Synopsys:
Nepal Finance Limited is a limited liability company domiciled in Nepal which has been in operation in Nepal since 2049/04/07. It is a public limited company and carries out banking activities in Nepal under the license from Nepal Rastra Bank as Class “Ga” licensed institution (National Level)
The Finance Company offers maximum banking services of banking products and services including loans and advances, deposits etc. to wide range of clients encompassing individuals, corporates, large public sector companies, government corporations, etc. as authorized by the Nepal Rastra Bank (Central Bank of Nepal).
The Finance Company is listed on Nepal Stock Exchange and its stock symbol is “NFS”.
* Five Point Review *
A: Loan Asset Classification
Real Estate Loans (425% growth)
- Significance: A massive jump in real estate loans from NPR 91.61 lakh to NPR 4.81 crore reflects a strong focus on real estate lending.
- Compliance: NRB has strict caps on real estate exposure to avoid the creation of asset bubbles and excessive speculative lending. Typically, NRB limits real estate loans to 25% of the total loan portfolio for finance companies. A sudden surge in this sector could signal a red flag if the institution exceeds NRB’s permissible limits.
- Risk: Real estate loans are high-risk, especially in a volatile property market. NRB guidelines mandate regular assessments of property values and loan-to-value (LTV) ratios to mitigate risk. A surge of 425% could pose credit risk, especially if property prices decline.
Overdraft (-47% Fall)
- Significance: Overdraft lending decreased sharply by 47%, from NPR 18.82 crore to NPR 9.93 crore.
- Compliance: Overdraft loans are typically short-term and carry higher interest rates. NRB guidelines recommend maintaining a balance between overdraft and other loan types to manage liquidity. The steep decline in overdraft lending suggests that the company may be tightening its credit lines or customers may be repaying at a higher rate, which can be positive from a liquidity perspective.
- Risk: A reduction in overdraft could reduce short-term income, but it can also indicate better credit risk management and reduced dependency on short-term lending
Loans and Advances to BFI:
NFS’s loan book has experienced a sharp decline of 77%, from NPR 22.62 crore in FY 79 to NPR 7.63 crore in FY 80, reflecting a significant reduction in interbank exposure. This substantial drop can be attributed to its exclusive focus on microfinance lending. Given the challenges faced by the microfinance sector, such as rising defaults, operational inefficiencies, and liquidity constraints, it is likely that these issues have contributed to the reduction in loans extended to microfinance institutions. This strategic pullback suggests a cautious approach in response to the growing risks within the sector
B: Deposit Book Classification
The deposit base of NFS has seen substantial growth over the last three fiscal years, showing an increasing trend
- FY 79: NPR 1,47.42 Crores
- FY 80: NPR 1,80.61 Crores (22.5% increase)
- FY 81: NPR 2,55.45 Crores (41.4% increase from FY 80)
- Steady Growth: The deposits have consistently increased year over year, which is a positive indicator of customer trust, expanding market share, or new deposit mobilization strategies. The significant jump in FY 81, with over a 41% increase, the reason could be high deposit rate in previous year
- Liquidity and Capital: A rising deposit base strengthens the institution’s liquidity position, which can be deployed into new lending opportunities or investments. It also provides the bank with a cushion to handle short-term liquidity needs, ensuring smooth operations even during periods of financial stress.
- Regulatory Compliance: With the increase in deposits, the institution must ensure that it maintains proper capital adequacy ratios and meets NRB (Nepal Rastra Bank) regulatory requirements. Higher deposits increase the institution’s obligations, meaning proper risk management systems are crucial to ensure compliance.
- Risk Factors: Rapid growth in deposits may also imply increased cost for maintaining these liabilities, especially if the interest rates offered on deposits rise. Additionally, while deposits boost liquidity, they can increase the pressure on the institution to find suitable lending or investment avenues to generate returns without compromising on asset quality.
In conclusion, while the sharp rise in deposits strengthens the financial stability and operational capacity of the institution, it also requires effective asset deployment strategies and robust risk management frameworks to ensure sustainable growth.
*Relation Between Deposit, loan & Interest*
- Interest Income represents 14%, 20%, and 14% of the Loan Given for FY 2079, FY 2080, and FY 2081, respectively.
- Meanwhile, the Cost of Interest (Interest Expenses) accounts for 6%, 9%, and 7% of the Deposits Taken across the same fiscal periods.
C: Loan & IMPAIRMENT
The table provided includes information about loan assets over three fiscal years (FY-79, FY-80, and FY-81), detailing customer and BFI loans, total loans, impairment provisions, and the percentage of total loan provisioned for impairment.
- Loan Growth:
There is a steady increase in the total loan amount over the years.
- FY-79: ₹1,41,61,22,355
- FY-80: ₹1,56,38,97,749
- FY-81: (expected): ₹2,36,75,92,608 (a significant jump expected in FY-81)
Customer loans are increasing, while BFI loans drop sharply from FY-79 to FY-80.
- Impairment Provision:
The total impairment provision decreases over time:
- FY-79: ₹20,92,12,379 (15% of total loans)
- FY-80: ₹18,41,73,167 (12% of total loans)
- FY-81: ₹17,37,52,933 (7% of total loans expected)
- Impairment Percentage:
– The impairment provision as a percentage of the total loan is decreasing, suggesting improved asset quality or more optimistic expectations for loan recovery.
*Analysis*
- Loan Expansion: The expected increase in FY-81 indicates either growth in lending or an acquisition of loan portfolios, but the decline in BFI loans may indicate a strategic shift away from institutional loans or repayments.
- Declining Impairment: The impairment provisions’ declining percentage suggests that the bank expects fewer defaults or has improved loan performance. This may be due to better credit assessment or stronger economic conditions.
- Risk: While the growth in loan assets is a positive signal, the assumption of reduced impairment may carry risk, particularly in a growing loan portfolio, as new loans could have unknown risk characteristics.
D: Non-Performing Loan
*Analysis*
1.Loan Performance:
-
- FY-79 shows substantial impairment across all categories, with Loan Losses making up the bulk of impaired assets. The net position in FY-79 is largely positive, especially in restructured and substandard loans, as they retained significant portions of their original value.
- FY-80 has higher gross loans, but the net position is much weaker, primarily due to higher impairments and Loan Losses. The only loans with positive net values are Substandard and Doubtful Loans, while Loan Losses have increased significantly.
2.Declining Net Loans:
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- The net loan value dropped sharply from FY-79 (₹2.41 crore) to FY-80 (₹0.57 crore), driven by a notable increase in impaired loans and loan losses. This indicates worsening asset quality, with a larger portion of loans becoming irrecoverable or requiring full provisioning.
3.Increased Loan Losses:
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- The jump in Loan Losses from ₹15.16 crore in FY-79 to ₹18.85 crore in FY-80 is alarming. These represent loans that are fully impaired and unlikely to be recovered, indicating possible poor underwriting or deteriorating credit conditions.
4.No New Restructure Loans in FY-80:
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- Restructured loans have disappeared in FY-80, which could suggest that the institution either managed to recover or close these loans in FY-79, or shifted focus away from restructuring to outright impairments and losses.
E : Key Performance Indicators (KPI’s)
Analysis of Key Indicators:
- Net Profit/Gross Income (%):
There is a significant drop in profitability over these three years. The sharp decline suggests that the institution is facing difficulty converting income into profits, possibly due to rising costs or falling margins.
2.Earnings Per Share (EPS):
The decrease in EPS shows a steady decline in profitability. Shareholders are seeing lower returns per share, which indicates that the company is either struggling with growth or controlling costs.
3.Price-Earnings Ratio:
A continuously rising P/E ratio indicates that the stock price is growing, but the earnings are not keeping up. This suggests that the stock might be overvalued, reflecting speculation or investor over-optimism despite declining profits.
4.Interest Income/Loans and Advances (%):
After a peak in FY 79/80, interest income declines in FY 80/81. This could indicate lower lending volumes or reduced interest rates, directly affecting the institution’s revenue from loans.
5.Interest Expenses/Total Deposits & Borrowings (%):
Interest expenses have been rising, putting pressure on profitability. Though the expense reduced slightly in FY 80/81, it remains high, indicating a growing cost of funds (higher deposit or borrowing costs).
6. Net Profit/Total Loans & Advances (%):
The ability to generate profit from loans is declining, signalling weaker loan performance or lower profitability from core lending activities.
7.Net Profit/Total Assets (%):
This metric follows a similar trend to net profit, showing decreasing efficiency in generating profits from total assets. The institution is likely facing challenges in using its assets to generate sufficient returns.
8.Total Loans & Advances/Total Deposits (%):
The institution is lending a large portion of its deposits, with a peak in FY 80/81. While this indicates aggressive lending practices, it may also increase liquidity risk if these loans underperform or default.
9.Total Operating Expenses/Total Assets (%):
Operating expenses as a percentage of total assets remain stable but slightly improve in FY 80/81, indicating some control over costs. However, this is not enough to offset the declining profitability.
10.Capital Adequacy (On Risk-Weighted Assets):
– **a. Core Capital**:
The core capital remains stable, indicating that the institution’s core reserves are being maintained, but the declining overall trend could constrain future growth.
– **b. Supplementary Capital**:
Slight increase in supplementary capital shows minor improvements in the institution’s ability to absorb risk.
– **c. Total Capital Fund**:
Declining total capital adequacy means the institution is becoming less able to absorb risks and comply with regulatory requirements, which could be problematic for stability.
11.Liquidity (%):
Liquidity levels are decreasing, signaling that the institution may have less cash or liquid assets available to meet short-term obligations. A drop to 48.70% in FY 80/81 could raise concerns about liquidity risks.
12.Non-Performing Loan/Total Loans & Advances (%):
The reduction in non-performing loans (NPLs) is a positive sign, suggesting improving loan quality and more effective risk management, which can help stabilize the institution.
13.Weighted Average Interest Rate Spread:
The slight decline in interest rate spread indicates tightening margins, which can pressure profitability. It shows the institution’s reduced ability to profit from the difference between lending and borrowing rates.
14.Book Net Worth (Per Share):
The book net worth per share shows modest growth, indicating that the institution is slowly increasing its equity value, though at a sluggish pace. This suggests a steady but weak improvement in financial health.
15.Number of Shares:
The increase in the number of shares suggests the institution is either issuing more shares to raise capital or undergoing share dilution. This can dilute existing shareholder value if not matched by proportional earnings growth.
— Key Observations–:
- Declining Profitability: Across the board, profitability metrics (Net Profit/Gross Income, EPS, and Price Earnings Ratio) are falling, indicating a weakening financial performance.
- Capital & Liquidity Risks: Both liquidity and capital adequacy ratios are declining, signalling rising financial risk. The institution may face challenges meeting regulatory requirements or financial obligations.
- Improvement in Loan Quality: On the positive side, the institution has successfully reduced its non-performing loans (NPLs), showing improvement in managing its loan portfolio.
- Narrowing Interest Rate Spread: The narrowing interest rate spread means that the institution has less margin between lending and borrowing rates, putting further pressure on profitability.
Summary
The financial health of the institution is deteriorating, particularly in terms of profitability, liquidity, and capital adequacy. The only major positive trend is the reduction in non-performing loans, but the institution must address liquidity and capital issues to ensure long-term stability.
Badnaam’s Dharke Analysis:
The NFS share has skyrocketed from 270 to 2600 in just 10-12 months, as if it struck gold mine. the upward movement has been unbelievable so we might think there must has astonishing improvement in its fundamental otherwise why would people pour money at such high valuation.
As written by Morgan Housel in the chapter “No One’s Crazy” from The Psychology of Money, what seems irrational to one person may make perfect sense to another based on their life experiences. He emphasizes that financial decisions are shaped by individual backgrounds and emotions. By understanding this, we can better appreciate the complexity of people’s choices and avoid harsh judgments. Ultimately, it’s about recognizing that everyone has their reasons, influenced by their unique circumstances.
So, here is my perspective on why the valuation was unjustifiable.
- The loan book, deposits, non-performing loans (NPLs), cost of funds, interest spread, loan market conditions, overall deposit inflow in the market, and improvements in operational efficiency in last 4 Quarter do not demonstrate the significant strength or potential necessary to justify NFS receiving such a valuation.
- While the year-over-year performance indicates some improvement, it is not substantial
enough to warrant a justifiable valuation.
- Given the improvement in BFI’s liquidity, we can expect increased competition in business growth, which should become apparent in the upcoming quarters. Additionally, it’s crucial to recognize that margin spreads and the cost of funds (COF) are likely to remain challenging and tight, particularly for finance companies, which will significantly NFS financials
- While the shares of NFS are characterized by low liquidity and a small market capitalization, these factors alone should not justify the soaring valuation.
Verdict: The current valuation of NFS lacks justification, as its financial fundamentals, recent performance, and market conditions do not show the robust growth or profitability to support it. With increased competition and persistent cost pressures, NFS’s valuation seems overestimated relative to its market position
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