCI): A financial asset
is subsequently measured at FVOCI if it meets the SPPI criterion and is held in a
business model whose objec ve is achieved by both collec ng contractual cash
flows and selling financial assets. At ini al recogni on of an equity investment
that is not held for trading, an en ty may present the subsequent changes in fair
value in other comprehensive income (OCI).
Fair valua on through profit and loss (FVTPL): All other financial assets are
classified as being subsequently measured at FVTPL.
July 2018 20
NBFC
Exhibit 20: Classifica on of Financial Assets
DEBT DERIVATIVES EQUITY
Contractual cash flow characteris cs test

(at instrument level)
No No No
Yes
Business model test Held for trading
(at an aggregate level)
Yes No
Hold to BM with obj. of Neither
collect collec ng of one
contract contractual
ual cash cash flow and
flow selling FA
Condi onal fair value op on FVOCI op on

(FVO) elected? elected?
Yes No
No No Yes
Amor zed FVOCI (with FVTPL FVOCI (with

cost recycling) recycling)
Source: MOSL
NBFCs holding investment in financial assets, subsidiary, associate and joint

venture would need to classify these investments as carried at FVOCI or FVTPL
depending on the business model. Fair valua on of these investments would
lead to substan al gain in net worth and income statement (in case of FVTPL).
Also, Ind-AS provides an op on to carry investment in subsidiary and associate
at cost. However, any op on exercised to classify equity investment is
irrevocable.
While non-trade investments in debenture, government bonds and treasury
notes will have to be fair valued on the transi on date, this would also lead to
one- me gain on networth.
MTM P&L gains and losses on investments carried at FVTPL would lead to
vola lity in the income statement.
July 2018 21
NBFC
FAIR VALUE PRINCIPLE PRESCRIBED UNDER IND-AS
FAIR VALUE FAIR VALUE

AMORTISED THROUGH THROUGH OTHER
INVESTMENTS COMPREHENSIVE
COST PROFIT & LOSS
(FVTPL) INCOME (FVTPL)
VALUATION AMORTISED COST FAIR VALUE FAIR VALUE
MTM Loss NA DEBITED TO P&L DEBITED TO OCI
MTM GAIN NA CREDITED TO P&L CREDITED TO OCI
TRANSFER FROM
REALISED GAIN CREDITED TO P&L* IGNORE
OCI TO P&L
*Amor zed based on Effec ve Interest Rate (EIR) method Source: MOSL
Deferred tax to witness significant changes on migra on

HFCs have provided for deferred tax liability in respect of special reserve created
based on the pruden al guidelines issued by Na onal Housing Bank (NHB) in
2014.
Transi on to Ind-AS would Managements of HFCs, however, believe that this special reserve created will
lead to reversal of DTL never be u lized, and thus, the tax liability will never be u lized. Under Ind-AS,
created on special reserve this guideline will thus become void.
as mandated by erstwhile We expect HFCs to maintain their stance of non-u liza on of DTL, which would
NHB circular
lead to reversal of DTL in opening net worth, resul ng in a posi ve impact for
most HFCs.
Exhibit 21: DTL reversal on special reserve to posi vely impact HFCs (INRb)
DTL on Special Reserve % of Net Worth

13.6%
6.4% 11.7%
8.1%
4.8%
39.2 3.1%
2.7%
1.7 4.1 1.9 3.8 0.9 13.0
HDFC PNBHF DHFL GRUH IHFL* Repco* LICHF*
July 2018 22
NBFC
Income tax on fair valua on gain: Any fair valua on gain or loss on transi on to
Ind-AS has to be included in book profit over a period of five years and
subjected to a minimum alterna ve tax. Also, any subsequent MTM gain or loss
will have to be included in book profits. This will lead to several financial en es
having significant investment book to pay tax under MAT.
Balance sheet approach under play: Under Ind-AS, deferred taxes are
computed using a balance sheet approach for temporary differences between
the carrying amount of an asset or liability in the statement of financial posi on
and its tax base. Under IGAAP, taxes are computed using the profit/loss
statement approach for ming differences in respect of recogni on of items of
profit or loss for the purposes of financial repor ng and for income taxes.
No requirement for virtual certainty for recognizing DTA: Where an en ty has a
history of tax losses, the en ty recognizes a deferred tax asset arising from
unused tax losses or tax credits only to the extent that it has sufficient taxable
temporary differences, or there is other convincing unabsorbed deprecia on, all
deferred tax assets are recognized only to the extent that there is virtual
certainty supported by convincing evidence that sufficient future taxable income
will be available against which such deferred tax assets can be realized. Ind-AS
12 does not lay down any requirement for considera on of virtual certainty in
such cases.
Other differences
Fixed assets revalua on: On transi on to Ind-AS, en es can measure all fixed
assets at fair value and can consider fair value as a deemed cost. The upward
revalua on can significantly boost revalua on reserves, and thus, net worth.
Land leases: Ind-AS 17 deals specifically with land leases. Land leases are
classified as finance or opera ng leases based on the general criteria laid down
in the standard. When a lease includes both land and building elements, an
en ty assesses the classifica on of each element as a finance lease or an
opera ng lease separately. Under Indian GAAP, no accoun ng standard deals
with land leases. According to an Expert Advisory Commi ee (EAC) opinion,
long-term land lease may be treated as finance lease.
Business combina ons accounted under ‘purchase method’: Ind-AS 103
requires all business combina ons within its scope to be accounted under the
purchase method, excluding business combina ons of en es or businesses
under common control, which are to be accounted using the pooling of interest
method. Current Indian GAAP permits both the purchase method and the
pooling of interest method in the case of amalgama on. However, the pooling
of interest method is allowed only if the amalgama on sa sfies certain specified
condi ons.
Consolida on: IGAAPs require the prepara on of financial statements only
when a company has one or more subsidiaries. However, Ind-AS requires
consolidated financials to be prepared even when an en ty has one or more
joint ventures or associates and no subsidiaries.
Segmental disclosures made more robust: Ind-AS requires segmental
informa on to be provided on how the chief opera ng decision-maker (CODM)
evaluates financial informa on for alloca ng resources and assessing
performance. This may require certain companies to change segment
disclosures consistent with internal repor ng.
July 2018 23
NBFC
HFCs to witness gains, Corporate financiers impacted

HFCs will see a benefit in the form of provisioning and reversal of DTL. Most
large HFCs have a proven track record of low LGDs and PDs, and carry
addi onal/con ngent provisioning on balance sheet. Processing fees on core
housing loans may be replaced by legal and other charges, and thus, not impact
the income statement. DSA expense amor za on and a reduc on in credit cost
are added benefits for HFCs. However, companies in the affordable housing
segment with a limited track record and a higher share of fee income could see
some impact. Companies with ZCCBs/structured liabili es/ESOPs are likely to
witness higher expenses ge ng routed through the income statement.
Corporate financers may witness higher provisioning, deferment of fee income
and a rise in employee expenses. Vehicle financers may see an impact on their
securi za on ac vity (awai ng final regula on on this) and a minimal impact on
provisioning.
Consumer financers are likely to witness an adverse impact on their employee
cost and securi za on ac vity, while they may benefit in terms of upfront
recogni on of gains on assignment. We expect the impact of loan provisioning
to be neutral to slightly nega ve.
Overall, the impact of Ind-AS convergence on our NBFC coverage universe will
be neutral-to-posi ve.
Exhibit 22: Material implica ons for many companies
Company Remarks Impact
HDFC (a) Fee recogni on: HDFC has ~27% corporate loan book, wherein fee income is Marginally Nega ve
high and its amor za on will impact earnings. Fee on retail loans is minimal and
could be offset against ini al costs or deferred.
(b) Loan origina on expenses: DSA charge amor za on on retail loans will lead to Marginally Posi ve
higher profitability in earlier years.
(c) Fair valua on of ESOPs: HDFC issued ESOPs in FY18. Annual fair valua on Nega ve
impact for the same is ~INR12.0b (impact due to fair valua on of ESOPs for part
of FY18 stood at INR6.0b, 7.1% of PAT).
(d) Expected credit loss: HFCs have low LGD in the range of 10%-30% for GNPA, Posi ve
which, in our view, will lead to adequate balance provision available (at ~1.2%)
for standard assets.
(e) DTL reversal on special reserve: Will increase FY18 networth by 6%. Posi ve
(f) Gain on direct assignment to be front-ended: Assigned book as at FY18 stood at Marginally Posi ve
INR64.5b, 1.8% of total loan book.
(g) Redemp on premium on ZCCB to be routed through income statement: Nega ve
Interest cost amor zed through reserve stood at INR3.8b, 4.5% of FY18 PAT.
(h) Fair valua on of investment por olio: Fair valua on on investments will Posi ve
posi vely impact networth on transi on.
LIC Housing (a) Loan origina on expenses: DSA charge amor za on on retail loans will lead to Marginally Posi ve
Finance higher profitability in earlier years.
(b) Expected credit loss: HFCs have LGD in the range of 10%-30% for GNPA. For Neutral
LICHF, balance available provision for standard assets stands low at 0.6%.
However, on the basis of lower historical slippages, we expect impact to be
neutral.
(c) DTL reversal on special reserve: Will posi vely impact FY17 networth by 12%. Posi ve
July 2018 24
NBFC
REPCO (a) Loan origina on expenses: DSA charge amor za on on retail loans will lead to Marginally Posi ve
(b) DTL reversal on special reserve: Will posi vely impact FY17 networth by 8%. Posi ve
(c) Expected credit loss: HFCs have low LGD in the range of 10%-30% for GNPA, Posi ve
which, in our view, leads to adequate balance provision available (at ~1.5%) for
standard assets.
Dewan Housing (a) Fee recogni on: DHFL has ~35% non-retail loan book, wherein fee income is Marginally Nega ve
Finance high and its amor za on will impact earnings. Fee on retail loans is minimal and
(c) Expected credit loss: HFCs have LGD in the range of 10%-30% for GNPA, which, Posi ve
in our view, leads to adequate balance provision available for standard assets at
~1.6%.
(d) Fair valua on of ESOPs: Further, DHFL issued fresh ESOPs in FY18. Its FV Marginally nega ve
will adversely impact FY18 earnings by 1.5%.
(e) DTL reversal on special reserve: Will posi vely impact FY18 networth by 5%. Marginally Posi ve
INR115.0b, 12.7% of loan book.
Interest cost amor zed through reserve stood at 8.4% of FY18 PAT.
PNB Housing (a) Fee recogni on: PNBHF has ~16% construc on finance wherein fee income is Marginally Nega ve
Finance high and its amor za on will impact earnings. Fee on retail loans is minimal and
(c) Expected credit Loss: HFCs have LGD in the range of 10%-30% for GNPA, which, Posi ve
in our view, leads to adequate balance provision available for standard assets at
~1.2%.
(d) Fair valua on of ESOPs: Will adversely impact FY18 earnings by 1.9%. Marginally Nega ve
(g) Redemp on premium on ZCCB to be routed through income statement: Marginally Nega ve
Interest cost amor zed through reserve stood at 1.5% of FY18 PAT.
Indiabulls (a) Fee recogni on: IBHFL has ~40% non-retail loan book, wherein fee income is Marginally Nega ve
Housing Finance high and its amor za on will impact earnings. Fee on retail loans is minimal and
(c) Expected credit loss: HFCs have low LGD in the range of 10%-30% for GNPA, Posi ve
which, in our view, leads to adequate balance provision available for standard
assets at ~1.2%.
(d) Fair valua on of ESOPs: Will adversely impact FY17 earnings by 0.9%. Neutral
(f) Securi za on: Securi zed book as at FY18 stood at INR124.2b, 10.2% of loan Marginally Nega ve
book. Recogni on of asset securi zed (in future) could adversely impact ROAs.
Interest cost amor zed through reserve stood at INR2.6b, 9.0% of FY17 PAT.
July 2018 25
NBFC
GRUH Finance (a) Loan origina on expenses: DSA charge amor za on on retail loans will lead to Marginally Posi ve
(b) Expected credit loss: HFCs have low LGD in the range of 10%-30% for GNPA. In Neutral
case of GRUH, we expect balance provision available for standard assets to be at
0.8%. However, with low historical slippages.
(c) Fair valua on of ESOPs: Will adversely impact FY18 earnings by 0.7%. Neutral
(d) DTL reversal on special reserve: Will posi vely impact FY18 networth by 14%. Posi ve
Mahindra Finance (a) Fee recogni on: Vehicle financiers derive typically 0.5-2.0% fee income, which Marginally Nega ve
would be deferred over the period of loan/rendering service. ~88% of loan
disbursed is vehicle finance.
(c) Expected credit Loss: VFCs have higher LGD in the range of 40%-50% for GNPA. Marginally Posi ve
However, given adequacy of balance provision available for standard assets at
~2.2%, we expect marginally posi ve impact.
(d) Income recogni on on NPA : Since MMFS has high GNPAs, it will be posi vely Marginally Posi ve
impacted.
Shriram Transport (a) Fee recogni on: Vehicle financiers derive typically 0.5-2.0% fee income, which Marginally Nega ve
would be deferred over the period of loan/rendering service.
(c) Expected credit Loss: VFCs have higher LGD in the range of 40%-50% for GNPA. Marginally Posi ve
However, given the adequacy of balance provision available standard assets at
~2.6%, we expect marginally posi ve impact.
(d) Securi za on: Securi zed book as at FY18 stood at INR155.7b, 20% of loan Marginally Nega ve
book. Recogni on of assets securi zed (in future) could adversely impact ROAs.
(e) Income recogni on on NPA : Since SHTF has high GNPAs, it will be posi vely
impacted. Marginally Posi ve
Cholamandalam (a) Fee recogni on: Vehicle financiers derive typically 0.5-2.0% fee income, which Marginally Nega ve
Investment would be deferred over the period of loan/rendering service.
and Finance (b) Loan origina on expenses: DSA charge amor za on on retail loans will lead to Marginally Posi ve
(c) Expected credit loss: We expect marginally low LGD at ~35% for GNPA as non- Marginally Nega ve
vehicle por olio cons tutes ~30% of loan book. However, in case of CIFC, we
expect a marginally nega ve impact, given that the balance provision available
for standard assets stands low at ~0.6%.
(d) Securi za on: Securi zed book as at FY18 stood at INR55.6b, 15.2% of loan Marginally Nega ve
book. Recogni on of asset securi zed (in future) could adversely impact ROAs.
(e) Gain on direct assignment to be front-ended: Assigned book as at FY18 stood at
INR6.7b, 1.8% of total loan book. Marginally Posi ve
Bajaj Finance (a) Fee recogni on: Consumer financiers have low (0.25%) fee income and tenure Neutral
for loan. Hence, deferment will not have any meaningful impact.
(b) Loan origina on expenses: Consumers financiers incur DSA charges. However, Neutral
tenure of loan is low; its deferment will not have a meaningful impact.
(c) Fair valua on of ESOPs: Will adversely impact FY18 earnings by 1.8%. Marginally Nega ve
(d) Expected credit loss: Consumer Financiers have higher LGD in the range of 50% Marginally Nega ve
for GNPA, which will lead to lower balance provision available for standard
assets provisioning at ~0.8%.
July 2018 26
NBFC
(e) Gain on direct assignment to be front-ended: Assigned book as at FY18 stood at Marginally Posi ve
Shriram City Union (a) Fee recogni on: Consumer financiers have low (0.25%) fee income and tenure Neutral
Finance for loan. Hence, deferment will not have any meaningful impact.
(b) Loan origina on expenses: Consumers financiers incur DSA charges. However, Neutral
tenure of loan is low; its deferment will not have any meaningful impact.
(c) Expected credit loss. We expect LGD in the range of 40%-50% for GNPA. While Neutral
SCUF has high GNPA at 9%, we believe that provisions made of ~INR16.3b will
be slightly lower than those required under Ind-AS.
(d) Income recogni on on NPA: Since SCUF has high GNPAs, it will be posi vely Marginally Posi ve
impacted.
L&T Finance (a) Fee recogni on: Corporate financiers derive high fee income, but LTFH currently Neutral
Holdings amor zes fee, which is in line with Ind-AS.
(b) Fair valua on of ESOPs: will adversely impact FY17 earnings by 0.8%. Neutral
(c) Expected credit loss: Corporate financiers have higher LGD in the range of 65% Nega ve
for GNPA. LTFH has GNPA of ~INR54b, 6.5% of loan book (including restructured
loans of ~INR21b). We believe that provision made of ~INR24b may be lower
than required under Ind-AS. It would be interes ng to see how LTFH provides
for its legacy book (Pre 2012).
(d) Dividend on preference shares: Will impact earnings (FY17: INR1.1b, 10.2% of Nega ve
PAT).
July 2018 27
NBFC
Opportuni es and key challenges

New financials to present a more contemporary picture
Ind-AS is likely to bring in much more transparency in the system and ensure
disclosures are in line with global standards. Under Ind-AS, companies would need
to (a) prepare an opening balance sheet on the transi on day, (b) recognize assets
and liabili es based on the new norms and (c) route the difference through the
reserves. This will imply a material change in networth. We believe that investors
need to be watchful of interpreta ons/adjustments made by companies during the
migra on.
Extensive disclosures: Ind-AS demands addi onal disclosures (e.g., on segment

repor ng, qualita ve and quan ta ve disclosure of ECL impairment and risk
assump ons) in line with global standards. This will not only enhance
transparency, but also provide vital informa on to various stakeholders.
More appropriate representa on: Since the new accoun ng standards are
based on the principle of ‘substance over form’ and ‘fair valua on,’ they are
likely to present a more contemporary picture of the state of affairs of the
companies, as against the conserva ve approach followed under IGAAP.
Facilitate comparability: Ind-AS will present a more comparable picture of the
peer set. Under IGAAPs, there is no specific guidance, and thus, corporates
follow different policies, making their financials incomparable.
Appealing to foreign investors: Ind-AS is not the same as IFRS, but it will bring
the accoun ng standards in India much closer to interna onal standards that
investors are familiar with and have confidence in. This, in turn, should improve
the appeal of Indian companies among foreign investors.
Several challenges as we migrate

First- me adop on: Although first- me adop on of Ind-AS is an opportunity for
all en es to align their accoun ng policies to best prac ces, it is also offers
room for cleaning up of books, the interpreta on of which is a challenge for
investors.
Extensive disclosures: These are required so that shareholders are aware of
every change in es mate, accoun ng policy, reclassifica on or recogni on/de-
recogni on of assets and liabili es. However, companies will have to decide
how much to disclose so as to meet the regulatory requirements and at the
same me maintain a compe ve edge.
Dividend distribu on policies: Companies may need to review and, if necessary,
amend their dividend distribu on policies in light of their changed financial
situa on post Ind-AS adop on.
Management es mates: A lot of accoun ng in Ind-AS is based on management
es mates. It would be challenging in ini al periods to maintain accuracy and
consistency in es mates.
Fair value: Use of fair value approach will bring in a lot of vola lity in
accoun ng. Also, we believe that since this concept is new to India, there is a
lack of knowledge and technical exper se to determine fair value.
July 2018 28
THEMATIC/STRATEGY RESEARCH GALLERY
Explanation of Investment Rating

Investment Rating Expected return (over 12-month)
BUY >=15% NBFC
SELL < - 10%
NEUTRAL > - 10 % to 15%
UNDER REVIEW Rating may undergo a change
NOT RATED We have forward looking estimates for the stock but we refrain from assigning recommendation
*In case the recommendation given by the Research Analyst becomes inconsistent with the investment rating legend, the Research Analyst shall within 28 days of the inconsistency, take appropriate measures to make the recommendation consistent with the investment rating legend.
Disclosures:
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buy or sell or subscribe for securities or other financial instruments for the clients. Though disseminated to all the customers simultaneously, not all customers may receive this report at the same time. MOSL will not treat recipients as customers by
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specific recommendations and views expressed by research analyst(s) in this report.
Disclosure of Interest Statement Companies where there is interest

Analyst ownership of the stock No
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its associates maintains arm’s length distance with Research Team as all the activities are segregated from MOSL research activity and therefore it can have an independent view with regards to subject company for which Research Team have
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Thema c | July 2018

A new, contemporary look

Contents: NBFC – Ind-AS: A new, contemporary look

NBFCs – a paradigm shi in ﬁnancial repor ng..................................................................... 7

HFCs to witness gains, Corporate ﬁnanciers impacted ........................................................ 24

Opportuni es and key challenges ....................................................................................... 28

Thema c | July NBFC

Brokers Poll 2018 for India will be adversely impacted.

HFCs to witness gains; corporate ﬁnanciers most impacted

Several opportuni es, but challenges remain

NBFC: Impact from Ind-AS transi on

Key diﬀerence areas IGAAP Ind-AS Impact due to Ind-AS

Exhibit 2: Ind-AS changes to impact income statement and networth

NBFCs – a paradigm shi in ﬁnancial repor ng

Transi on to Ind-AS – much more than just accoun ng change

Earnings and networth to be impacted under new norms

Impairment Fee income DTL on special Fair valua on of

IND-AS TO IMPACT NBFCS’ EARNINGS AND NETWORTH

INCOME STATEMENT NET WORTH

Deferment of fee income/origina on cost on loans

Exhibit 4: Integral & non-integral fees to be recognized over diﬀerent me horizons

Orgina on fees paid

NII to be impacted on factoring in redemp on premium as interest cost

Exhibit 5: NBFCs: Interest cost on ZCCB to impact earnings (INR m)

Forward-looking ECL approach to impact loss provisioning

Exhibit 7: Ind-AS prescribes a three-stage asset classiﬁca on model

0 - 30 Days SMA 0 Stage I

NPA <= 1 year Sub-Standard: Unsecured 25.0%

>1 year Sub-Standard <= 3 year Doub ul: 1 - 3 year 40.0%

Exhibit 8: Overview of the ECL model

Change in credit quality since in al recogni on

Stage 1: Performing assets with low credit risk

Stage 2: Underperforming assets with signiﬁcant increase in credit risk

Stage 3: Non-performing assets (NPA) with objec ve evidence of

Key observa on:

Exhibit 9: Provision requirement to increase as assets shi to a higher stage

Exhibit 10: Signiﬁcant increase in credit risk

Change in forward-looking marginal life me Pds, guided by credit

Watch lists (Wholesale)

Rebu able presump on – a BACKSTOP

Objec ve evidence of impairment /default (migra on from stage II to stage III)

Key observa on:

The transi on to ECL is subjec ve framework based on management judgment,

Calcula ng Expected Credit Loss (ECL)

ECL = PD * LGD * EAD * DF

Loss Given Default (LGD)

Exposure at default (EAD):

Provision coverage ra o – cri cal to access the impact

GNPL NPL 73.8

For FY18 Source: Company, MOSL

For FY18 Source: Company, MOSL

Determining impact of ECL

Accordingly, we ﬁnd that:

Standard GNPA Total Provision Remaining Provision available

HDFC 3,594.4 3,555.2 39.2 20% 7.8 50.0 42.2 1.2%

PNBHF 570.1 568.3 1.9 20% 0.4 7.0 6.6 1.2%

SHTF 796.7 723.0 73.8 50% 36.9 55.3 18.5 2.6%

Corporate Finance Companies

Employee beneﬁts costs may rise

Exhibit 14: Employee cost recogni on varies under Ind-AS

Long-term employee beneﬁts •Actuarial loss / gain

Share based payments • Fair valua on of ESOPs