Rating Rationale

Strengths
* Majority ownership by, and strategic importance to M&M
The ratings factor in the financial and operational linkages that Mahindra Finance has with M&M. While M&M currently holds a majority stake of 51.2%, there is a possibility of the stake reducing to below 51% in future when Mahindra Finance taps equity capital markets to support growth without M&M's participation in the same. Nevertheless, M&M will remain the largest shareholder and maintain controlling interest in Mahindra Finance over the medium term, given the latter's critical role in facilitating M&M's sales. In December 2017, the company raised Rs 2111 crore of equity capital (Rs 1056 crore through QIP and another Rs 1055 crore from M&M), resulting in M&M maintaining its stake at current levels.

The company remains of strategic importance to M&M, as the former continues to finance around 30-35% each of M&M's UV, light commercial vehicle (LCV), and tractor sales. However, financing of M&M vehicles as a proportion of Mahindra Finance's yearly total loan disbursements has reduced over the past few years. As part of its growth strategy, Mahindra Finance has been increasingly financing vehicles of other manufacturers. The proportion of captive finance business has declined to 45% of overall disbursements in fiscal 2017 from 75% in 2008. Nevertheless, M&M's majority ownership of Mahindra Finance, shared brand, and strong linkages between the two imply a moral obligation on M&M's part to support Mahindra Finance in case of distress.

* Strong and established market position in rural and semi-urban areas, particularly in UV and tractor financing business
Mahindra Finance's market position in the UV and tractor financing segments remains strong, given the operational linkages with M&M, which enables Mahindra Finance to access the parent's widespread dealer network. Main competitors include cooperative and nationalised banks and financing entities in the unorganised sector. Mahindra Finance has considerably strengthened its distribution network: it had 1178 branches across 27 states and 4 Union Territories as on December 31, 2017, with a large number of branches in semi-urban and rural areas, where it enjoys a strong market share. To leverage its existing presence in these geographies, Mahindra Finance entered rural housing finance through MRHFL.

* Adequate capitalisation and stable resource profile:
Capitalisation continue to be adequate with Tier I and overall capital adequacy ratios of 17.0% and 23.5% respectively, as on December 31, 2017 (12.8% and 17.2% respectively as on March 31, 2017). Networth was sizeable at Rs 8868 crore and gearing at 4.1 times as on this date. The company's capital profile is also supported by its demonstrated ability to raise equity capital. In December 2017, the company raised Rs 2111 crore of equity capital (Rs 1056 crore through QIP and another Rs 1055 crore from M&M), resulting in M&M maintaining its stake. As a result of transition to 90+days-past-due (dpd) for classification of non-performing assets (NPAs), the networth coverage for net NPAs declined to 3.3 times as on December 31, 2017, as compared to 4.0 times (on a 120+dpd basis) as on March 31, 2017. On a like-to-like (120+dpd) basis, the networth coverage for NPAs actually increased to 4.0 times as of December 31, 2017, as compared to 2.8 times as on December 31, 2016.

A stable and diversified resource profile and substantial unutilised bank limit provide significant financial flexibility to raise resources at competitive costs to meet increasing funding requirement. Average cost of borrowing declined to 8.4% for the nine months ending December 31, 2017, from 9.1% for the previous fiscal. Borrowing costs are expected to remain better than industry average over the medium term.

Weakness:
* Modest asset quality impacting profitability:
The gross NPA ratio increased to 12.7% as on December 31, 2017 (9.9% as on March 31, 2017). The company transitioned to 90+dpd NPA recognition as on September 30, 2017 versus 120+dpd NPA recognition until June 30, 2017.
While all the asset segments have witnessed higher delinquencies, the LCV, tractor and three-wheeler portfolio have been impacted the most. Stress on asset quality and accelerated provisions have resulted in increased provisioning cost (based on managed assets) at 2.9% as of December 31, 2017 (3.0% as of March 31, 2017; 2.7% as of March 31, 2016). Consequently, profitability has been affected, with low annualised return on managed assets (RoMA) of 1.3% as of December 31, 2017 (0.9% as of March 31, 2017; 1.7% as of March 31, 2016). The company is increasingly focusing on collection and recovery efforts; on a static-pool basis, final credit loss in the loan portfolio is expected at 2.0-2.5%, indicating delayed, but ultimate collections.