Fedbank Financial Services Ltd. (Avoid)

Highlights

Fedbank Financial Services Limited (Fedfina) incorporated on 1995 which is promoted by the Federal Bank Limited is a retail focused non-banking finance company (NBFC) that caters MSMEs and the emerging self-employed individuals (ESEIs) sector. The company is the one among five private banks promoted NBFCs in India.

The company has a well-tailored suite of products targeted to match its customers’ needs, which includes mortgage loans such as housing loans; small ticket loan against property (LAP), and medium ticket LAP, unsecured business loans, and gold loans.

Fedfina has the second and third lowest cost of borrowing among the micro, small and medium enterprises (SSMEs), gold loan and MSME & gold loan peer set in India in Fiscal 2023 and three-months period ended June 30, 2023, respectively. As on March 31, 2023, the company had the third fastest AUM growth among NBFCs in the peer set in India with a three-year CAGR of 33 pct between FY20 and FY23, and the fourth fastest YoY AUM growth of 42 pct for three-months period ended June 30, 2023. Also, it had the third highest growth in disbursement among the peer set with a three-year CAGR of 35 pct between FY20-23.

As of June 30, 2023, they have covered 190 districts in 17 states and union territories in India through 584 branches. Their branches are located in states, such as Andhra Pradesh (including Telangana) and Rajasthan, which have better asset quality than other states as of FY23.

Fedfina have been rated “AA” by CARE for their non-convertible debentures (NCDs) since 2022, and “AA-”– by India Ratings and Research Private Limited for their NCDs and bank loans since 2018.

Out of the total proceeds of Rs. 10,992 mn, Rs. 6,000 mn would be utilised to increase Company’s Tier – I capital base to meet future capital requirements which are expected to arise out of growth of our business and assets, and to ensure compliance with the NBFC Scale Based Regulations. And Remaining amount would go towards existing selling shareholders. Federal Bank will continue to own more than 51 pct of its outstanding share capital post the completion of the Offer.

Key Highlights

• Housing finance and gold loans cover 46 pct and 12 pct of the retail loans industry, respectively, in India in FY23. As of March 2023, CRISIL MI&A estimates the outstanding value of loans given out by organised financiers’ – banks and nonbanking financial companies – to be Rs. 6.1 trillion, with non-banking financial companies accounting for one-quarter of the market. According to the CRISIL, the ESEI and MSME segment is largely unaddressed by lending institutions in India. Fedfina believes that this segment provides them with a sizeable opportunity to rapidly grow and expand further.
• As on June 30, 2023, 86.24 pct of its total Loan Assets are secured against tangible assets, namely its customer’s gold or property. Their average ticket size was Rs 0.13 mn in the June 30, 2023. About 16 per cent of the overall Rs 93,000 mn loan book is unsecured business loans, and management said that the RBI’s revised norms on risk weights will impact the company as borrowing costs may go up, but the impact will be short term.
• Fedfina focuses on the underserved category of the Indian retail loan market, as they follow prudent customer selection policies with 86.71 pct of its customers having an established credit history, and 77.94 pct of their credit rated borrowers rated with a CIBIL score greater than 650 or CMR score less than or equal to 6 as on June 30, 2023.
• The average cost of borrowing of the company was 2.22 pct, 1.86 pct, 7.77 pct, 7.44 pct and 8.30 pct for the three-months periods ended June 30, 2023, and June 30, 2022, and FY23, FY22 and FY21, respectively. They have the ability to access borrowings at a competitive cost due to its stable credit history, credit ratings, conservative risk management policies and strong brand equity.
• The Comprehensive digitization and automation of their processes enables them to offer quick turnaround in processing complemented by digital marketing as well as data validation through API integration for, among other things, KYC function, doorstep gold loan offering, and e-disbursals. Fedfina has disbursed door-step loans aggregating to Rs.1,255 mn and Rs. 3,450 mn in the three-months period ended June 30, 2023 and FY23, constituting 5.46 pct and 4.64 pct of their total disbursals for gold loans.
• The company AUM grew from Rs. 48,624 mn to Rs.90,696 mn as of March 31, 2021 and 2023, respectively, registering a CAGR of 36.57 pct, and increased to Rs.94,342 mn as at June 30, 2023. While GNPA of the company declines to 1.65 pct in Q1FY24 against GNPA of 6.66 in Q1FY23. Also, NNPA of the company increased to 1.76 in Q1FY24 pct from1.56 pct in Q1FY23.

Key Risk

• The Company has a huge concentration of loans to ESEI and MSME, and as of June 30, 2023, ESEI and MSME comprise 45.22 pct and 64.75 pct of its total loan profiles, respectively. The risk of non-payment or default by its borrowers may adversely affect their business, results of operations and financial condition.
• Fedfina is subject to periodic inspection by the Reserve Bank of India. In the past, the RBI has imposed penalties for certain non-compliances with its observations. Non-compliance with the observations of the Reserve Bank of India could adversely affect their business, financial condition, results of operations and cash flows.

Valuation

Fedbank Financial Services is a growing NBFC with a significant presence in a vast and underserved market. Fedfina has shown robust growth in their AUM over the last few years of over 35 pct YoY annual growth of AUM. However, its business operations are concentrated in a limited number of states, and its loan portfolio is heavily weighted towards the ESFI and MSME sectors. At the upper price band company is valued at P/BV of 2.6x based on Q1FY24 book value.

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