SBFC Finance – NBFC focused on secured lending – MSME / Gold Loans

Hello, found an old thread on SBFC finance, but since it was closed, starting a new one. I have put this in Stock Opportunities category, if you believe its better suited for some other category, please move it or let me know, I would do so.

I started reading up on this business by means of its most recent investment presentation for Q2FY25 and witnessed a few things, sharing them here.

Any inputs, critical view of thought process, feedback, inputs appreciated. If someone has spent time reading through their annual reports, previous quarter presentations, calls and anything that is worth digging further to develop a better understanding of their business, please share.

Business

• 99% Secured book, despite that their GNPA is 2.69%. They seem to be lending to a really risky segment – but needs further digging.
• Their return on assets is really strong at 4.56% but because they have high capital adequacy ratio (38.6% CRAR) their overall return on equity is in low double digits (12.67%)
• The business is currently valued at over 3x the book value, but if they increase their gearing ratio (leverage) thereby reducing their adequacy ratio (CRAR), they might be able to scale up their return on equity and hence profitability. Remains to be seen what are their growth targets (and whether they are sustainable).

Concerns

• Asset quality given their book is 99% secured (GNPA 2.69%, NNPA 1.63%, Credit Cost: 0.95%)
• Low provision coverage ratio 40.17%
• Average ticket size is quite high, meaning a low number of customers can really spike the asset quality unless they scale this rapidly enough – basically high ticket size with high volumes such that small customers don’t have the ability to take away profits by being delinquent / delayed on their payments.
• The yield of 17.64% on secured lending seems worrisome. Why can’t customers run away to more established lenders or at least small finance banks after a year or two’s consistent payment thereby showcasing their ability to pay?
• Cost of funds is high as compared to a small finance bank – 9.33% – meaning they will be forced to lend at high rates, thereby either sticking to low quality in customers – but doing high ticket sizes (so higher chances of large delinquencies) or considerably bringing down their yield – hence profitability / return ratios.

Earnings Call Q2FY25

• In this environment the challenge isn’t the bounce rates going up, but the challenge has been once the customer slips to bring the customer back has become that much extra difficult. The
• The environment has become tighter and now in the current market environment usually what happens is that when unsecured lenders tighten the belts, the secured lenders do face some impact which naturally comes thereafter.
• The difficulty to bring the customer back once slip, once he goes to 60 DPD then he keeps being stable, but we find it difficult to bring him back to normalcy which was a little easier earlier
• Q: You also mentioned your cost of funding going up, which is fair, but incrementally are we able to really pass it on to customers because I think in the 1st Phase of the rate hike you are able to maintain your spreads very well. Do you see that incrementally while the cost is going up, it’s a challenge to pass it on.
  • Response: We have a category of customers which range anything between 5 lakhs to 30-odd lakhs, and towards the higher end of the ticket sizes and for the higher end is 15 lakhs and above, we tend to co-originate those loans, which effectively means that only 20% of those loans are with us and 80% is with the co-originating partner…. if you look at even our current quarter you would see co-origination as a percentage is at 17%-odd and the balance is on the SBFC book so you would see a positive impact there… largely the book is on a variable rate so our ability to pass on is extremely high on the book.
    • Concern: They are already yielding close to 18% on secured lending (property and gold). And they see further increase in rates due to the cost of funds going up – how sustainable is this? These are inching close to microfinance rates for secured lending.
    • This concern is further emphasised by management mentioning that it usually takes them 10-12 working days to finalise decision to lend whereas in unsecured the turnaround is quite rapid – within a few days
      • In fact, I will be very worried if someone wants me to say a yes or no in 24 hours. So, by default, probably my answer is going to be no. So, we really don’t want to lend up in a hurry and then take a long time collecting it. So, in secured, there are multiple things that go in before we decision it. While a financial decision is relatively easy provided he has all the documents together, but that seldom happens for an average 10 lakh customer. The second part that the time taking part is the property details, which is respect to legal or title. So, thereabout, we would take close to around 10 working days to 12 working days to finally decision and hand out the money to the customer. So, unlike unsecured, secured does go through a bit of detailing before we hand out the money to the customer.
      • So, for a customer who is given money at very high rates, why would they stick around if they can get a loan from a small finance bank rather quickly at almost similar interest rates or maybe even lower as the small finance bank’s cost of funds would be much lower.
  • Aseem Dhru mentions this challenge:
    • Maintaining margins is going to be a key challenge and as bank’s NIMs come under pressure, NBFC NIMs will also come under pressure. Our ability to manage is what will get tested.
    • That [passing rate increases to customers] is of course an option available, we have a variable portfolio. But we also have to be cognizant of the fact that we deal with customers who are vulnerable to EMI increases. So, we don’t want to do it as much as possible. We will do it if we have to. But as much as possible, we would rather find innovative ways to reduce our cost of fund.
    • We have diversified our holding away from banks, we have been continuously dropping our percentage borrowing from banks and we have gone to the NCD market which is giving us a better yield. We are now going to raise it from multilateral financial institutions shortly. So, we have to find ways to battle it.
• Q: Customer segment
  • Response: it’s not that there is a whole hoard of customers that have fallen in, it is just that the regular customers who used to bounce and pay, their ability to collect has declined to some extent, only within that cohort of customers. And when two EMIs pile up, it becomes a little difficult for the customer to pay 2 EMIs because, of course, see, the post-pandemic inflation has been quite substantial, and the incomes haven’t really kept pace. So, it’s very logical, and we are not dealing with the top-end of customers in the space, we are dealing with customers who are managing to keep their ends meet. So, there is a demand on their incomes, more than what their incomes are in line.
  • Also, small businesses have their own challenges. As India gets more organised, some of the small businesses find the competitive intensity quite a lot. And today, if you see corporate results, they show pain of growth. Now, obviously, that same growth is also affecting the small businesses. It’s just that they don’t come in newspapers, and there is no data readily available as to what impact they have.
  • So, nothing really dramatic. It is just that a slight slowdown in their income or a slight increase in their cost, they find it a little difficult to service, but these come back. These are cycles. They will be brought back. It will take some time, but they will all be brought back.
  • Since they do secured lending overall loss of money is quite low/insignificant, in secured assets, overall in the last three years, we have just written off around 10, 12 crores. So, it’s immaterial to that extent. In unsecured portfolio, we would have done some write-offs, but that’s a rundown portfolio, now only 55 crores is left. So, from an overall perspective, there has been hardly any write-offs.
• Q: On increasing leverage
  • Response: Liabilities are more than plenty. I don’t think there is any challenge of liabilities in the market. Also, if you see, while the MCLRs are going up and the cost of borrowing in the markets are going up, but we have been able to maintain our cost of borrowing. So, that also in a way says that since we have enough liquidity, our ability to negotiate and bargain a good price is there. So, I think there is no problem from a liquidity point of view.
  • your other question as to in terms of leverage, you are absolutely right. As we go along, the entire growth is going to be funded through debt till the time we achieve a respectable leverage. The reason you are seeing sometimes in a quarter-to-quarter basis is there is a profit which also kicks in, which adds to the net worth of the company. And that’s the reason the leverage sometimes may look optically similar. But all the growth is getting funded through debt.
  • We are sitting on a lot more cash than we need to, just to ensure that we have a good night’s sleep. So, we are sitting on excess liquidity. So, that also is a factor.
• Q: RBI declined HFC application
  • Policy level decision, nothing against SBFC finance. RBI doesn’t want a regulated entity under another regulated entity.
• Q: Several participants asked questions about business model / business fundamentals. Helpful to hear that to build understanding of the business.