It's equity raising time for NBFCs, but capital boom may not lift all boats

Gunit Chadha, the founder-managing director of APAC Financial Services, takes pride in the fact that his firm secured funding from Multiples Alternate Asset Management in December last year, three months after the shadow banking crisis had blown up. “It tells you that a good business model backed by strong risk management will continue to attract funding. There is significant private equity (PE) interest in funding differentiated non-banking financial companies (NBFCs) today,” he said.

But will it ever be like the boom you saw between FY15 and HIFY18 when PEs had pumped in $2.36 billion into NBFCs?

“Over the last few weeks, we have had conversations with numerous NBFCs. Several of them are contemplating to shore up their equity capital,” said Rajeev Suneja, partner at Deloitte India. He, like many others in the industry, will not put a number as to how much by way of PE money is in the pipeline for NBFCs to tap into, but would like to believe that Advent International’s move last week to infuse Rs 1,000 crore into Aditya Birla Capital is the lung-opener for the business. This level of optimism though appears tough to buy into. 

Tucked away in the Reserve Bank of India’s (RBI) Report on the Trend and Progress of Banking India (2018-19) is this nugget.

The number of NBFCs whose certificates of registration was cancelled by the RBI quadrupled to 900 in FY19 – both over FY18, and the preceding two financial years. It was also more than triple the registrations during this period. As they could not meet a piffling minimum net worth of Rs 20 million. Now, one way to look at it is – it’s about the small fry who anyway did not want to be on the RBI’s radar. Another is to view it as a subset of the thinking within the RBI on NBFCs. How the larger financial world looks at them.

While the central bank has spoken on the need for India Inc to have skin in the game (promoters having enough equity), somehow corner-room ears in NBFCs never gave this serious enough thought. The blowout at the Infrastructure Leasing & Financial Services (IL&FS), the unravelling at Dewan Housing Finance, and the tightening of asset-liability management norms has woken up everybody. And despite RBI’s move to hike banks’ single counter-party exposure to an NBFC to 20 per cent of their tier-capital (from 15 per cent), or the partial-guarantee scheme to purchase highly rated pooled assets from them, the truth is the needle has hardly moved.

Says Girish Nadkarni, Partner & Co-Head (PE) at Investcorp India: “Valuations are down by 40 per cent in some cases. The rating of NBFCs will be critical. It is good if it is ‘AA’; even ‘BBB minus’ in some cases. It depends on the business models NBFCs have”.

Suneja has not “seen a fall in valuations in the deals that have been consummated of late”. And points at Five Star Business Finance which raised $50 million in July this year led by TPG Capital valuing the Chennai-based NBFC at $950 million. Backed by Matrix Partners, Five Star raised equity from Morgan Stanley, Sequoia Capital, and Norwest Venture Partners. TPG Capital had also led a $100-million funding for the company just before IL&FS blew up – but not many will be in the league of Five Star which has had it good for two years running. That said, Suneja agrees “the number of deals in which PEs or VCs will show interest from hereon may be lower”.

Raising equity is more about when now; not why do so. For the only other development which can change the game completely for NBFC is if  the central bank were to make a fundamental shift in its worldview, at least on the big boys. Keki Mistry, vice-chairman and CEO of Housing Development Finance Corporation notes: “I would like to mention that for a longer-term outlook, there is a need to examine a road map for the merger of NBFCs into banks with appropriate guidelines to grandfather the balance sheet and relaxation in the maintenance of the cash reserve ratio, statutory liquidity ratio and priority sector lending requirements”. And that may be asking for the moon as on date.

Who gets to be on the podium?

“The governance premium has dramatically gone up; equally business models of NBFCs will come under sharp focus. This is good, not bad” says Chadha; who adds “And I am clear that there can’t be two ways when it comes to governance -- you have to be and can be in control of it even though this may not always hold true for the business model which is subject to more externalities”.

And on Monday, India Ratings cut its outlook on NBFCs to negative from stable; and also the growth forecast for FY20 to 10-12 per cent from 15 per cent due to funding challenges, slowdown in auto sales, rural infrastructure activity, and the stress in small and medium enterprises. It says there will be a fall in margins and an inability to pass on the funding cost to retail borrowers due to the subdued demand.

If all this was not bad enough, the jury is still out if the two sets of players which were not as matured when the last rounds of PE funding happened will change the playbook – online lending NBFCs and small finance banks (SFBs).

“The scalability of pure-play on-line lending platforms will hold the key to attract PE interest. If they are merely using up capital without a viable business model which can bring the customer acquisition cost curve down with scale, it will not work. Many NBFCs are also investing in their digital platforms”, points out Nadkarni.

Sanjeev Krishnan, Leader (PE and Deals) at PwC is of the view that the exuberance over SFBs may have been a bit overstated; and it is unlikely that the entry of freshly minted SFBs down the line will greatly alter the narrative. 

Eyes are also on the new kids on the block led by bankers like Chadha, Jaspal Singh Bindra (Centrum Capital) and Bhupinder Singh (InCred Capital); and NBFC veterans — Vimal Bhandari (Arka Capital, backed by Atul Kirloskar); Shachindra Nath of UGRO Capital (it has raised Rs 58 crore from PEs and is said to be in the hunt for still more) make their moves. Given that they helm new-age NBFCs which raised funds in the recent past, their steps ahead will give a cue as to how they read the tea leaves. And given digital-play, it will also be interesting to see if technology funds will hop in; or even a Massachusetts Institute of Technology which has invested in H P Singh’s Satin Creditcare (it is also to apply for an SFB license).

“What I can say is that governance will be up there; some NBFCs with a good sales network can also aspire to secure PE funding,” says Krishnan. 

On governance, Chadha points to the fact APAC has Varsha Purandare (former chief credit and risk officer at State Bank of India) as an independent member on its credit committee; and that “all decisions have to be unanimous or the product programme or credit proposal gets declined, with no court of appeal.” Not many NBFCs will stand scrutiny to the high standards which Chadha lays claims to, but what you can’t get away from is there is no court of appeal left for them either.