Rating Rationale

Strengths
* Experienced management team
Top management comprises experienced professionals with proven expertise in the wholesale and retail financing. The company has also hired senior professionals to drive the vehicle, housing and small and medium enterprises (SME) finance verticals that will help to scale up business while maintaining underwriting standards. Furthermore, the company benefits from the high level of involvement of the key institutional investors and their expertise in areas of policy formulation, risk management, credit approvals, and regulatory compliance. The management and key institutional investors share a common vision and philosophy for IndoStar, supported by the relatively long horizon of investing entities. This will enable IndoStar to further grow its business in line with its stated strategy, and with continuing adherence to the overall risk philosophy.

* Strong capitalisation to support expansion in book including retail portfolio
Networth grew (Rs 2,893 crore as on June 30, 2018) post the initial public offer in May 2018 wherein it mobilized Rs 700 crore of fresh capital. Overall capital adequacy ratio (CAR) was comfortable at 32% with Tier 1 CAR of 31.7% as on June 30, 2018. Healthy capital position will support expansion in loans book (Rs 7,341 crore as on June 30, 2018) on both retail and wholesale segments over the medium term.

Gearing would increase to 4-5 times over the medium term with expansion in the retail financing segment. Moreover, capital position is supported by flexibility to raise additional capital from markets.

* Healthy earnings profile
Return on assets (RoA) averaged around 4% levels and was 3.5% (fiscal 2018) exceeds the industry average. This is supported by healthy spreads, fee income and steady improvement in funding profile. Over the years, funding mix has diversified with proportion of bank borrowing declining 38% as of June 2018 from 52% in fiscal 2016. The company has been profitable almost since inception. It earns healthy spreads and fee income on its loan portfolio, especially on its real estate loans that supports the earnings.

Expansion in retail segment will diversify the income, though it will result in normalization of RoA from current levels. This will be due to lower spreads and higher operating expenses compared to wholesale financing. Meanwhile, any sharp deterioration in asset quality could, escalate credit costs and impact profitability.

* Conservative liquidity policy
The company maintains minimum 15% of networth in the form of liquid investments such as fixed deposits and liquid funds, including undrawn bank lines. It does not run an asset-liability mismatch, and the favourable trend of repayments and prepayments provides cushion to the overall asset-liability management position. The company also has ability to securitise loans and therefore, efficiently withstand any liquidity pressure.

Weaknesses
* Asset quality susceptible to concentration risks; retail lending to bring granularity over medium term
Asset quality will remain vulnerable to concentration risks inherent in the wholesale lending business, despite strong credit appraisal and risk management processes in place. As on March 31, 2018, the five largest loans constituted nearly 21% of the portfolio. Furthermore, around 40% of the portfolio comprises real estate loans, a segment that is vulnerable to cyclical downturns.

IndoStar follows strong credit appraisal and risk management practices, especially in the real estate segment. The company targets borrowers with a long track record of timely repayment. All corporate loans have a minimum security cover of 1.5 times, with real estate loans having a minimum security cover of 2.5 times. The company mainly caters to reputed developers in the residential market. All project cash flow is escrowed and the loan is structured in a manner that enables mandatory prepayments, resulting in early repayment of loans. The company also sells down some part of the real estate loans originated. It has had only three non-performing assets (NPAs) on the corporate book (gross NPAs of 1.2% as on June 30, 2018), of which two accounts are fully recovered.

While Indostar, primarily remains wholesale financier, the proportion of non-corporate loans (SME, retail finance) increased to 28% (as on June 30, 2018). The proportion of SME, retail loans may increase further over the medium term and bring some granularity in the portfolio. However, inherent nature of the loan portfolio renders IndoStar vulnerable to economic stress. Any sharp deterioration in asset quality may also affect profitability and capital.

* Expansion in new business segments
While the company has a reasonable track record of operations on wholesale financing front, it has started SME finance from fiscal 2015 and retail finance from fiscal 2018. The company has hired senior professionals from industry and set up adequate infrastructure to manage the retail lending business. The Company has marked its presence in more than 13 states and opened more than 130 branches. However, given the nascent stage of retail lending operations, the performance of portfolio needs to be seen through economic cycles.