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;

SHRIRAM CITY UNION FINANCE

Background

Shriram City Union Finance (Shriram City) established in 1986, is part of the nearly four decade-old Shriram Group, and has its origins from the needs of the Chit Funds customers. The company started operations with truck financing. In October 29, 1988, the company became a public limited company and renamed as Shriram Hire Purchase Finance Ltd. In March 1990, City Union Bank Ltd. acquired shareholding 200,000 shares at par. Consequently, the name of the company was changed to Shriram City Union Finance Ltd. The company registered as a deposit taking asset financing NBFC with RBI and went public in 1994.

Prior to 2002, the company was exclusively engaged in transport finance with special emphasis on financing pre-owned commercial vehicles to small road transport operators. In 2002, the company discontinued the truck financing business (except for trucks > 10 year old) as that business was consolidated in its sister concern (viz. Shriram Transport Finance Ltd) and started as a separate business unit in year 2002 as Shriram City Union Finance Ltd.  Listed on BSE in 2003.

Today Shriram City offerings comprise finance for Two Wheelers and Three Wheelers, Four Wheeler Finance (both new and pre-owned passenger and commercial vehicles), Personal Loans, Small Business Loans, and Loan against Gold. This has made Shriram City the only NBFC to offer such a wide range of products under one roof.

Vision: Serving the under-served. Creating value at the bottom of the pyramid.


Main Products/Segments

  • Niche Diversified Product Portfolio
As on Sep 2013 MSME Loans Gold Loans 2 Wh Loans Auto Loans Personal Loans
Inception Dec 2005 Oct 2006 Dec 2002 Dec 2005 Jan 2006
% Loan Book  49% 22% 15% 10% 4%
Avg Yield 18-22% 14-18% 24-26% 22-24% 24-27%
Avg Ticket size 700,000 40,000 35,000 150,000 75,000
Avg Loan to Value NA 55% 70% 60% NA
Branches offering  493 (1021)  714 (1021)  832 (1021)  359 (1021)  396 (1021)
Gross NPA  1.4%  1.6%  3.8%  3.7%  4.8%
Net NPA  0.3%  1.4%  0.8%  0.4%  0.0%

Source: Company, CRISIL

  • Branch Network – 1021 Total branches, 724 Owned Branches, 297 Shared Locations
  • Geographic Concentration – AP [48%], TN [32%], MH [9%], KN [2%], OTHERS [9%]
  • Group Customer Base – ~4 Mn Chit Fund customers; 95% of MSME customers referred by Shriram Chits

Main Markets/Customers

  • Strong Positioning for the Niche Addressable Under-penetrated Market – primarily the Self-Employed – without formal credit history and/or future cash flow signature – primarily feeding-off the Chit Business and concentrated in AP, TN, MH – hugely scalable – completely protected (?) market – may continue to grow nicely
    • MSME Loans, Gold Loans, 2 Wh Loans and Personal Loans
  • A piece of the MSME Non-Chit action – primarily concentrated in North India – primarily leveraging regular credit worthy customers with credit history and adequate documents – Max 1 Cr loans – Avg Ticket size 20-25 lakhs – may see cautious growth – as this is untested market/untested models
  • Nascent Niche presence in the under-penetrated Housing Finance segment – focusing on Tier 2 & Tier 3 Cities and the under-banked – Avg ticket size 10 lakhs – insignificant currently, but growing rapidly – may become significant within 4-5 years

Bullish Viewpoints

As on Sep 2013/ Jan 2014 SCUF SCUF
(Dec ’13)
SHTF Chola Sundaram MMFS Bajaj Finance
Size (AUM) 15800  14937 49700 19000 17600 27900 17100 Small
Years in Business
(Effectively)
28 (11) 28 (11) 35 36 60 23 27 SHTF, MMFS have also grown AUM fast
Capital Adequacy 23.3%  24.26% 19.9% 17.1% 17.7% 19.1% 20.9% Industry best
3Yr Earnings CAGR  45%  45%  19%  74%  20%  39%  58% Robust
Cost to Income 37%  38.68% 26% 50% 37% 33% 45% Industry Median
Cost of Funds 12.6%  11.74 9.8% 10.6% 10.6% 9.9% 10.3% Industry Highest
Margins 11.2%  12.35% 7.0% 7.6% 8.4% 9.4% 12.1% One of Industry highest
Yield 22.1%  21.19% 16.3% 15.4% 17.7% 16.4% 20.7% Industry best by far
 RoA  3.2%  3.36%  2.9%  2%  3%  3.4%  3.6% One of Industry highest
 P/B  2.2  1.8  1.5  2.4  3.05  1.6
 P/E  12.7  10.37  10.6  15.14  14.35  11.24
  • Huge under-penetration in Target customer base – With only 9-10% penetration of the ~4Mn Shriram Chit Customer base, there is huge headroom to grow in its niche with virtually no competition
  • Improving Product Mix – With Gold Loan share coming down (expected to stay within ~20-25%), Product Mix decisively tilting towards higher tenure, higher yields
  • Strong Growth Drivers – Deeper Product Penetration into existing branches especially in high-yielding MSME, 2wheeler and Personal Loans will keep driving growth.
  • Dominant position in MSME Loans – As per a Frost & Sullivan study SCUF share in overall MSME Loans disbursals in FY11 was a dominant 53%. Shriram City concentrates on ticket sizes comprising Very Small Loans (sub Rs. 1 Lac), Small Loans (Rs. 1 Lac – Rs. 10 Lacs) and Medium Loans (Rs. 10 Lacs – Rs. 50 Lacs), with the bulk of its MSME book constituting Small Loans – 42% market share as per 2013 AR.
  • High Capital Adequacy – With the recent Capital Infusion, CAR at ~23% is the highest in the industry. Tier I Capital is at a comfortable~18%. This should be adequate to fund growth for next few years
  • High growth trajectory -While FY14E AUM growth will be muted – partly due to Loan Book recast and partly due to disruption in normal business in AP due to Telengana protests, next 2-3 years could see 25% CAGR growth
  • High Yields look sustainable – SCUF has the highest yield among similar NBFCs at ~22%. Given improving Product mix, yields likely to stay high
  • Operating Costs likely to come down – SCUF Cost to Income ratios had been climbing up mostly due to Employee expenses shooting up over last 3 years – from ~6% of Expenses in FY11 to over 13% in FY13. This was largely due to integration of Shriram Chit Employees into its fold (From ~3000 to just over 19000 in 2QFY14). With the process getting completed and conservative branch expansion targets hereon, this is likely to stabilise and head downwards in next 2-3 years
  • Valuations – Given the strong positioning in its niche, SCUF appears to be trading at reasonably attractive 2.2x P/B valuations (CMP 1030)

Bearish Viewpoints

  • Concentration of business in AP & TN – 80% of business currently comes from these 2 states with AP (48%) and TN (32%). Any disturbances and/or policy change in the key states could impact business significantly. The ongoing Telengana issue and protests had seen disruption in normal business activity and had affected disbursements to MSME customers. The impending bifurcation of AP and likely protests means SCUF remains vulnerable to disruptions again – and that may impact growth
  • Asset Quality seemingly deteriorating (Advancing recognition Norms)
SCUF SHTF Chola Sundaram MMFS Bajaj Finance
GNPA 2.4 3.2 1.0 1.0 3.0 1.5
Recognition Norm 150d 180d  180d 120d 150d 90d
  • SCUF’s NPA’s are on the higher side. This should also be seen from the context of significant share of Gold Loans (with low NPAs) in Loan Book. However to be fair, Recognition norm at 150d is conservative and keeping ahead of RBI stipulations/timeline.
  • Advancing Recognition Norms/Standards Asset Provisioning may be raised – As per Usha Thorat Committee DRAFT Guidelines, NBFCs may have to move to 120-day NPA recognition norm from April 1, 2014 and 90-day norm from April 1, 2015. Also Standard Asset provisioning may be raised to 0.40% from 0.25% effective March 31, 2014. This may lead to higher costs on provisioning impacting earnings. Eventual write-offs though could be lower (nature of customers/business). As per Management, in the entire 28 years history actual delinquency is <1-1.5%.
  • Gold Loan remains a significant portion of Loan Book. Gold price volatility may impact growth possibilities

Barriers to entry

  • Chit Model – 90% of the current business/addressable market is mostly insulated from competition. For its target segments a Shriram Chit customer will go out of the group only if SCUF is unable to meet the customer requirement
  • Strong Brand Equity – “Shriram Brand” has high brand equity within its target segment – leading to low spend on advertising in both existing and new geographies

Interesting Viewpoints

  • Leveraging/Piggy-Riding on parent/group – Shriram City Union completely leverages the groups strengths – Customers, Database, home-grown systems and processes for the self-employed, and IT systems. Expansion to newer geographies can be incrementally calibrated by piggy-riding on group ecos-system and branch network, with minimal capital outlay
  • Regulator view of NBFCs turning favourable? – Even 2 years back regulatory risk may have been cited as a key risk for NBFC businesses. However of late RBI is seen to be shifting its hawkish stance (as evidenced in say the recent Comprehensive Financial Services for Small Businesses and Low Income Households Report chaired by Nachiket Mor, Central Board Member, RBI) and acknowledging the key role and value-added contribution that NBFCs could make towards financial inclusion in India. Also recent 23 Jan 2014 Speech Non-Banking Finance Companies: Game Changers, by P. Vijaya Bhaskar, Executive Director, RBI
  • Only 7% of MSMEs seek external sources of credit, the rest managing with self-financing or with funding from informal sources. MSMEs have a total finance demand of Rs. 32.5 trillion, of which only 36% is widely considered as addressable by financial institutions. The remaining 64%, ordinarily considered unviable because of inadequate/poor credit profiles, preference for debt from informal sources, reliance on self-financing etc. presents a rich potential for NBFCs if adequate safeguards can be built in to protect asset quality[Source: Ministry of Micro, Small and Medium Enterprises, Company AR, MSME FInance in India IFC Report]
  • Shriram City for the most part caters to the Micro Enterprises segment. Their research indicates that in the event of the GDP growing between 4% – 5%, the MSME sector should see a long term growth of between 15% – 20%. [Source Company AR]
  • Shriram City Housing Finance – Incorporated as a fully owned subsidiary in Nov 2010. Currently 76.5% owned by Shriram City and 23.5% by Valiant partners. Focusing on Tier 2&3 cities and the under-banked with average ticket size of 10 lakhs, this business is at a nascent stage with Asset size of ~340 Cr as on Sep 2013. Growing rapidly with disbursements crossing ~215 Cr in Sep 2013 up from 40 Cr in Sep 2012 – a building block being laid for future disproportionate growth?

Disclosure(s)

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


Shriram City Union Finance Management Q&A : Jan 2014

Management Q&A

1.   THE BUSINESS, INDUSTRY & OPPORTUNITY SIZE

Kindly explain to us the key guiding tenets for your business. How exciting is it to be where SCUF is today?

As a group (Shriram) it’s in our DNA to look at Financing segments – where they find it difficult to get financing – typically the Self-Employed (non-salaried class).They face a shortage of credit – the formal Banking sector is not much interested in them – as they can’t provide salary slips or proof of regular/future cash flows.

But this does not mean we jump into every opportunity in this space. There must be SCALE and MARGINS must be PROTECTED. We get in when a) it is difficult to do b) there are higher margins adequate enough (for the inevitable bad eggs in the basket).

How important is the MSME space in overall scheme of things? How difficult or complex a business is this?

Success in MSME financing business is pretty simple, actually. It’s a plain vanilla labour-intensive game. There are 1000’s of middle level executives involved. It is their persistence and sweat. It will be wrong to say there is a big “classy” process behind this. It is the labour and the humility to relentlessly chase for collections. There is a process for sure, but that process is in building people (like a factory) – who can stay true to persistence and sweat and humility to chase – each situation is different!  80% of our success can be attributed to this patience and diligence at the branch level and only 20% to Intellect-driven systems/processes.

MSME financing is important. We have a dominant position in the small loans segment. MSME pie of the Loan book has been increasing. From over 35% a year back it is now at ~50% levels. It could reach 70% of Loan book in 2-3 years. Gold Loan has come down to ~25% levels – this business we will be doing at our own pace – we are certainly not getting out. There is also 2Wh and Personal Loans which are doing well. Depending on the environment, we will take our calls, we will be nimble.

How well-placed is SCUF in MSME NBFC funding space? When do we see Banks/FIs addressing this space in an institutionalised way?

Banks are not very active in MSME funding where the Risks are higher. When they do fund they are mostly funding “Manufacturing” businesses unlike us where our share is more on the “Services” businesses.

What about PSU Banks? And Credit Guarantee Shemes from the MSME Ministry where funds are available for upto 1 Cr without collateral.

Well these schemes have been there since almost a decade without much of an effect. Our sense is that Bankers are inherently uncomfortable lending where there is no collateral (as recourse to recovery is generally poor in our country). They are not well-trained to study and evaluate or rate a small business that can’t offer much by way of collateral. PSU Banks are used to the Customer coming to them for Loans. They are not used to go to the Customer (save Deposits). Look at the turnaround time – in CGSH schemes and in general practice, is 6-9 months. And then some of our customers tell us – the effective cost is the same.

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

We should do 20-25% CAGR over 3-5 years. As & when the economy spurts, we will also do better.

“Scalability” ( how long is the runway? What are the assumptions for growth for the next 3/5/10 years? Can you actually grow outside home base? ) and “Repeatability” (Can you simply keep doing more of the same and what could hinder this – i.e. Recruitment, training, technology, competition poaching etc. )

Scalability – In terms of opportunity there is space for even 100 players to step in and everyone can grow. We are only scratching the surface in terms of what we have touched so far. However this is hard terrain – Not everyone can step in and do what we are doing, as successfully.

Repeatability – As explained before, yes the whole thing is about repeating the same labour-intensive dogged pursuit of collections. At our core, we are an out & out collections company with humility, persistence and sweating as the key cornerstones for our success.

What do you see as the biggest threats to your growth plans?  e.g. government regulatory changes, etc.? Is increasing regulatory oversight a good thing/bad thing in the longer term?

We have a feeling things are changing at the regulator/RBI level. They are more willing to listen. The recent RBI report on Financial Inclusion chaired by Nachiket Mor actually speaks highly of NBFCs and the useful role NBFCs can play in India. There is lot of new ideas being brought in by eminent people like Shikha Sharma and Vikram Pandit and others on the panel. Even 2 years back, things were difficult. Now we are very hopeful that things are changing, the regulator will start playing a more positive role.

Our biggest risk is our own execution. As we scale up we should remain glued to the groups conservative ideals, processes and systems. That we do not fall prey to foolhardiness – cutting corners or taking shortcuts. The Economy has slowed down, credit is tight. A growing economy will help us scale faster.

You have applied for a banking license – what impact will this have on existing operations?

Let’s make it clear that we have made a conditional application. Because of our understanding of small business, we believe we can significantly contribute to financial inclusion aims of RBI and Government of India. As our group director has said recently, we won’t pursue our aspiration to become a bank at the cost of our existing business, but only if RBI is willing to support and facilitate us to lend to these segments appropriately.

And what’s the take on Shriram Housing Finance? Do you have big plans there?

Our plans are very clear. It will take 3-4 years before it becomes significant. As mentioned before we don’t do anything that CAN’T SCALE.

2.  OPERATING STRUCTURE

Kindly brief us a little on operating structure and major business processes? Why do you have 2 MDs, to start with?

Basically different skill-sets. Mr Sundararajan – MD – ex CMD Fullerton – he is the public face of the company – he meets the press, regulators, media.

Mr Duruvasan – MD – he has been there for last 35 years+ with the group. He joined after +2 level and got his degree by attending night college. He started as a collection executive in chit fund and rose to be its ceo. He was also MD Shriram Life Insurance.

He is a great leader and visionary. Much of what Shriram group is today can be credited to him.

Kindly tell us a little more on his early years, achievements and leadership style?

To give you a perspective in 1990 Shriram TN business was 10x AP business size. In the next 8 years from 1990-1998 he built up the AP business to 2x TN size. He is a great man with an eye for talent – right person for right job – and building teams.

From 1990-96, we used to add ~9-10 branches per year, as we had good teams throwing up good leaders. But from ’96-’99 we added ~25-30 branches every year. Team was flush with talent – we needed to accommodate ~75 people who had grown capabilities for next level of leadership within the teams.

Shriram chits acted as a distribution arm as well. We used to distribute CDs/Mutual Funds. People developed multiple skill-sets – market development, debt collection. Even today Shriram Life Insurance derives 70% and Shriram City over 45% of its business from AP.

Back-Office/IT systems/Risk Management

Entire Back-office, ERP, IT facilities including Centralised Cheque Printing facility is based out of Chennai.
CTO & CAO – Chandrashekhar. He is a cost accountant with IT skills. He handles all our home grown IT/ERP systems. The internal audit team reports to CAO as do the Account Heads at branches.
CFO – Subhashri Sriram. She handles Fund raising, Securitisation and interaction/ management with PEs. The risk management team reports to CFO.

Business/Strategy – Front Office

Operations HQ is Hyderabad and Business handled from respective regions.

COO – Y S Chakravarti – He handles Operations. The Business guys and the Credit guys report into the COO. The Product heads at branches report into the COO.

And Region-wise there are CEOs for TN/AP/MH and also for North and another for MP, Chhatisgarh, Kerala and Gujarat.

Role Clarity – Accountability

Roles are clear as is the accountability. In his own area, each is a MD, which also means no one can hide behind anyone’s back. There is no overseeing that is needed. No Senior Management reporting/briefing is necessary. The MD usually needs to meet Operating Heads at Board Meetings only. We are all home-grown, grown up on the job- with the business. We are like family comfortable with each other, with clear individual/team goals set for us.

3. MAIN BUSINESS MODELS

You have the MSME CHIT model running in AP/TN/MH primarily referred from Shriram Chits. Kindly brief us on the key characteristics.

CHIT Model -South

As you are aware this is primarily in Andhra Pradesh, TamilNadu and Maharashtra with Shriram Chits customers primarily. This has a run-rate of 250-300 Cr per month. Average ticket size ranges 10-12 lakhs. Some are in 18-20 lakhs. Maximum lending is upto 1 Cr. This is mostly secured business. In AP it is 65-70% secured.

Did the Telengana stir disturb normal operations?

Yes it was affected during that period as normal business was disrupted. However it is back to usual once the protests are over.

You are trying to replicate this same CHIT model in North India?

CHIT Model – North India

We are trying to replicate this CHIT model slowly in North India over last 2 years with small loans. Average ticket size is 2 to 2.5 lakhs. This is kick-started by mining our 2Wh Customer database. Small business owners like Stuffed-toy makers, Ice-Cream makers, Trinket manufacturers. In 2 years time this now has reached a run-rate of ~2 Cr/month.

Also you are trying out basically the regular (NON-CHIT) NBFC MSME funding model in North India.

External Model – North India

We decided to step into the regular CIBIL credit-scored MSME financing model in a slow cautious way, 3 years back. We recruited experienced executive level senior people for the job who in-turn recruited fresh talent for building the Team. In 3 years now this segment’s run-rate has reached ~20 Cr/month. Average ticket size is 20-22 lakhs.

How are you looking to scale this probably important segment?

This has been a learning phase for us. We are extremely cautious here as this was a completely new turf. One cycle of lending and closing is over. The Team is doing very well. Net NPAs are <0.2. Lending Caps were <1 Cr till now. Only recently this has been enhanced to <2 Cr. We don’t have any branch/numbers driven expansion targets. Our philosophy for expansion is – when we have next rung of capable people (home-grown) ready to take on branch leadership roles, only then. Maybe 2-3 years down the line we will have a good crop of capable leaders for expanding presence.

You have been integrating employees from Shriram Chits into SCUF fold now. Is the process complete? What are the overlaps now with Shriram Chit Fund?

OVERLAPS with Shriram Chits

Shriram Chits also plays the role of a distribution arm from group company products, also for SCUF. Employee integration from Shriram Chits is now mostly completed. Any shared office infrastructure (with Shriram Chits) is now owned and run by SCUF, shared by Shriram Chits.

4. MAIN BUSINESS PROCESSES

How do you employ customer knowledge from chit fund history? How is it used operationally? Is there a formal score? If not, how do you prioritise or incentivise better track record customers?

Customer look-up can be done from the Database. It can provide some rough pointers. We have what is called a CHIT Rating system. Customer consistently paying within the month (actual payment date is by 7th) are tracked. Very simply put, any customer with more than 15 installments paid within the month is considered credit-worthy.

When a Loan turns non-performing, what recourse do you have, how do you go about recovering?

We don’t have Big Clients (Big Defaults). Big Clients are not even approachable much of the time. And when you do reach them the refrain can well be “Business/Economy is not doing well. What can I do? You come back when business cycle recovers”. Small clients have an ingrained honour system. They want to preserve their reputation. Our people are able to sit with them in their house and work out a deferred plan (usually they are willing to pay the penalties for late payments). Payments get deferred, but rarely turn delinquent.

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

We don’t need MBAs and financial experts. Normal graduates can do the job. We need local people familiar with the terrain. Understanding the customer comes first. People who can understand the customer, work on the relationship, gain their trust and imbibe the groups ethics of humility, persistence and sweat.

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

It’s mostly on-the job! Our Management Trainees go through more than a year of exhaustive on-the ground training. Usually it’s baptism by fire from day one – collecting money from tough clients, with monthly reviews.

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

First of all nothing in our business is outsourced! The one who sells/lends also collects. 60% of incentives are aligned to Sales and the balance 40% for Collections.

What about Manager level/Executive level Incentives?

For the Branch Manager it’s is an aggregate of different product lines – MSME, 2WH, Gold. Average of incentives collected by Teams under him. For the Divisional Manager again, it is an average of the Branch Managers reporting into him. Likewise for Zonal Managers.

Any discretionary powers in the Loan Hierarchy?

Not really. The only discretionary power is on the Processing Fees side – some 2% at Account Head levels – marked as deviation – requires Approval.

What is the experience over last 3/5 years versus last 10 years and is there is any clear trend? On collections and recovery of bed debts, say?

In our entire history (28 years+) Collections at Loan Termination has been over 97%. And 6 months from date of termination collections are 98.5% -99%. So terminated arrears are 1%-1.5%. Greater than 180d NPAs are <0.5%.

5.   RBI GUIDELINES AND NBFC BUSINESS

Kindly explain the current guidelines and its impact on SME business

Well these were proclaimed in 2012. We have learnt to adjust. As you might have seen we have been keeping ahead of the RBI timeline. We have advanced our NPA recognition norms to 150d from 180d.

As per the DRAFT RBI guidelines, NBFCs may have to move to 120-day NPA recognition norm from April1, 2014 and 90-day norm from April1, 2015. Also Standard Asset provisioning may be raised to 0.40% from 0.25% effective March 31, 2014. Kindly comment how are you prepared for this?

NPA recognition norms may move from 360d to 180d to 90d but as explained before, in our DNA we are a collections driven organisation. There will be delays, but hardly any delinquencies. Our customers are rarely defaulters.

Unlike say Banks (10x leverage) or NBFCs (upto 6x leverage) or even a Manufacturing Enterprise (3x leverage) a small service/trading business capital structure is usually the reverse. It is 3:1 Equity:Debt and in most cases 5:1. The intention to pay is there (as is the capability). Capital is always large (as compared to debt). Unless they have 5x losses they are able to service the debt.

So what kind of impact will these have on earnings?

TBD

What about the Securitisation cap impact?

While Securitisation may be the cheapest source of funds for us, does not mean our other source of funds are not okay. Securitisation is not a panacea. You must also look at the time factor involved – 9 months of seasoning vs instant availability. Today because of our reputation and Shriram groups standing we can have immediate access to Funds. If we require 900 Cr, we can get it.

Because of further restrictions on NCDs, etc. dependency on banking sector will increase? to what levels?

See as a group, we have access to comparatively lower cost Funds. Today we are at 15,000 Cr. Shriram Transport has already shown us the way to 50,000 Cr. Let’s reach that phase first. We believe we can reach there in the next 5-6 years without much issues. We can worry about next level of scalability then. By that time Shriram Transport might show us the way to 100,000 Cr.

6.  MARKET MAP/COMPETITION

Give us a sense of your market? How is the competitive scenario?

Market is huge. This is just the tip of the proverbial iceberg we have touched. There is room for more than 100 players if need be. We are really in competition with the customer (to accept debt).

Bajaj Finance and some others do Loan against property business for small business and get yield of around 13-14%. They classify it as MSME business. Isn’t that competition?

Loan against Property (LAP) is a different segment – the loan is secured against the property with lower yields like you mentioned. Most NBFCs who mention MSME financing are actually doing only LAP products.

So how is a LAP product different from MSME Financing?

LAPs are usually longer duration products. The customer is typically saying, I have a property. Unlike in our business where the customer is more likely to say I have a business…and I need a loan for my business for 6 months to 1 year (or 2 years).

Is it correct to say ~1/3rd of your MSME loan book is secured which is ~17% of your overall Loan Book (MSME Loans at ~50% of Loan Book)? The question is how do you compete effectively? Are your yields much more comparable to LAP rates for this segment?

TBD

7.  FUTURE GROWTH/PROFITABILITY DRIVERS

Shriram Chits customer base is your biggest strength. It also enjoys very high reputation with your customer base. Your customer acquisition costs remain low on account of this. But somehow “Chits” business generally has got an adverse image in India. Kindly comment.

There are some rotten eggs in every sphere in India. CHIT as a product is best suited for a country like India. CHIT is used both as a savings product as well as for borrowing for business. Sometimes by the same individual for different needs (savings for his wife) and the borrowing Chit for his business purposes. CHITS were popular even in China, Africa and Italy.

Is it correct to say Shriram Chit fund has ~ 3Mn customers? Is it correct to say currently more than 90% of MSME customers are through Chit fund customer database?

Shriram Chits base is ~4 Mn customers. Yes 90-95% of MSME customers are referred from Shriram Chits.

How much of this Customer base is already addressed for SCUF product portfolios? How much is still virgin opportunity?

Not more than 20% perhaps. So one can say 70-80% is still available for fresh addressal.

And this is a completely protected base – that is unlikely to go out to seek their financing needs?

Shriram group brand equity is very strong with this customer segment. This segment of customers are very keen on “who’s the lender?” Normally for our target product segments, they are unlikely to go outside to seek financing.

What is the overall growth expected in next 2-3 years? And MSME Loan book proportion expected?

Next 2 years may be tough for the economy. Having said that, we are probably better insulated than most, because of our diversified but niche product bases. We should be able to do 20-25% CAGR over next few years. MSME Loan book proportion could touch ~70% as we have both width (<50% branches currently offer) and depth (penetrate deeper into existing branch customer base) to explore.

What’s the broad mix of SME business which are being financed in terms of %?

We are completely industry agnostic. One can say we are more focused on Traders/Service Industry than Manufacturing industries.

How much of growth will be driven by higher penetration and how much from geographic expansion?

Growth will come from deeper penetration of customer base at existing branches and widening our presence. We have more than 1000 branches today. MSME Loans are currently offered at ~50% of the branches.Gold Loans at 70% of branches and 2Wh Loans – the earliest Loan product is offered from ~80% of the branches. More than 200 branches are shared locations. Incremental growth will also come from shared office space with group companies. We can expand reach at low incremental cost by putting up 2-3 people at shared locations without much capital outlay.

Plans to expand branches outside AP & Tamilnadu over next 3-5 years?

As explained before, we do not have formalised branch expansion targets/plans.

To what extent political disturbance in AP is impacting your growth in MSME loans?

It was only for that period of protests. Now operations are back to normal.

Because of the increasing mix of higher yield and higher tenure MSME Loans (vs Gold), is it likely we will see a higher margin picture in next 2-3 years?

It is possible. But we have to see that the Gold Product had lower NPAs. Net ROA is likely not changing much. Post-tax RoA should remain around ~3%.

8.  DIFFERENTIATION/OTHER NBFC MODELS

Do you see any benefit in developing specific industry expertise, relationships with machinery OEMs? And priortising/focusing based on growing industries, leveraging the machinery relationships, funding machinery assets?

As mentioned before, we are completely industry agnostic. We have a dominant position in the MSME Small Loans funding space. We are doing well in 2Wh and Gold Loan space. We see opportunity size before us as huge – we are just scratching the surface.

Any NBFC having such differentiation – how valuable is that expertise in the long term? Would you go so far as to say this is highly valuable and may create niche dominance in SME asset financing?

Definitely there is value for specific industry expertise. However one has to weigh the scalability front. Funding machinery as opposed to funding Individuals – Entrepreneurs. Besides there is lot of merit in product diversification of the kind SCUF has. Any mono-liner (including SHTF) product has to go through stress some time or the other, is inherently more risky.

Which are some of the other NBFC models that you admire?

Mahindra & Mahindra Financial Services. They have done a good job with rural penetration. REPCO Home Finance and GRUH in the Housing Finance space are other commendable success stories.


Disclosure(s)

Donald Francis: More than 5% of Portfolio in the Company; Holding for more than 6 months;
Tirumal Rao: No Holdings in the Company; ;
Davuluri Omprakash: No Holdings in the Company; ;
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