SBFC Finance Limited analyst Q&A

Thank you. We will now begin the question-and-answer session. The first question is from the line of Kunal Shah from City Group. Please go ahead.

First is with respect to the overall OPEX and the employees, so there have been almost like 220 odd additions to the employee during the quarter, sir, if you can just highlight in terms of maybe what verticals these are being added, there is almost like 6 odd branches additions and similarly maybe with respect to the overall cost, we had seen an improvement, but how do we expect the overall cost to assets to settle there?

We have continuously been investing in infrastructure, so what you are saying is right, the number of branch has been continuously going up at a slow and steady pace. So, we added about 6 branches in this quarter. So, the investment in terms of people is happening throughout in terms of new branches, but as well as increasing more resources in the branches where we are able to do well, so it is all across. We are originating a long tenure loan and so by that meaning the operating leverages will keep on improving. We further expect that from here on the OPEX should further come down while the investment in the branches is continuing.

Sir, in terms of the addition to employees, maybe the branch oriented would be a significant part of it or these are in other verticals as well?

No, significant will always be branch.

So, Kunal, I think if you look at the total structure every quarter we have been adding close to around 6-7 odd branches, so if you probably cumulatively look at the number, you will have close to around 14 -15 branches in the last 2 quarters and roughly we have 14 -15 people in a particular branch including gold and ME so that largely sums up the overall headcount, which is there, but that is largely the customer facing roles that we actually invest in. In addition, we are also beefing up the collections infrastructure where the number of employees that have come through has come through in the last quarter. So, that largely sums up the 200 plus number that you see in the data come through in the last quarter.

And secondly, any plans on housing now, are we re-evaluating the structure, how are we looking at it, maybe obviously from the regulatory side, it was quite clear, but any revaluation on that front?

So, housing is we are seeking the regulators no d to get the license. If that comes about, we do housing. Within the NBFC where it has been a little bit of a stretch to start housing loan because the unit economics have to add up , s o we are waiting for a subsidiary nod to get into that business. As and when that happens it is fine. Until then, we stay focused on what we are doing right now.

Thank you. The next question is from the line of Shubranshu Mishra from Phillip Capital. Please go ahead.

Two or three questions, the first one is on the co-origination, what is the unit economics here in terms of cost of funds sharing, OPEX sharing and credit cost sharing and where do we think we will end up in terms of percentage of AUM in the next 2-3 years? Second is on the ALM, given the fact that we lend long, would we want to match the ALM and borrow long, which will have a detrimental impact on our spreads as and how we borrow long, so that is the second? Third is on the PCR at Stage-3, so in India the PCR or Stage-3 is closer to the LGD given the fact that we have largely secured assets, this seems a high LGD if my interpretation is correct? These are my three questions?

So, let me take the broad construct on the co-origination piece. I think what we have been guiding also is that we are very comfortable for our co-origination to be at almost 18% to 20% odd and that is the range that we have been at. This is largely at a disbursal level , so, obviously at an AUM level comes with a lag. So, if you look at our current number, you would probably see our disbursals also in the range of 20% odd, a couple of percent here or there. Also, as Aseem in his opening remarks mentioned that now as a percentage of the overal l AUM, the reliance on co - origination is now almost close to 18%, which is up from 11% from last year. Moving forward, we expect the current trajectory and the momentum to continue , we feel with a higher base we will be able to continue to build at 18% to 20% of our disbursal and as a result, our AUMs will also move in that particular direction. I think co-origination is an excellent tool. It is a great ROE enhancer, extremely profitable and obviously from a liability construct perspective, it helps us on our overall AUM bit up as well. We don ’t call out the exact unit economics on the co- origination bit. That is something between us and the co-originating partner, but we will just like to leave you with saying that it is a great ROE enhancer for us and hence i t is at 20% of our overall current AUM and disbursal as well. Narayan, you might want to pick it up on ALM.

In terms of ALM, on the asset side, first the secured MSME obviously is a long tenure asset, but at the same time gold which is a 15% of AUM is a short tenure asset. So, in a way the weighted average on the asset side comes to roughly about 4.5 years, but on the liability side, you are right, liability in the market is not available for so long. So, what we do is number one, we don’t borrow any short term, that is one what we do. We try and maximize the tenure on the liability. At the same time coupled with the liquidity we keep; I think we don’t have any ALM mismatch on any bucket from ALM point of view.

On PCR, we have been constantly increasing the PCR. We were at 39% last year. We are at 45% now. You are right that the LGD on these assets would not be more than 20%-25% adjusting for time value, but we create war chest for our cycle to turn and credit cycles do turn, and therefore we create double of what regulatory requirement is and we continue to strengthen our provision coverage ratio. During the quarter as well, we have created additional provisions to the tune of 1.5%, taking the overall PCR up to 45%.

Just to slip in one last question, this increased PCR, is it a posturing for the credit rating agencies for a better rating?

And just to clarify, it is nothing from a rating perspective.

Thank you. The next question is from the line of Renish Bhuva from ICICI Securities. Please go ahead, sir.

Sir, just two questions from my side. One on the asset quality, so when we look at the gross NPA ratio, of course, it is range bound, but on sequential basis it went up by 4 -5 basis point, despite the high denominator wherein we saw the AUM growth growing by 9 %, so which essentially reflects that the forward flows are still high. So, could you please throw some light on what is happening at the underlying ground situation?

So, as you rightly said, the GNPA numbers is range bound and that is based on our model where we expect that to be around 2 .5%. The portfolio if you look at in last 3 years, we have seen a growth post COVID and there is a portfolio maturity curve also which is hitting. From a model standpoint, we expect the numbers to be stable and range bound, and we don’t expect any impact on the credit cost side. So, credit costs, we expect to be stable around 80 to 90 basis points.

And secondly, on the secured MSME disburse ment side, so when we look at the ticket si ze, it went up pretty sharply on sequential basis and similarly the volume sort of has moderated plus when we look at, let us say the AUM vintage wise on the branch between 12 months to 36 months, again, there is a sharp fall from 43 to 31, so I mean what is happening at those branches? I mean ideally the branches with more than 12 months of vintage , AUM should keep on increasing, why there is a sharp fall on sequential basis?

So, I will take the first one. So, largely on the co-origination bit that probably explains why the ticket size went up. So, the ticket size went up to almost 9.67 lakhs and this was at almost 9.38 lakhs, but it is still lower than probably what was recorded last year in the similar quarter of above 10 lakhs. Last quarter, it is consciously by design that we had moved our reliance on co- origination slightly higher, which explains that on an average basis, what we maintained is our average is going to be between 9 and 11 odd lakhs, so by and large it should hold up. So, that explains the disbursal and why the average ticket size has marginally been higher. With respect to the average AUM per branch, if I were to give you some comparisons with related to the branches which are matured and which are more than 36 months - there were 11 branches which moved up, which were more th an 3 years where the average is now hitting almost Rs. 50 odd crores. There were a significant number of branches for the full year, there were close to around 31 branches which got added where the averages being between Rs. 8 and Rs. 9 odd crores; and the 12-to-36-month branches significant or high number of branches moved up into the more than 36 months bucket and that is where you see a significant bump up coming up there. So, if you look at the overall trend, even if you probably look towards the end of the year trend for the last year, you will see the 12-to-36-month bucket is moving towards or close to around Rs. 29 to Rs. 30 o dd crores and that is what we have been talking about. And as the branches are maturing more than 3 odd years , you are now beginning to see it now hitting out Rs. 50 odd crores. If you were to even do a peer group analysis and probably look at it , for more than 3 years, you would see similar ticket sizes in the range of close to around Rs. 30 to Rs. 40 odd crores, so at least that bucket is doing significantly better. Even if you were to look at 12 to 36 odd months, you would see industry moving anything between 18 and 22. So, we would probably be there, but during the year as you start seeing these ages, you would probably see them gradually going up, but these are range bound and will continue to be range bound. As per our internal threshold that we maintain, we feel that in 3 years your branches on average should be Rs. 30 odd crores. That is the internal benchmark that we hit and as long as we are hitting that, we are largely comfortable.

Thank you. The next question is from the line of Nis chint Chawathe from Kotak Institutional Equities. Please go ahead.

This is actually on the math on co-originated income, and I think in one of your slides you have shown the bump up in the yield this quarter because of co-origination income being recognized out there. I think the number works out to around something like Rs. 6-Rs. 6.5 crores and that is approximately around 2.8% to 3% of loans outside balance sheet. So, is that a fair run rate to assume?

Yes, Nischint, you are right. The amount is closer to Rs. 6.3 crores that has been reclassified from fee income relating to co-origination to an interest income that is given a 0.45 basis uptick during the quarter and that is what you see in the bump up from 17.17 % to. 17.62%. And the yields quarter-on-quarter across the quarters have been stable at 17.2%. There are two adjustments during the year that have happened, one in quarter two that we did not book interest on NP A that was one adjustment. The second adjustment is on th is co -origination interest income. Net of both of these, we continue to have yields in the range of 17.2%, which is sustainable for the foreseeable future.

And just very simply, if I look at loans outside balance sheet that you put, basically you have minus loan book on balance sheet and I try to kind of look at 80% of the co -originated AUMs, it doesn’t fully tie up, I mean there is a small difference?

No, it cannot be. We can take it offline and take you t hrough the numbers. These will exactly tie-up. This is the EIS, the Rs. 6.3 crores which Sanket mentioned and you also mentioning is excess interest spread on the off book as what you mentioned is absolutely the same.

The other thing is on the asset quality, if you see gross stage two loans have increased in the last two quarters and the ratio has also gone up on a year-on-year basis. So, how should we think of it? We know that FY23 was obviously an exceptionally good year because we came out of COVID and is this going to be like a new norm or is it something which has kind of bumped up in last two quarters and we are trying to reduce it?

So, overall, if you look at Stage-2 assets, Quarter 4 was 3.55%, which is 4.37%. Within this, if you look at MSME that is around 3% range earlier and this is around 3.2% range now. So, we expect this number to be range bound. There was a slight increase we have seen in gold in terms of Stage-2, but that also is based on the asset f rom a positioning stand, but earlier the Stage-2 and Stage-1 contribution used to be 90% plus current. The numbers remain the same. So, we expect the numbers to be stable from here on. So, on Stage-2, if you look at MSME remains stable.

And gold when was the last time you did auctions?

We do quarterly as an exercise, so based on the aging, when customer hits 90 plus as the process, the auction process gets conducted.

So, basically the bump up in GS2 is basically gold, that is what am I reading it?

Yes.

And anything on the outlook on the MSME business, given the fact that this year you have kind of exceeded your guidance, how do you see the economy going forward , we are sort of just getting into an election, so some of your peers have kind of given a little bit of a caution. So, just wanted to get your sense, how comfortable are we to kind of have the current run rate?

Nischint, we are just coming out of a Goldilocks scenario for lending that was there last year and this year the headwinds are clear . Now, how we navigate is a different story, but the headwinds are clear that here the regulator is basically guiding the industry for a lower growth. I mean it is all but telling the banks that it would want them to soften down and improve the CD ratios over time. So, one is that the regulator has been guiding a lower growth and eventually the industry always moves to what is regulatory guidance. So, we will see a slowdown of loan across the system next year in my opinion. The second is that NIMs would be consistently under pressure as the scramble for liabilities will continue. The stock market continues to be buoyant, then the banks will continue to struggle for deposits and then the price of the deposits will move up. The US Fed has crossed 5% and when US Fed crossed 5% and the dollar is also getting stronger, Yen has moved towards toward its historical weakness and we are seeing that the Indian rupee, I mean you saw Indonesia also trying to defend its currency. So, if the RBI will still have its act to ensure that the currency remains under control and with that there is no chance in my opinion of an interest rate decrease happening in the US as well, forget what would happen in India. So, the likely scenario is that the repo rate will continue where it is for the year. Bank MCLRs will continue to leak into our cost of funds and NIMs will be a challenge that all of us will have to address. And we are coming out of an extremely low credit cost as an industry and from this kind of low, chances of it going lower are ruled out. Chances of it inching up a little are more likely, so I would say 3 clear headwinds for the industry and for us as well protecting NIMs, ensuring growth and ensuring the credit cost is under control.

Just one last point here is one of the large private sector banks has significantly raised lending rates in business loans and does that mean that it gives you tremendous pricing power to kind of maintain your margins as well?

So, we are a very small company and generally the GDP, the economy doesn’t affect us. We are solving a very small problem for a specific set of customers which are the small customers , we are solving for excess. We are not solving for speed, etc., or competitive pressure because most of the customers we lend to are first-time commercial borrowers in a sense. They have a CIBIL score which has come out of small assets loan they have taken. So, these set of customers are not so price sensitive, and you are able to price what is reasonable and we also want to ensure that the IRR of the business should be sufficient to price it, because the minute you price it beyond what the IRR of the business is, you are inviting trouble eventually. So, we have to be cautious and it is not that we have unlimited pricing ability , but we have to be cautious , but wherever we see that there is an opportunity to price something which is within range we would go for it. If you see our results last year, we have increased our yields across the year and we have to see how the year pans out and how do we navigate the year, how do we ensure that the right jaw between the yields and cost of funds is maintained, and it doesn ’t clench down. So, that is going to be the challenge which we think we will handle as the year goes by.

Thank you. The next question is from the line of Laxmi from Tunga Investment. Please go ahead.

This is Laxmi Narayanan here. Couple of questions. First, I just want to understand what kind of loan rejection ratio you have. I just want to understand your funnel, how many people apply for and how many goes through the check and then finally, how many people end up getting the loans disbursed?

So, on the approval rate, typically we look at the credit login, typically 50% is the approval ratio. What comes to the credit from a login standpoint, 50% goes through.

And second, in terms of the MSME, so can you just give us some little details on how the various sectors in MSME? What kind of break up you actually have, either in terms of the size of the business or in terms of the industry they operate in?

So, these are largely consumption related businesses, these are the mom & pop stores and obviously when your ticket sizes are between Rs. 9 and Rs. 11 odd lakhs, so these are largely non-manufacturing. So, if you look at our target customers, these would largely be classified as Micro Enterprises, but most of them would be typically under the service enterprises. These would be your retailers across segments. These could be converters. These could be salons. Any establishment that you can probably find in your neighborhood would be a different customer.

And what kind of balance transfer out happens in your customer segment and you mentioned that most of them are maybe first time formal borrowers and who you actually lose your assets to in general, if you look at in the last 3 years or 2 years, where actually it goes and what are your plans to arrest it?

So, if you look at the entire secured segment, which is largely by property, almost 80%-85% of our customers are borrowers for the first time against their commercial or residential property. So, they would have a typical credit score, but they would be borrowing against their property for the first time, so almost 85% of our customers who we disburse are of that category. So, we don’t take over those set of customers. We would tend to take over some of the customers, which would be in the ra nge of between 10 % and 15% odd. That is on the incoming customers. In terms of outgoing what we typically say is that while our door-to-door tenure of loans would range from anything between 7, 12 and 15 years, but behaviorally, these customers are with us for largely 5 years and as these customers are credit tested their scores obviously move up with the right kind of repayments. Ultimately , they would migrate, and they would migrate into the private banks or some of the public sector banks who can offer them significantly lower rates. So, we have seen an entire spectrum, so not any particular bank per se, but you would have the different banks in the different geography who would probably want these customers over a period of time.

And you have a clear exit thing for your customers, right , so they have to pay their penalty on the total disbursement amount or something like that?

Not all. So, it is a part of the agreement that, wherever it is applicable, they would pay, but we have not put in a minimum clause that they have to be with us for 3 years. It is not a part of agreement. So, you can’t technically do that.

And then one last question, once you disburse the loan, how do you, is this a typical practice I see that till the loan is dis bursed, most of the finance institutions d ue diligence and post that as long as the mon ey comes, they leave the pedal, they just don’t do it. So, do you do something differently where you actually after the loan get disbursed, you keep corroborating the GST or you do subsequent analysis whether the particular borrower is doing better , the cash flow is improving or some process you have in place, so how do you do that?

So, unlike banks, who operate overdraft account or cash credit account which are largely operative accounts where you probably can look at the end-use even post disbursals, unfortunately for NB FC, we don ’t have operative accounts, but what we typically do is something which is called hindsighting where we look at all customers who have been disbursed as to how the pattern has been . Second is obviously we keep evaluating the valuation of the property and do some kind of checks, but on a transactional basis that obviously doesn’t happen. Most of our customers aren ’t really the GST range customers , if you are considering the total borrowing that they do is Rs. 9 to Rs. 10 lakhs. So, they are largely out of that, and it is very unlikely that those kind of variables and the transaction monitorable are going to be there.

Just to add, as part of portfolio management exercise we also do bureau scrub and trend analysis that also tells us how the portfolio is behaving and if there is any area where we have to look into that gets actioned.

Thank you. The next question is from the line of La xmi Narayanan from Tunga investment. Please go ahead.

So, there has been a sounding by is the regulator saying that the microfinance institutions have to bring their interest rates slightly down right , now, how does that impact a player like you, whether how positively it would impact or negatively it would impact?

Ultimately, what the regulator seeks is that there is a fair practice code that you put with customers in all its true spirit. So, it would want that you are lending at a rate which is not usurious, it would want that you are transparent to the customer and there are no hidden charges, or nothing not disclosed to the customer. It has to be fair to both parties. So, at the moment what we are doing is that we are pricing it for risk and if you look at our lending category and look at our peers we are not at the higher end of the lending. There are several p eers of ours who are lending at a much higher rate to a similar set of customers. We are lending where we believe is a fair rate to both of us. And I don’t think that any move being planned there is going to have any impact for now as what we understand.

And if you look at risk going forward in the next 3 to 5 years, what are the key risks you actually foresee for you as well as the industry, I think for the industry you talked about NIM compression and also little lower asset growth, but for you per se, what do you look at as risk and what kind of efforts you are making to counter them?

If I tell you the risks, ho w much time do you have? I can go until afternoon. So, the reality is that in the lending business everything affects you because lending is a derived demand. It is not a principal demand. Nobody needs a loan for the sake of it. People need things and therefore they take a loan for it. So, eventually, it depends on which end of the spectrum you are. We are not on the consumer end of the spectrum. In the consumer end of the spectrum, the worry would be whether the money is going into creating assets or money going into consumption which could not be a good growth of loan to have. We are in the business loan segment where we are lending to small bu sinesses who are not leveraged, i t is the first time borrowing that they are doing against property. So, to that extent we are doing what is very traditional finance and ultimately the risks comes more from our own operating efficiencies. The risk comes more from our own credit judgment because ultimately the borrower is not some body who has been wonderful tax audited statutory reports and none of our borrowers file GST, they are way below that threshold. So, the ability to really understand the customers and shift out data points which give you the confidence to lend is data -driven with a fair amount of judgment also in it and whenever you are doing even a little element of judgment, the risk of the lending goes up which is justified with the higher interest rate that we charge , then it makes RAROC efficiency. So really the risks to us, one comes from the environment which is what I mentioned earlier , the second risk comes from our own foolishness and mistakes and the third in misreading the environment or taking steps like too fast er growth, for example, now we have to take a growth rate that we are comfortable with in terms of managing the outcomes and we have to keep watching our portfolio for what signals it is giving us. So, still at the end of the day just a 6.5- year-old company and we have to be careful. We have to watch many cycles to be able to be confident that yes, now we have we have got it well. So, we are still figuring ourselves out, we are learning, we are making mistakes, we are correcting and hopefully we are improving.

And in terms of the gold portfolio and the MSME portfolio, what is the yield you get on gold?

So, in terms of the yields, we are now closer to 18% odd and in terms of the MSME, we are in the range of 16.75% to 17% odd.

And from a top up loan point of view, what kind of retention you have on the gold loan in terms of the repeat gold loan because as you said it is a short -term loan, so that is one in terms of retention? And second in terms of the top up loans , what percentage of your borrower’s did MSME avail top up loans and what is your criteria to do that?

So, typically what we do is that we wait for at least a year before we consider him for a top up. And obviously the top up has a lot of considerations to be looked at, whether his income has moved in line with his requirement, because that is where your FOIR is linked with and whether there is sufficient margin available on this property si de for us to give him that particular loan. So, as I mentioned earlier that our overall top up doesn’t exceed more than close to around 15% odd. So, that is largely range bound in that particular case. With respect to the gold, it is a short tenure product, it is between 3 and 6 odd months that we on board. We on-board close to around 3000-3500 customs every month . A lot of these customers, typically even after they close the loan, end up coming back after a few months and typically we see some bit of repeat customers come in. They would be roughly close to around 30 % to 35% would be repeat customers that would eventually come back to you.

Thank you. As that was the last question for today, on behalf of ICICI Securities that concludes this conference. Thank you for joining us and you may now disconnect your lines. Thank you.