L&T Finance Holdings Q2 FY21 results were steady. Operational performance was mixed as higher provisions dented PAT performance. Operational numbers were strong, asset quality has put up a good show, (lowest-ever GS3), and L&T Finance Holdings has guided to reduce its liquidity surplus, which are key positives. Net interest income (NII, Calculated) was up 7.7% yoy and up 13.5% qoq. Whereas, pre provision profit (PPOP) improved by 21% qoq (above expectations).

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However, L&T Finance Holdings PAT declined by 51% yoy to Rs. 287.4 cr (up 16% qoq) mainly due to continued higher provisions (mostly on conservative basis). Credit cost for the quarter was at Rs 1024 cr, which includes Rs 144 cr of mark down to a specific HFC in defocused book. Excluding this, credit cost in Q3FY2021 was at Rs 880 cr (vs Rs 821 cr in Q2 FY21) and was still at elevated levels. Till now, L&T Finance Holdings was maintaining surplus liquidity at Rs 16442 cr (was Rs 17449 cr in Q2) with liquid assets of Rs 7709 cr (was Rs 8660 cr), which continues to be a drag on margins.

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L&T Finance Holdings Q3FY2021 saw an uptick in rural and infrastructure finance, led by revival in the economy, leading to significant m-o-m improvement in collections. However, micro loans may still take time to recover and normalise, and collections efficiency (CE) is at 98.3% as of December end. Within assets under management (AUM), specific segments such as rural, two wheelers, and home loans posted strong growth. However, owing to improved collections and other segments being tepid, overall AUM was flat (up 1% yoy).

Focus on the new tractor business and increased refinance helped gain market share to become the top farm equipment finance and stay among the top-3 players in the two-wheeler financing segment. While asset quality and cost of funds outlook is improving for NBFCs, Sharekhan believes the discussion paper on NBFC regulation (expected next week) is an overhang on the NBFC sector as it may suggest measures (may include CRR/SLR etc. requirements, norms for bank conversion etc.), which add to uncertainty for the medium-term business growth momentum/profitability of NBFCs. 
Considering the changed outlook for L&T Finance Holdings, Sharekhan have downgraded the recommendation to Hold with a revised price target of Rs 103.

Key positives:

L&T Finance Holdings fee income increased by 12% qoq, led by highest quarterly fees in rural since FY2017. 
L&T Finance Holdings (with AAA rating and a strong parentage) has seen lower average liquid assets during the quarter (qoq) which resulted in cost of borrowing reduction by 50 bps qoq (from 8.32% in Q2 FY21 to 7.82% in Q3 FY21).

Key negatives:

L&T Finance Holdings ROE stood at 7.54% (marginally dipped from 7.58% in Q2 FY21) but is still below ROE of 16.5% in Q3FY2020, mainly weighed down by the additional provision. Hence, ROE recovery trajectory appears to be elongated. Š
Segments like MFI book yet to normalize on Collections efficiency to pre Covid levels and is a challenge

Key risks:

Increased L&T Finance Holdings delinquencies due to the pandemic magnified by slower disbursements could impact credit cost and profitability. The overhang of changing regulatory landscape also clouds visibility.