Mumbai/Bangalore: Private equity (PE) firms are chasing non-banking financial companies (NBFCs) even as India’s banking regulator has signalled its determination to tighten its grip on the sector.
Since January, PE firms have invested $200 million (around Rs 890 crore today) in six NBFCs and more such deals are in the offing, said fund managers.
Baring Private Equity Partners India Pvt. Ltd, which invested in Muthoot Finance Ltd last July, is scouting for more NBFCs in which it can invest. “We are still looking for other opportunities to invest in this sector,” said Munish Dayal, partner at Baring Private Equity Partners. He added that several NBFCs that received a first round of funding will need a fresh round of capital in the next two-three years.
Dhanpal Jhaveri, partner and chief executive officer of PE fund Everstone Capital Management, also sees a huge opportunity in the sector. “Sophistication of the credit markets and financial inclusion strategies are two drivers for growing PE interest in NBFCs,” he said.
According to PE firms, NBFCs will do well in India because banks haven’t been able to meet the needs of all borrowers. Indian law limits any entity’s investment in a bank at 5%; given this, NBFCs are an attractive alternative.
Dayal of Baring PE said retail asset-backed NBFCs such Magma Fincorp Ltd, Shriram Transport Finance Co. Ltd, and Manappuram General Finance and Leasing Ltd are more financially inclusive and cater to a population that doesn’t have access to banks.
Some PE firms are even joining hands to set up NBFCs. For instance, the PE arm of Goldman Sachs, Ashmore Group Plc and Everstone Capital are setting up Indostar Capital Finance Pvt. Ltd to lend to Indian firms.
There is still the challenge posed by a valuation mismatch, said Viren H. Mehta, director at Ernst and Young India, referring to the gap between what PE firms are willing to pay and what NBFCs’ promoters want. According to Mehta, PE firms that invested in Indian NBFCs in 2000 and 2001 have made huge gains, and this has prompted other firms to look at the sector.
It helps that NBFCs themselves are on an equity-raising drive following the Reserve Bank of India’s (RBI) stipulation that they will need Rs 15 of capital for every Rs 100 they lend by March 2012 (up from Rs 12 of capital currently).
Debt is an option, but the ideal route to do this is equity, said Saurabh Tripathi, partner and director at Boston Consulting Group (BCG) India.
Some NBFCs will do both. “We are done with our round of equity-raising and are now looking at a non-convertible debenture issue worth Rs 750 crore in August. We have already appointed investment bankers and the draft prospectus will soon be filed with the capital market regulator,” said I. Unnikrishnan, managing director at Manappuram.
NBFCs that cannot raise deposits from public depend on banks and financial institutions to raise money, which they on-lend to their borrowers. But a recent RBI move has restricted the flow of bank funds to some extent. RBI has said that bank lending to only microfinance NBFCs will get the priority sector tag.
Under RBI norms, banks need to direct 40% of their loans to agriculture and other mandated areas that are together known as priority sectors. Till recently, bank loans to NBFCs used to be considered as part of priority sector loans as long as the latter, in turn, loaned money to people in rural areas. “Out of the purview of priority sector, NBFCs are finding it difficult to raise money; at the same time the cost of funds has also gone up,” said BCG’s Tripathi. Unnikrishnan said the impact of this move on Manappuram has been a 1.5 percentage point increase in its cost of funds.
RBI also removed gold loans from the definition of priority sector lending and restricted NBFCs from expanding overseas.
An internal RBI panel, headed by its former deputy governor Usha Thorat, is now closely looking at the sector. Its brief includes defining and classifying NBFCs, addressing regulatory gaps, maintaining standards of governance, and strengthening supervision.
PE firms see these developments as positives that will instil discipline in a business not known for governance or transparency. And, some NBFCs are far more profitable than banks.
“These businesses have high net interest margins as compared to a bank,” said Baring PE’s Dayal.
Still, despite their reach and profitability, not all NBFCs have sound business models. Some have turned into one-product institutions and many others have not been able to grow beyond a particular geography. “Scaling up is an issue with NBFCs, as cost of funds is relatively expensive. Also, it will not be easy for NBFCs to reach the same level of distribution as easily as banks that have built this over a long time,” said Avinash Gupta, head (financial advisory) at Deloitte Touche Tohmatsu India Pvt. Ltd.