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Carving out niche in underserved business segment; superior return economics

We organised an investor interaction with the senior management of Five Star Business Finance (Five Star) including Mr. D. Lakshmipathy (chairman & MD), Mr. K. Rangarajan (CEO) and Mr. G. Srikanth (CFO) to discuss the company’s evolution, business dynamics and strategy. Five Star equity instruments are unlisted and not traded on any exchange.

The report has been prepared based on interaction with the senior management and information received/verified from/by the company. Founded in 1984, Five Star is an NBFC with AUM of Rs45bn catering to a business community of 177k customers with an average outstanding ticket size of Rs250k.

It has created a niche in lending to ‘underserved’ business owners and self-employed segment in tiers 3-6 cities, thereby commanding IRRs of ~24% and spreads of ~12%. The execution excellence helps it manage opex/AUM at 6-7% and contain credit cost, thereby generating RoAUM of 8-9% and RoE of 16-18%. The scale-up all through past couple of decades was led purely by customer addition (not increased average ticket size).

* Carving out niche in lending to small businesses:

Company has created its niche in lending to small business owners and self-employed individuals engaged in everyday cash and carry businesses with bias towards services. Businesses to whom lending is targeted are usually businesses with cyclical experience, running successfully for few years and profitable too, but are outside the credit map. These customers have the potential to bounce back much easier and faster from disruption. Also, the loan is given in the name of several members of the family to ensure family’s collective loan decisioning.

The family cashflows generally range between Rs25k-40k per month and typical collateral value is Rs1mn (no vacant land or commercial property). The end use of the loans provided (of ticket size of Rs0.1mn-1.0mn) is primarily for business purposes, but there might be some asset creation as well (home renovation / improvement and other mortgage purposes). Management is of the view that the manufacturing sector is susceptible to economic cycles, hence it doesn’t encourage lending to business owners in manufacturingrelated segments.

* Fully backed by hard collateral with right sizing of loan amount:

100% of Five Star’s lending portfolio is backed by hard collateral, of which ~95% is self-occupied residential property (SORP). Loans are right sized within its internal parameters of LTV and IIR of about 50%. The customers are largely sensitive to speed of response, amount of the EMIs and not as much on the rate of interest. Hence the loans are structured with relatively longer tenures (maximum seven years and minimum two years) to reduce the EMI burden (average behavioural tenure is of about 5 years).

* Differentiates with respect to customer, geography and product profile:

Customers whom the company caters to might not be entirely new to credit (as they may have MFI, gold or 2W loans), but for over 75% of its customers, Five Star would be the only institutional business financier for a loan amount of this size. It therefore commands high pricing power with IRRs of ~24%. In fact, over the years, as it expanded, got the benefit of scale and thereby lower cost of borrowing, it passed on the benefit to its customers and reduced its lending rates from 30% to 24%. Also, 100% of sourcing is in-housed through 2k relationship managers (RMs). Company is primarily focused on the underserved segment in tiers 3-6 cities predominantly in southern India.

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