Rating Rationale

Strengths:
* Market leadership in the pre-owned commercial vehicle (CV) financing segment
STFCL is the largest CV financier in the country with assets under management (AUM) of Rs 113,346 crore as on September 30, 2020, up ~5% Y-o-Y and on a sequential basis, the AUM growth was 1% Q-o-Q.

With presence of over four decades in the pre-owned CV financing business, 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.

Of all the business segments, CV financing (HCV and M&LCV) together constituted the largest portion of AUM at ~71% as on September 30, 2020. Passenger vehicles formed another 22% of AUM. The composition of AUM has remained largely unchanged with the pre-owned vehicle loan book at Rs 98,089 crore as on September 30, 2020 and comprising 87% of the AUM, marginally higher than the 86% as of March 31, 2020. The new vehicle portfolio growth slowed down with this segment degrowing by 16% Y-o-Y and its share in AUM stood at 8% as on September 30, 2020. While STFCL's growth will continue to be driven by pre-owned vehicle financing business, the new vehicle segment also remains a key focus area of the company in spite of competition from banks and NBFCs.

CRISIL believes that the business prospects for the pre-owned CV financing segment remain strong given the large unorganized market and significant entry barriers. STFCL has gradually expanded into rural markets and had 976 rural centres as on September 30, 2020. Owing to increased demand for pre-owned vehicles in deep rural areas, the company has been increasing its presence in rural and semi urban areas to maintain its niche presence. End September 2020, the total branches stood at 1,784 of which 55% were in rural areas. In the last one year the company has been adding new branches, majority of which are the satellite branches outside the semi-urban centres. Consequently, the share of rural AUM has also risen to 48% of total AUM as on September 30, 2020 as against 46% end September 2019.

STFCL had also innovated in establishing Shriram Automall India Ltd (SAMIL), a reliable platform for sale, refurbishment, and auction of pre-owned vehicles, besides enabling better price discovery of such vehicles. While STFCL sold majority stake in SAMIL in April 2018, it will continue to hold a large minority stake. CRISIL believes that despite the minority stake, SAMIL's business operations will continue to be closely integrated with STFCL.

Overall, CRISIL believes that STFCL has strong structural advantages over its peers, which will support its growth plans and help it maintain leadership position in the pre-owned CV financing segment over the medium term.

* Adequate capitalisation and earnings profile
STFCL's capitalisation remains adequate with networth of Rs 20,453 crore and an adjusted gearing of 4.7 times as on September 30, 2020. STFCL has raised capital of Rs 1,493 crore in August 2020 which has helped in improving capitalisation and gearing metrics. CRISIL believes that STFCL's capitalisation will remain comfortable over the medium term, given its demonstrated ability to access markets. The company's tier I and total capital adequacy ratio also were comfortable at 20.12% and 23.44% respectively as on September 30, 2020, well above the statutory minimum.

STFCL has adequate earnings profile with annualised return on average managed assets (RoMA) of 1.71% for the first six months of fiscal 2021 as against 2.2% last fiscal. The profitability in the first six months of fiscal 2021 was impacted primarily due to higher provisioning expense for portfolio under moratorium and covid-19 related stress. The overall covid-19 related provisioning of STFCL was 2,282 crore from Q4 of fiscal 2020 to Q2 of fiscal 2021 of which Rs 1,373 crore was in H1 of fiscal 2021. This has also resulted in credit cost of 2.9% (annualised) in H1 of fiscal 2021 against 2.2% in the corresponding period of previous year. However company's strong competitive position and relatively high yields in the pre-owned vehicle financing segment should ensure stable profitability than that of other CV financiers over the medium term.

Weaknesses:
* Modest asset quality
The company largely caters to borrowers with modest credit profile and relatively under-banked customers. The borrowers of the company are primarily individual small road transport operators whose truck utilisation and income streams are more vulnerable to weak economic activity. The impact of the lockdown was witnessed in the early phases with the collection efficiency² of STFCL dropping to 9% in April 2020 which had improved but still remained low at 51% in August 2020. However, since then, collection efficiency has improved to reach 95% in September 2020 and around 97% in October 2020. Further while historically, the reported gross non-performing assets (GNPA)/ Gross Stage 3 metrics has remained elevated in the range of 8.5 to 9.0%; as of September 30, 2020, it stood at 7.26%, owing to moratorium offered to its borrowers and asset classification freeze resulting in roll-back from overdue collections. In the light of increase in Covid-19 cases in a few States and localised restrictions, the sustainability of collections and maintenance of asset quality metric remains to be seen.

CRISIL also notes that STFCL has displayed ability in the past to ultimately recover from these accounts, even post loan maturity date. The overall credit costs have been in the range of 1.7% to 3.0% over the past 3 years. This is further supported by the analysis of vintage wise static pool data which shows recovery / roll-back of around 50-60% from peak 90+ reached for a particular disbursement vintage. This has been due to the company's long track record in the vehicle financing business, understanding of the target customer segment and relationship based lending model could support the asset quality metrics.

The Reserve Bank of India (RBI) has also allowed implementation a resolution framework for Covid-19 related stress. Given the trend in collection efficiency, the company expects the overall restructuring in the portfolio to be about 3%. However, not many borrowers have opted for restructuring till October 31, 2020. CRISIL believes that the focus of all lenders is on collections and the restructuring route is likely to be offered only by December once there is clarity on the expected roll-forwards. Hence, the ultimate impact on the asset quality, as indicated by the weak asset ratio (gross NPA + restructured assets), is likely to crystallise post December quarter and will remain a key monitorable.

* Average, albeit improving resource profile with higher cost of borrowings than peers
STFCL has an average, though improving, resource profile. It has an established track record in raising retail borrowings which helps diversify its resource profile. However, its cost of borrowings continues to be higher than peers. The average annual borrowing costs stood at 9.5% (annualized) for the six months ended September 2020. Further, fund raising also remains a key monitorable for STFCL due to their reliance on securitisation. STFCL, in the past, had a diversified resource profile and has tapped the overseas markets successfully in the past. In fiscal 2021, the company has raised about Rs 11,600 crore till September 30, 2020; however, about 51% of the incremental funds are through securitisation. CRISIL notes that access to capital markets for STFCL remains subdued. The yields for bonds of STFCL in the secondary market also have been higher in the recent past than the primary market issuances which also impacts the fund raising ability for STFCL in the near'term. The ability of STFCL to raise resources from traditional routes of term loans and capital market instruments is a key monitorable.