Rating Rationale

Key Rating Drivers & Detailed Description

Strengths:

Market leadership in overall NBFC ecosystem

Post the consummation of the merger, SFL is now the largest NBFC in India and the fourth largest non-bank financier (including HFCs) with AUM of Rs 177,912 crore (including SHFL) as on September 30, 2022. The AUM continues to be predominantly vehicle finance based given the size of erstwhile STFCL; however, diversification in the book has increased consisting primarily of commercial vehicle (58%), passenger vehicle (16%), MSME (10%), and others. Pre-merger, STFCL and SCUF reported AUM of Rs 135,249 crores and Rs 36,117 crores respectively.

The company is expected to continue to retain its predominant market position in the pre-owned CV financing business and the SME loan segment. The erstwhile STFCL has created a strong and sustainable competitive advantage through deep understanding of the borrower profile and their credit behaviour. They have done so by building a scalable operating model, extensive reach and strong valuation capabilities of pre-owned vehicles. The company faces limited competition from other organized financiers, including banks, in this segment, due to inherent riskiness of the target product and the customer profile. SCUF on the other hand had a well-established market position in SME loan and two-wheeler financing segments. In the SME loan segment, the company is a leading financier among retail NBFCs. The company has grown significantly in the unique space created from its legacy chit fund ecosystem. The main characteristics of SME loan portfolio are that the borrowers have limited documentary income proof and the ticket size is small at average of Rs 10 lakh-Rs 15 lakhs.

Overall, CRISIL Ratings believes that SFL has strong structural advantages over its peers, which will support its growth plans and help it maintain leadership position over the medium term. Further, the merger also enables higher potential for cross sell within the customer segments of the entities. Ability to continue to scale up operations remains a key monitorable.

Adequate capitalisation and earnings profile

SFL’s capitalisation remains adequate with an estimated networth of Rs 38,152 crore and an adjusted gearing of 4.3 times as on September 30, 2022. CRISIL Ratings believes that the capitalisation profile will remain comfortable over the medium term, given the demonstrated ability to access markets.

With the consummation of the merger, the earnings profile of the SFL has improved driven by the addition of the high yielding book of erstwhile SCUF. Post the consummation the net interest margins for the SFL are estimated to have increased to 7.8% for the first half of fiscal 2023 as against 7.3% for the erstwhile STFCL. Nevertheless, while yield benefit is accretive, SME business is operational intensive, and therefore, the operating expenses are estimated to have increased to 2.4% for the first half as against a 1.6% for STFCL. The credit costs however, remain range bound despite the elevated reported asset quality metrics driven by the ability of the entities to recover even post an account turning NPA. Credit costs were at around 2.0% for the first half of fiscal 2023 for both the merged entity as well as for the erstwhile STFCL. Consequently, the ROMA stood at an estimated 2.8% for the first half (2.2% for fiscal 2022) as against 2.7% for erstwhile STFCL.

Weaknesses:

Exposure to inherent asset quality-related challenges arising from lending to borrowers with modest credit profile

The asset quality metrics for SFL have been elevated over the past several years. Historically, STFCL and SCUF have operated at elevated reported asset quality metrics with GNPA/Gross Stage 3 assets at 6.9% and 5.9% as on September 30, 2022. The asset quality metrics have been elevated over the past several years given the fact that the company largely caters to borrowers with modest credit profile and relatively under-banked customers.

Nevertheless, CRISIL Ratings notes that the entities have displayed ability in the past to ultimately recover from these accounts, even post loan maturity date. Consequently, the overall credit costs have been range bound over the past 3 fiscals. Further, the restructured portfolio for the company was also negligible at sub 1% as on September 30, 2022. However, ability to scale up the portfolio whilst improving asset quality metrics remains a key monitorable. Nevertheless, company’s long track record in its business segments, understanding of the target customer segment and relationship based lending model could support the asset quality metrics.

Average, albeit improving resource profile

SFL has an average, though improving, resource profile. Both STFCL and SCUF had an established track record in raising funds from the markets with STFCL also being able to tap retail borrowings which helps diversify its resource profile. However, the cost of borrowings continues to be higher than peers. While the company has managed to tap various borrowing sources having raised over Rs 30,000 crore in the first half of fiscal 2023, the biggest traction across funding avenues was post Q4FY21. Further the company has also been able to raise funds via retail deposits.

However, the cost of borrowings is relatively higher than peers. Ability to trim down borrowing costs from the current levels and diversify further into domestic capital market will be key to support the earnings profile amidst the current environment. CRISIL Ratings notes that the yields for bonds of STFCL in the secondary market which were higher than benchmarks in the previous years have now been on an improving trend over the last six months. Consequently, the ability of SFL to now consistently raise resources from traditional routes of term loans and capital market instruments at optimal costs remains a key monitorable.