MUTHOOT CAPITAL SERVICES

Background

Muthoot Capital Services Ltd. promoted by Muthoot Pappachan Group is a deposit taking Non Banking Finance Company (NBFC) registered with the Reserve Bank of India and listed on the Bombay Stock Exchange. 

Established in 1994, Muthoot Capital Services Ltd offers vehicle loans – primarily 2 wheeler and 3 wheeler loans.


Main Products/Segments

Muthoot Capital AUM (Cr)
9mFY14
GNPA
Q3FY14
Sales (Cr)
9mFY14
 Contrib
%
2 Wheeler 504.54 1.01% 386.46 96%
3 Wheeler 105.41 4.86%    6.57 4%
Blended 609.95 1.68% 403.03
Muthoot Capital FY09 FY10 FY11 FY12 FY13 9mFY14 FY09-FY13
CAGR
AUM (INR Lacs) 7167 9669 17184 29578 45569  60995  58.79%
Disbursements (INR Lacs) 1044 4285 13835 28845 43117  40316  153.53%
Avg Lending Rate 24.25% 28.81% 28.74% 28.39% 28.79% 27.09%
Avg Borrowing Rate 10.72% 11.01% 11.08% 11.92% 12.83% 12.39%
NIM 13.53% 17.80% 17.66% 16.47% 15.96% 14.69%
Avg Loan Size (INR) 33405 33315 39391 43351 45139 42502 7.82%
Gross NPA 0.94% 0.81% 0.63% 0.26% 1.00% 1.84%
Net NPA 0.73% 0.63% 0.52% 0.20% 0.87% 1.61%
RoA 9.32% 8.43% 6.85% 6.24% 5.50% 3.89%
RoE 38.29% 38.29% 38.27% 26.71% 22.92% 19.51%
Cost to Income Ratio 0.44 0.38 0.39 0.42 0.45 0.46
Capital Adequacy Ratio 21.12% 20.86% 16.48% 28.56% 21.71% 19.61%
Total Customers 4343 15393 46589 99647 118568 212682 128.58%
Avg Monthly Disbursement 260 1072 2927 5545 7960 10540 135.23%
Salary Costs/Op Income 5.05% 11.15% 13.84% 18.22% 20.39% 21.90%
Sales (INR Lacs) 1712 2239 3770 6701 10664 11235 57.98%
PAT (INR Lacs) 542 717 967 1551 2176 1626 41.55%
Total Employees 55 207 505 1034 1626 2146 133.18%
Avg Employee Count 131 356 770 1330 1886
Sales/Avg Employee (INR Lac) 17.09 10.59 8.70 8.02 5.96
PAT/Avg Employee (INR Lac) 5.47 2.72 2.01 1.64 0.86

Source: Company

  • Group Branch Network: 3800 Fincorp branches -currently as cash payment collection points
  • Operations Network: 29 Hubs; 8 MCS owned and 21 shared premises with Fincorp
  • Dealer Points: – 1200 @2-3% commission; Usually 1 Customer Sales Executive (CSE) at dealerships
  • Disbursements Concentration 9mFY14 (FY13): Kerala 54% (60%), Tamilnadu 15% (14%), Andhra Pradesh 10% (9%), Karnataka 16% (13), Goa 0.6% (0.6%), Gujarat 2% (1.5%), Mahrashtra 2% (1.5%)
  • Group Customer Base: ~3.2 Mn Fincorp customers; Not much active cross-selling at the moment because of absence of unified database. (planned availability FY2015)

Main Markets/Customers

  • Strong Kerala Presence statewide – 20-25% market share. Competes strongly with IndusInd Bank and HDFC Bank. No#2 in Kerala just behind IndusInd Bank. Total Kerala market ~40,000 vehicles financed per month.
  • Muthoot Fincorp branches in Kerala are pretty much all leveraged by MCS. Fincorp has 900 branches in TN and around 600-700 branches in AP and KN each which leaves lot of space for leveraging on.
  • Nascent presence in Tamilnadu, Karnantaka, Andhra Pradesh (historical stronghold of Shriram City Union Finance?). These 3 states are traditionally huge markets for 2Wh financing. The company plans to grow Sales substantially leveraging existing Fincorp branch strength (without incurring much by way of fixed costs) – which is pretty entrenched in these 3 states.

Bullish Viewpoints

As on Mar 2013/
Dec 2013
Muthoot
Capital
SCUF SHTF Chola Sundaram MMFS Bajaj Finance
Size (AUM Cr) 610  15800 49700 19000 17600 27900 17100 Dwarfed when compared to Industry
Years in Business
(Effectively)
20
(6)
28 (11) 35 36 60 23 27 Miles to go before proving itself
Capital Adequacy 19.61% 23.3% 19.9% 17.1% 17.7% 19.1% 20.9% Adequate; may need replenishing
3Yr Earnings CAGR 50% 45%  19%  74%  20%  39%  58% Robust growth
Cost to Income 46% 37% 26% 50% 37% 33% 45% High
Cost of Funds 13.10% 12.6% 9.8% 10.6% 10.6% 9.9% 10.3% Industry Highest
Employee cost/Avg no of Employee (Lacs)  1.66  1.75  5.36  12.19 Industry Lowest
Business Size/Avg no of Employee (Lacs)  38  92  385  553 Industry Lowest
Margins 14.69% 11.2% 7.0% 7.6% 8.4% 9.4% 12.1% Industry Highest
Yield 27.4% 22.1% 16.3% 15.4% 17.7% 16.4% 20.7% Industry Highest
Gross NPA  1.68%  2.4%  3.2%  3%  2.5% Industry Lowest
RoA 3.89%  3.2%  2.9%  2%  3%  3.4%  3.6% Industry Highest
P/B (CMP 87) 0.88   2.2  1.8  1.5  2.4  3.05  1.6 Attractive
P/E (CMP 87) 4.57   12.7  10.37  10.6  15.14  14.35  11.24 Attractive

Source: Company, Annual Reports

  • High Growth – Earnings have grown at an impressive 50% CAGR over last 3 years next only to Bajaj Finance – albeit on a much lower base. There is huge headroom to grow -provided the funding constraints get adequately addressed.
  • Highest Yields & Margins in the Industry – Again despite a declining trend, Margins (14.69%) and Yields (27.4%) for 9mFY14 are the highest in the industry, although on a much lower base compared to bigger competitors.
  • Highest Profitability in the Industry – Even with a declining profitability trend over last few years, MCS RoA at 3.89%  (9mFY14) is the highest in the industry. With the steps Management has been taking, RoA looks set to improve in near to medium term.
  • Stringent Credit Policy – As per the Management the primary reason for its strong showing and low NPAs is very strict adherence to the robust and detailed credit policy laid down by the company – extensive covering of different models and different customer segments (salaried, income-based, Asset-based, or NO docs financing with higher down-payments). Different Loan to Value (LTV) levels apply for different customer segments.
  • 85% of Loans backed by “Own House” documents – This is probably unique to Muthoot Cap that 80-85% of its disbursements follow asst-financing model – loan to folks with own-house document proof – either the borrower or the guarantor (usually close relative). This helps the company in collection/recovery process – as borrower is reluctant to run the risk of property attachment in case of default – especially for small loan sums < Rs 40,000.
  • Lowest NPAs in the Industry – Gross NPAs at 1.68% is the lowest in the auto-financing industry. All auto-financiers including Bajaj Finance have been seeing a spurt in NPAs in recent quarters. MCS has been managing the NPA situtation admirably. Collection Executives are focused on bringing down the ~15.75 Cr of likley NPAs substantially down by 31st March 2014 or, Gross NPAs to <1.5% or less. Senior Management is focused on closely monitoring stressed A/Cs (likely to become NPAs) and Collections on a daily basis.
  • Extreme Focus on write-offs recovery – MCS is again probably unique in its focus of trying to ensure recovery of every rupee that is written off. Post Arbitration (company has appointed arbitrators) 3-4% of cases vehicles are repossessed and sold off. Cases are filed and in due course company is confident of recovering loan amounts due along with legal costs and charges.
  • Big Productivity Improvements likely in FY15 & FY16 – With enterprise-wide automation being introduced and Profit Center benchmarks being established, company is embarking on a productivity linked budgeting exercise from FY15 onwards. Management opines this will help the company monitor income and expenses more granularly and modify policies for getting the best productivity – locations-wise and team-wise.
  • Cross-selling within Fincorp customer base – Fincorp has a customer base exceeding 3.2 Mn Customers today. Effective cross-selling may become possible once Fincorp group database becomes available (post automation) in FY15 and may provide a kicker to Sales growth.
  • Attractive Valuations – MCS is currently (CMP 87) trading at a discount to Book and ~4.5x PE with a 4.8% dividend yield – which looks reasonably attractive.

Bearish Viewpoints

  • Declining profitability trend – While 5 year Sales or Profit CAGR may look healthy, and FY14 Sales may register 40%+growth, FY14 PAT is likely to register flattish or negative growth. Return on Assets (RoA) have consistently declined and halved from ~9% levels 5 years back.
  • Employee Productivity bottleneck – If we examine the reasons, what strikes immediately is the nearly ~3 to 5-fold drop in Sales and Profitability per employee. The situation has got accentuated on 2 fronts. First, disbursements didn’t keep pace with recruitment leading to under-utilisation. Company was doing ~60 Cr disbursement by Mar 2013, but in 9MFY14 has managed to disburse only ~400 Cr. Secondly there is enormous duplication of excel-based data-entry work between Operation Hubs and Back-Office in the absence of enterprise-wide automation. Company has been cognizant of the second front and has been working to introduce fully-automated Loan Origination System covering Sales, Operations and Credit processes from April 2014 -planned to be fully operational by end of Q1FY14.
  • Delay in Bank Funding – Disbursements have been hampered by delayed funding availability from Banks. Typically Bank Limits are enhanced based on the current Balance Sheet. The BS gets ready by April/May with Banks taking another 2 months. So while company had a disbursement run-rate of 60 Cr by Mar 2013, it could disburse only ~40 Cr in Apr-Aug’2013 (up to 50-60 Cr for Sep-Dec’13) despite otherwise having ready sales/operations personnel – leading to under-utilisation. In earlier years this hadn’t proved a bottleneck (probably shareholders equity sufficed for first few months till enhanced bank borrowings kicked in) but it certainly has impacted disbursements and profitability significantly in FY14. For FY15 Company expects to kickstart approval process with banks within Q4FY14.
  • Deteriorating 3 Wheeler Market/Portfolio – MCS 3 Wheeler Loan market (primarily Kerala) has been steadily deteriorating. Monthly Sales at 7500 vehicles is now down to 3500 vehicles per month. Reportedly daily earnings of 3-wheelers down to 450/- from Rs 850/- earlier. The 4 wheelers Tata IRIS/ACE has also started doing well. 3 Wheeler Associations have written to prominent vehicle finance companies to stop issuing 3 wheeler loans in Kerala. Debt servicing capability of borrowers is badly dented and gross NPAs are on the rise [~5% in 9mFY14]. However, 2 Wheeler gross NPAs remain firmly under control and are probably the best in industry at ~1%
  • High Cost of Funds – MCS Cost of Funds is the highest in the industry at 13%+. Dependency on Bank Funding is high and  current A (negative outlook) rating by CRISIL (clubbed with Muthoot Fincorp) isn’t helping either. Public NCDs/other options are probably restricted till a ratings upgrade is in place.
  • A (Negative Outlook) CRISIL Rating – While the reasons and rating sensitivity cited by CRISIL in its negative outlook are mostly attributable to the Gold Loan business of Muthoot Fincorp, declining profitability on MCS count has not helped either. Senior Management is strongly of the view that they have proven in last 6 years that MCS 2Wheeler/3Wheeler Auto Financing is a successful, sustainable, and scalable business model. They have moved out completely from the Gold Loan business. They deserve a standalone MCS rating which they feel merits much better rating – that may alleviate its funding constraints in a major way. Discussions are on with ICRA and CARE.
  • Single Product dependency – MCS product portfolio currently comprises of only 2 wheeler and 3 wheeler loans. With 3 wheeler NPAs rising company is consciously cutting back on 3 Wheeler loans. Dependency is very heavy on 2 wheeler loans. Any adverse developments in the industry/economy could significantly affect the company’s fortunes. Going forward the company has to look at product diversification for better risk-adjusted growth profile.
  • Funding constraints – Tier I & Tier II Capital – Currently Capital Adequacy stands at ~19% (Min CAR of 15% as per RBI). If MCS continues to grow at 40-50% rates, it will need capital infusion in the form of Tier I or Tier II Capital pretty soon. Raising Tier I (Equity Capital) is probably not an active option for the company (cf. current valuations). For Tier II Capital MCS has options of either going the route of Sub-ordinated Debt or Preference Capital – which may get decided based on Group liquidity levels in 2015/16.
  • Hero/Honda Company Financing – MCS is hugely dependent on financing for Hero and Honda 2 wheelers. In the event that either of these start their own financing arms – and provide preferential access to financing from their dealerships – MCS prospects can be affected significantly.

Barriers to entry

  • Unique/Flexible cash payment schemes – Customers can pay from any Fincorp branch anywhere in the country. A web-based collection module of MCS provides access to customer details and payment schedules, etc. for all Fincorp branches. Customers can choose to pay the monthly EMI say Rs 1500/-, in even Rs 200/- or Rs 300/- flexi-instalments. Fincorp collects 0.5% (up from 0.2%) as collection fees from MCS from FY 2013.
  • Leveraging widespread Fincorp network – With a growing pan-india network of more than 3800 branches – this is at the heart of the efficient collection system for MCS. MCS can simply piggy-ride this expanding retail network and does not really need to set up this infrastructure of its own as it scales up. MCS does not need branch offices as sales originate primarily from Sales Executives placed at Dealer Points. [Operational Hubs are required for managing every 30-40 Dealer points – where again shared (but separate) premises with Fincorp is the norm. Out of 29 Operational Hubs only 8 are MCS-owned including the Head Office location.]

Interesting Viewpoints

  • Started taking Deposits – MCS has recently started taking 1-3 year deposits at upto 12% rates through Muthoot Exim which acts as the broker. ~40 Cr deposits have been mobilised so far. The company seems confident of mobilising ~150-180 Cr (the max limit – 1.5x Net Owned Funds) within FY15. This will go way a long way in ensuring Margin Requirements with Banks and pave the way for enhanced Term Loans availability for the company.
  • Impending introduction of Automation – As per the company major automation in Loan Origination System (LOS) – covering Sales, Operations and Credit processes – is set to be introduced across all company Hubs and Offices in 1QFY15. Part of a much larger group automation project standard operating procedures (SOPs) have been defined by IBM in consultation with functional departments over the last 2 years. 3I Infotech is the major vendor and implementation partner. Apart from providing single-source unified MIS views, this is likely to bring in huge operational efficiencies and savings in FY15.
  • Muthoot Fincorp Sales Agency model – With Gold Loan business volumes coming down, Muthoot Fincorp has started proactively sourcing customers for MCS on commission basis (2%). Started only a year back, all Fincorp branch personnel have now been trained. With Muthoot Fincorp intrinsically incentivised (low Gold Loan Sales) this is expected to be rolled out to all 3800 branches in FY15 – reducing the dependency and large costs incurred by MCS on Sales Executives at Dealer points. Model is working well and expected to start delivering ~7500 vehicles (avg 2) a month.

Disclosure(s)

Donald Francis: More than 5% of Portfolio in the Company; Holding for more than 6 months


Muthoot Capital Services Management Q&A: May, 2014

Management Q&A

1. THE BUSINESS, INDUSTRY & OPPORTUNITY SIZE

Muthoot Capital has chalked up a rapid growth rate only in the last 6 years or so, despite being listed from 1995. Kindly take us through the journey and the key success factors. What has changed, and how exciting is it to be where MCS is today?

As you are aware in 1994 Mr Thomas Kuruvilla (ex SEBI) was appointed as the MD & CEO of the company which was started for offering Capital Market Solutions, though the Company did not start the business. It did not have a NBFC license then. In ’95 there was a small but well subscribed Public Issue.

The company did not do well and was more or less dormant till 1997-98. It was revived in 1998 after getting the NBFC License. The company started doing business of Gold Loans. In 2005-6 the company started some 2 wheeler loans but did not succeed in making a mark – and was stopped. In 2007, 2-wheeler Loans were again started but this time only to Fincorp group customers (Gold Loan, Insurance products).

1st Mar 2008, Mr R Monomohanan joined the company as CEO. He had a Corporate Banking background – 20 yrs with SBT. He headed IndusInd Bank Kerala Operations from ‘1996-‘2003 and was with Exim Bank Tanzania from ‘2003-‘2007. The Company also brought in Mr R Balakrishnan – with over 15 years of hard-core 2-Wheeler industry experience in Operations, Sales and Collections spread over Integrated Finance and TVS. Mr Balakrishnan was given a free hand in setting up his team.

This was the time many players were vacating the 2 Wheeler financing space due to high default rates – like ICICI Bank, Citi Financials, UTI Bank. We saw it as an opportunity due to our reach and loyal customer base.

In Oct 2008 we started full-fledged operations. We started lending outside the group too. We disbursed Rs. 10 cr, Rs. 43 cr Rs. 138 cr, Rs. 288 cr and Rs. 431 cr respectively in 2008-2009, 2009-2010, 2010-2011, 2011-2012 and 2012-2013 respectively. In March 2009 we reached a loan book size of Rs.10 Cr, Rs. 40 Cr in 2010, and followed it up with ~Rs. 130 Cr in 2011. In 2012 we reached Rs. 290 Cr and ~Rs. 482 Cr in 2013.

We hope to keep the momentum going. We have laid strong foundations. We have been testing waters so far. In 5 years we have reached a level of ~650 Cr, where (we daresay) reaching 2000 Cr was not difficult.

We believe we have demonstrated a robust business model in the tough terrain of 2-wheeler financing. While we have grown rapidly, we have ensured high Return on Assets (RoA) and some of the lowest NPAs in the industry.

2Wh Loans constitute the bulk of the Loan Book. Post 2008 (2009-10) timeframes Private Banks mostly vacated this space. Also NBFCs like Fullerton (300 Cr Auto Loan book), CitiFinancial, GE Money scaled down operations drastically. Why has this business proved difficult in the past? Why were you confident of executing where others have failed before?

As mentioned before, this is a difficult terrain. There were very high defaults in 2008-9 time frames – Retail Banking was a numbers game being played out – anyone and everyone could avail of a loan – proper verification procedures were probably not in place, and credit policies were lax.

Because of our Corporate Banking background, we ensured we offered the Right Product.

And what is the Right Product?

Product that is first and foremost backed by a Robust & detailed Credit Policy. Policies that ensure a wide coverage of different models, different repayment schedules and different customer profiles – salaries based, income based financing, asset-based financing, and even a No-Docs financing (50-55% down-payment).

We started offering only for Honda and Hero vehicles – we are the preferred financiers for them today.

Secondly this is backed up by 3-level customer profiling and verification (which goes up to 5 levels in certain cases). First by the Counter Sales Executive (CSE) at dealer premises, followed up by an independent Field Investigation (FI) Verification Agency that confirms physical address proof and background check, and finally a CIBIL score elimination.

Thirdly we offer a product that is tailored just-right for its audience segment. Flexible Repayments. We do not take any Post Dated Cheques (PDCs). In what is probably a first-in-industry and unique to Muthoot we allow the customer to pay in cash – in any of the 3800 Muthoot Fincorp branches – all over the country. For an EMI of Rs. 1500/- say, he can even pay in Rs 300/- or Rs 200/- flexi-installments, any time he chooses. We call this facility “Ultimate Flexi Payment”.

Apart from these obvious Product structuring strengths, kindly elaborate on the key business tenets for MCS?

The core business tenet is “Asset Quality”. This is our primary concern for every employee of MCS. Nothing is outsourced – except the Field Investigation Agency. We follow a stringent system of concurrent audits (audits happening at the Operation Hubs concurrently with approvals).

For maintaining desired Asset Quality, we lay great stress on our people. Interestingly we do not follow the prevalent Agency model.  Unlike Direct Sales Agents (DSAs) we have a Counter Sales Executive (CSE) stationed at Dealer premises – an employee on our rolls. Every employee has been handpicked/recruited by referrals – no advertisements. Employees are assured great career advancement prospects – to ultimately retire with the company. From 15 employees in 2008 we have grown to 2100 employees today, in 7 states.

How well-placed is MCS in 2Wh/3Wh space? Who are your main competitors? Is your audience segment completely different from those served by Banks?

Our main competitors are IndusInd Bank and HDFC Bank. IndusInd Bank has higher expenses because of higher incentives for dealers at 4-5%. Their NPAs are also higher. HDFC Bank as you know has a separate vertical for Auto Finance. They are the bigger players.

We are a small player with ~2% market share. We have huge headroom to grow.

Where does MCS see itself 5 years from now vis-a-vis current competition?

We aim to become a significant player in this space in the next 5 years with atleast 10-12% market share. Major players have somewhere between 15-18% market share today.

What do you see as the biggest challenges to your growth plans?

Availability of Funds and maintaining our Yields at current levels.

How ready are you organizationally for the challenges ahead? And Why?

As you are aware, we are a small organisation. We have laid a strong foundation with the right people, right product and processes within the organisation. However in-order to enable us to scale up significantly from here, we have been taking following steps:

a) Complete Automation – major automation is being introduced in Loan Origination System (LOS) – covering Sales, Operations and Credit processes – set to be introduced across all company Hubs and Offices in 1QFY15. This is part of a much larger group-wide automation project where standard operating procedures (SOPs) have been defined by IBM in consultation with functional departments over the last 2 years. 3I Infotech is the major vendor and implementation partner. Apart from providing single-source unified MIS views, this is likely to bring in huge operational efficiencies and savings, starting FY15.

b) Productivity linked Budgeting –  Company is embarking on a productivity linked budgeting exercise from FY15 onwards – Profit Center benchmarks are being established  – this will help the company monitor income and expenses more granularly and modify policies for getting the best productivity – locations-wise and team-wise.

c) Arbitrator appointment – For speedier processing of loan recoveries appointment of Arbitrator has been started.

Muthoot Pappachan Group is a diversified conglomerate -Financial Services, Hospitality, Automotive Dealerships, Real Estate & Infrastructure, IT Services, Healthcare, Precious Metals, Global Services and Alternate Energy. Ev
en during the press release of MCS results update MD speaks about Muthoot Pappachan group and other businesses like MF, Housing, gold loan etc. – Which is the priority and how is promoter/management bandwidth?

We are a completely professionally run set-up. There is zero interference from the Promoters in day to day activities.

2. OPERATING STRUCTURE

Back-Office/IT systems/Risk Management

Entire Back-office, New automation system for Loan Origination System and other IT facilities, Document Storage, and Risk Management Team is based out of Cochin.

Business/Operations – Front Office

Sales originate from the ~1200 Dealer Points spread across 7 states.

Operations HQ is Cochin. There are some 29 Operational Hubs. These Hubs usually handle sales origination from some 30-40 Dealer Points. Operational Hubs usually house the Credit Team, Operations Team with Tele-Callers, Collection Team and a Concurrent Auditor.

Team Sizes

Sales – ~950-1000; Collections – ~800, Operations – 115; Credit -~50; Risk Management – ~40

3. BUSINESS PROCESSES

What is your Loan Eligibility process?

Around 80% of loan origination happens in non-metro regions – at rural location dealers.

Loan eligibility is decided on various parameters. Broadly the flexibility increases as the Loan to Value (LTV) goes down. If everything is in order, Loan Approval is sanctioned. 80% of loan disbursal is for Honda/Hero products. LTV is different for different 2-wheelers. Generally resale value for Honda/Hero 2-wheelers is higher, so there is better security.

Different combinations of LTV, proof of landed property, customer profile, income documents, guarantors, kind of 2-wheeler being financed, existing relationship with MCS/group companies and CIBIL score decides the loan amount.

More than 90% of the customers have a property in their or guarantors name. MCS takes copies of tax receipts of the property. This helps MCS in case arbitration/legal proceedings are needed for recovery of loan.

MCS can disburse a loan without income proof – where the LTV has to be lower than 50%. Less than 10-15% of accounts may be under this category. Of course 2 guarantors are signed-up for almost all cases.

When company/competition markets “100% funding” schemes – this is only smart product packaging. In such products advance EMIs of upto 5 months is collected upfront by anyone offering such schemes.

Generally 80% loans are based on assets owned by the client, 5% cases are based on his income proof, and balance are no-income/asset proof cases.

Kindly educate us on the Loan Sanction/RISK Management process?

Counter Sales Executive (CSE) does the first round of customer profiling by collecting details and documents from customers directly. The Tele-caller at Operational Hub makes the next round of residence and employment verification.

Field Invstigation (FI) agency does the address verification at customer’s residence and also does a background check by contacting neighbours, etc.

A CIBIL report is also generated.  CIBIL records are available for 30% cases. Though the score is not used directly, the repayment habits and current liabilities of clients are ascertained using the CIBIL report.

Whenever Loan to Value (LTV) is above 70% the risk team appraises the case before sanctioning. A Risk Team (stationed at HO) consisting of ~40 employees work closely with the Hubs. Risk team picks up cases through random sampling, references from credit team and on any other triggers/hints they get.

The trigger/hint may be in the form of abnormal number of defaults from a specific sales staff, dealer, area, segment of clients etc. There is a list of “negative” segments.

Flexible repayments is what is said to be MCS “real differentiator”. Kindly elaborate.

Very flexible installment payment options and various methods to evaluate credit capacity allows MCS to compete effectively. A customer can pay his installments partly or in full at any Muthoot Fincorp branch in the country. He need not give PDCs or ECS instructions.

In any PDC system 80:20 rule applies. 20% of the cases there is cheque bounce. When customers of competitors have to deal with penalties for cheque bounces i.e. defaults,  a MCS (defaulting) customer can make at least a part payment. He can pay daily/weekly or monthly.

The MCS Operations Team sends an SMS reminding them of the due date. The Collection Team then guides customers to the nearest branch for the payment.

Kindly educate us on Collection And Recovery Processes.

An SMS goes to the customer informing due date and amount for payment of installments.

If the customer does not pay in time, Tele-caller calls to check. Customer is persuaded for making the payment/even if partly, at any of the Fincorp branches.

The big Fincorp branch network ensures that collection team guides the customer to nearest Fincorp office. The flexibility to pay daily/weekly ensures collection of some amount happens.

Collection Team consists of ~800 execs with each Team Leader managing on an average 7 Executives.

What are the main advantages/differentiators vis-a-vis Competition?

Competitors employing collection agencies and using PDCs route for monthly payment are usually slower to start the follow-up as the trigger for follow-up is usually on cheque bounce being first reported.

Competitors would perhaps take around 45 days for collection process to start after the due date – once any PDCs bounce, and penalties are imposed. A large chunk of 2-wheeler customers may not be used to regular banking habits and PDC bounces might be frequent. The penalties will further irritate them.

MCS collection team works very closely with the customers and this also gives valuable information about the clients, their whereabouts, best way to collect from them etc.

How strong/influential is Customer Knowledge and the Relationship? And role of Guarantors?

With ~800 executives in the collection team and attrition being low at 1%, the long term relationship (in-place) with clients  is very important for recovery. Teams are very well versed with the area they operate in.

MCS strategy is to operate in areas around Fincorp branches, thus there is high possibility of a client being an existing client of Fincorp or being known to a client of Fincorp. Many a times Fincorp’s help is requested to know more about the clients of MCS.

Most clients do not want a collection agent to visit them, and/or interact with their colleagues, family members or neighbours. Hence in most cases recovery is successful through positive persuasion.

The 2 Guarantors usually are close relatives or friends. This also acts as a deterrent/strong persuasion point for defaulting customers. MCS can proceed with arbitration against Guarantors as well.

What is the process on payment defaults?

Whenever the customer defaults one of the first 3 EMI cheques are utilised. The Credit Team and CSE concerned are also utilised for persuading the client. This is because the client and his details/whereabouts are still fresh.

2-wheeler loans being low-ticket items most customers do not want recovery actions, especially when even their property can technically be at risk. MCS possesses the vehicle in case of default over 3 months. Some of them (25% in FY13) are released after collection of some amount.

When the company repossesses and sells vehicles, the balance un-recovered amount is written off immediately. But MCS is confident of recovering this amount through arbitration/legal proceedings.There are 550 Cases under arbitration now.

[Senior Management is very confident about the Arbitration/Legal process for recovery – due amount plus all legal fees/charges included. They opine “Every Rupee given out since 2008 will be recovered, there would not be any real “write-offs”.

MCS is very confident of its 2-wheeler loan book and gross NPAs are currently at 1%.] p>

What kind of skills-profile do you require for these jobs?

Normal graduates.

What kind of training do you equip employees to deal with – say the tough collection process?

Orientation training at HO. 1st-15th of the month training facilities are always booked. Whenever Credit Team or Operations Team visits – local trainings are conducted. Most of the learning though is on the job.

How do you create the right incentive structures? Loan growth vs profitability vs Collections?

We have an incentive structure which rewards the field level executives in both sales and collections according to their contributions. The structure also takes care of their supervisors, for keeping the field staff motivated and involved. For the senior staff, we have a flat 10% incentive structure plus a component based on quantum of disbursement. As mentioned before, we are bringing in productivity-led benchmarks that will help us to fine tune incentive structures in the near future.

 4. SALES/MARKETING

What is the total market size of 2 Wheeler Autoloans? What is the market share that MCS has in Kerala & overall?

Overall we have ~2% Market share. Some 40,000 vehicles per month need financing in Kerala Market. We are able to do ~10000 vehicles per month, so ~25% market share.

30 lac customers for the group and 2.25 lac for MCS. How do we plan to tap this base?

As mentioned before, major automation/ERP systems is being introduced within the group. Both MCS and Fincorp will have Loan Origination System (LOS) operational by Q1FY15. We should be able to leverage the group database fully from the coming financial year.

Do you share branches with Muthoot Fincorp? How many branches are company owned?

As mentioned before, MCS does not need conventional branch presence – Sales originate form dealer points where we maintain a Counter Sales Executive (CSE). What we do need is what we call Operation Hubs – which on an average manage some 30-40 dealer points. We have 29 Operations Hubs. 21 of these are shared (but separate) premises with Fincorp branches, and 8 belong to MCS.

There are 20,000+ staff working in the 3800 Fincorp branches all over the country. We are uniquely positioned to leverage on this group branch network that acts as Cash collection points for us.

So what is the relationship/arrangement with Fincorp? How do you account for the costs involved?

Fincorp branches also act as our Cash collection points. We pay them 0.5% as commission from FY14 onwards (revised upward from 0.2% earlier).

Any other synergies with Fincorp/Other group companies?

Yes. Sales Promotion activities for 2-wheeler loans are regularly arranged near Fincorp branches – to leverage the group customer base.

And of late Fincorp branches have started generating sales for MCS. We have provided required training to personnel at all Fincorp branches. This will be rolled out across all branches in FY15 – we expect significant traction from this going forward – roughly 2 vehicles per Fincorp branch per month run-rate is targeted by the end-of-year.

Why does this work for Fincorp? Why would they prioritise any Sales for MCS?

As you are aware the Gold Loan business is seeing a down-cycle. So it’s a win-win situation for the group companies.

New product lines – Company mentioned LAP, second hand auto loans, lease financing, tractor loans. What is the plan and opportunity size?

At the moment we are focused on 2-wheeler/3-wheeler loans. Other avenues will become available as we attain some scale and are also able to attract substantial funding.

What is your strategy around tie ups with more players besides Hero Motocorp and Honda?

We are the preferred financiers for Honda and Hero vehicles. They are growing at a rapid pace. At the moment we are focused on servicing this market.

How is you expansion plan playing out in Goa, Gujarat & Maharashtra? Do you expect to maintain the NPAs in these markets also? You would have had a better credit history of customers in your primary market because of group/historical customer relationships. Will this be an additional risk in the new markets?

Our recovery performance and low delinquency ratio in Kerala and the other Southern States are on account of our business model, which include strict customer profiling, flexi-payment option to borrowers, doing the business with own employees instead of engaging agencies, strict and vigorous collection measures, etc. We expect to continue the same collection performance and low levels of NPA in the other States also, by continuing the same business model.

You have presence across 1200 dealers? How will this number grow over time?

Currently we have ~1200 dealer points. If things go as planned this will reach 1600 dealer points next year and 2000 dealer points by FY16.

Will it be correct to assume a similar trend for disbursements?

Yes. We certainly hope to maintain a fast clip. As mentioned before, we think reaching 2000 Cr in disbursements  is not difficult – and a good target for us to achieve within next 2-3 years.

How much contribution comes from 3 wheelers today? What is the average yield, default rates and tenure of 3 wheeler loans? Does permitting play a role in terms of what the demand is like?

3-Wheelers constitute a very small portion of our product portfolio ~4%. 3-Wheeler Loan market (primarily Kerala) has been steadily deteriorating. Monthly Sales at 7500 vehicles is now down to 3500 vehicles per month. Reportedly daily earnings of 3-Wheelers down to 450/- from Rs 850/- earlier. The 4-wheelers Tata IRIS/ACE has also started doing well. 3-Wheeler Associations have written to prominent vehicle finance companies to stop issuing 3-wheeler loans in Kerala. Debt servicing capability of borrowers is badly dented and gross NPAs are on the rise [~5% in 9mFY14]. However, 2-Wheeler gross NPAs remain firmly under control and are probably the best in industry at ~1%

What percentage of your customers would have a CIBIL record? Do you initiate a credit check for all your customers before sanctioning?

Roughly 30% of customers have a CIBIL record.

What is the competitive advantage that you have over your competitors especially in areas where you don’t have your branches and Muthoot brand does not have a strong recall?

The Ultimate Flexi-Payment facility across 3800 Fincorp branches all over the country has proven to be our key differentiator. Also being a single-product company we are certainly more focused on this segment than our much larger bigger competitors (Banks like IndusInd and HDFC). Our products & processes are probably more finely-tuned to the requirements of the customer segment we serve.

How do you handle the Trade? 2-wheeler Dealers in metro cities are known to demand huge trade advances and higher commissions?

We are a small company. We can not pay 1 Cr trade advance! We offer between 10-15 lakhs as trade advance. While competition is known to offer 5% kind of dealer commissions we offer 2-3% commissions. But we do offer the best payment terms to the dealers – payments are processed immediately without any delays. Some of the bigger competition is known to delay payments by over 2-3 months.

What is the Rural/Urban Sales mix for Muthoot?

80% Rural, 20% Urban.

What is your current organization structure? What is the average tenure of the employee? What kind of attrition levels do you deal with

Sales – ~950-1000; Collections – ~800, Operations – 115; Credit -~50; Risk Management – ~40

1% Attrition levels. There is no retirement in Muthoot group. Post 58 years employees are offered gainful engagement on contract basis – based on the skills profile.

5. FINANCIALS/CONCERNS

Your borrowing costs are creeping higher over the last couple of years? What is the current cost of borrowing and do you expect it to further trend higher? How are you compensating for this rise in cost of borrow
ing?

Our average lending rate for 9m FY14 is at ~27.09% while average borrowing rate is at 12.39%. NIM is thus 14.69% and the highest in the industry. Maintaining yields is becoming a difficult task. We are in discussions with ICRA & CARE for standalone MCS ratings – that should help bring down our borrowing costs somewhat, in near future.

In the last quarterly results the Admin costs have increased from Rs 3 Cr to Rs 7 Cr YOY & Employee costs increased to Rs 9 Cr from Rs 6 Cr YOY? Why are such huge jumps happening?

There was significant scaling up on the Employee front which resulted in the higher costs. We had factored in higher disbursement rates for FY14 based on our Mar 2013 run-rate achieved.

Going forward what will your target NIIs, ROAs and expense ratios? Your expense ratios have been climbing sharply over the last 2 years?

Profitabilty was hit in recent quarters as expenses shot up but disbursements couldn’t keep pace. We expect RoAs to climb back to 4.5 to 5% levels.

How are your Gross NPAs faring? Is the incidence of NPAs increasing? What are the measures your are taking to reduce the overall incidence of NPAs?

Gross NPAs for 9mFY14 are at 1.84% levels. It has gone up significantly as compared to previous years. This is in line with the stress in the overall economy. However our NPAs are still the lowest in the industry and reflects the focus within the company to manage collections and customer relationships, identify stress areas early and work towards reducing likely NPAs.

Can you give us some sense of the increasing NPAs? Are some segments effected more than others?

As mentioned before 3-Wheelers constitute a very small portion of our product portfolio ~4%. 3-Wheeler Loan market (primarily Kerala) has been steadily deteriorating. Monthly Sales at 7500 vehicles is now down to 3500 vehicles per month. Reportedly daily earnings of 3-Wheelers down to 450/- from Rs 850/- earlier. The 4-wheelers Tata IRIS/ACE has also started doing well. Debt servicing capability of borrowers is badly dented and gross NPAs are on the rise [~5% in 9mFY14].

However, 2-Wheeler Gross NPAs remain firmly under control and are probably the best in industry at ~1%.

So how long is the pain going to continue in 3-Wheelers? Any plans of reducing/exiting this segment altogether?

We have already curtailed fresh 3 wheeler disbursements. The total disbursement in FY 13-14 for 3 wheelers was only Rs. 20 Crore, compared to Rs. 80 Crore in the previous year. The portfolio will be depleted substantially in another 2 years.

So is it correct to say 2-wheeler NPAs are doing just fine?

Absolutely, Yes. 2-wheeler (96% of the business) NPAs remain within ~1%

If the NPA recognition is reduced to 90 days from 180 days currently?

These were proposed in 2012. At the moment they remain as proposals only and we haven’t seen any indications/activity on that front.

However, if these norms do get introduced, it will affect the NPA situation significantly.

But that actually defies current trends in the 2-wheeler industry too? Why are your NPAs keeping so low when the whole industry’s/bigger player NPas are rising?

As mentioned before at the start of this discussion, this is a reflection on 3 things. Robust Credit Policy backed by Stringent Verification Norms and a Right-Fit Product flexibly tailored for the needs of the segment we serve. We have some unique differentiators in place.

At the same time, we maintain the highest focus on customer relationship and collections – tracking and helping them maintain their repayment schedules.

6. FUNDING/CONSTRAINTS

Raising adequate funding is probably a key challenge for MCS. There is probably heavy dependency on Bank Funding and options are rather limited? How will you ensure enhanced funding availability? Kindly comment.

We have started taking deposits recently – we have a deposit-taking NBFC License. We have reached a deposit base of ~40 Cr. Interest rates offered are upto 11.25% with a 1-3 year tenure going upto 5 years in some cases. Muthoot Exim is the broker and they are being paid a 2% commission.

We can raise a maximum of 150-180 Cr deposits as of now (1.5x Net-owned Funds). Seeing the current uptake we think reaching a 100-150 Cr deposit base is pretty comfortable. For Term Loans, Banks require us to maintain 25% with the Bank as our own Funds (Margin requirement).

Having this deposit base will take care of this margin requirement, free up tied capital and enhance our working capital limits.

You had this issue in each of the last 2-3 years – of delayed Bank Funding – sometimes by end of Q1? Why are you confident this situation will be better managed this year and will not prove another unnecessary constraint for disbursements?

We already have some sanctions from banks in place and some other facilities in advanced stages of sanctioning. We have adequate working capital for continuing operations in the first quarter of the financial year itself.

There is also the issue of A (Negative) Rating from CRISIL. Is it right to say that Public NCDs will be an option as & when (or if) Ratings improve to AA. Kindly comment

The rationale and rating sensitivity cited by CRISIL in its A negative outlook are mostly attributable to the Gold Loan business of Muthoot Fincorp. We are strongly of the view that we have proven in last 6 years that MCS 2Wheeler/3Wheeler Auto Financing is a successful, sustainable, and scalable business model. We have moved out completely from the Gold Loan business.

We deserve a standalone MCS rating which we feel merits much better outlook/rating. This will alleviate our funding constraints in a major way. Discussions are on with ICRA and CARE. We are pretty confident this will be resolved soon – even the CRISIL rating should get revisited.

Capital adequacy at 19.61% looks adequate at the moment. But you have set a fast clip in dealer point expansion and disbursements growth. You are looking at a disbursement target of probably 100-1200 Cr for FY15. Why wouldn’t you require enhanced Tier I/Tier II Capital in FY15 itself? Or would that become necessary only by FY16? Why or Why not?

We are projecting a loan book size of about Rs.1000 Crore for FY 2015. We may require enhancement in Capital for maintaining the Capital Adequacy Ratio above 15%. We are thinking of a Tier II issue of about Rs. 50 Cr during the FY 15.

What is the Management/Promoter thought on raising Tier I Capital at current valuations? And is it fair to assume Tier II Capital is the only real option in the near future?

You may be right, Tier I Capital at current valuations is not an option. For Tier II Capital we have 2 options. Either raise Sub-ordinated Debt (lock-in of 5 years and may need higher interest rates) or Preference Capital – which may get decided based on Group liquidity levels in 2015.

CFO Anil Kumar R resigned 30th Nov 2013? What were the circumstances?

He was 56 years old – had a bypass surgery. He resigned due to health reasons.

_______________________________________________________________________________________

Disc: Ayush Mittal, Vinod MS, Gaurav Sud and Donald Francis were involved in this extensive Management Q&A and follow-up discussions.

Ayush Mittal – Invested; <5% Portfolio allocation, from more than 6 months

Vinod MS – Invested; >5% Portfolio allocation from Jan 2014

Gaurav Sud – Invested; >5% allocation from more than 2 years

Donald Francis – Invested; >5% Portfolio allocation from Feb 2014


Disclosure(s)

Ayush Mittal: More than 5% of Portfolio in the Company; Holding for more than 6 months;
Gaurav Sud: More than 5% of Portfolio in the Company; Holding for more than 2 years;
Vinod MS: More than 5% of Portfolio in the Company; Recent Entry;
Donald Francis: More than 5% of Portfolio in the Company; Recent Entry;