PE’s affinity to financial services: A short-term or a long-term phenomenon?
The significant under-penetration of financial services in India and the huge growth potential for the sector are attracting PE investors
Private equity and venture capital investors have demonstrated strong interest across the financial services value chain; including banks, non-banking financial companies, online credit platforms, insurance companies, and payment solution companies for the past 3-4 years.
Since 2016, the Indian financial services sector has received $14 billion in PE/VC investments, which is greater than the sum total of all investments in the sector from PE/VC investors in the 10 years prior to 2016. The significant under-penetration of financial services in India and the huge growth potential for the sector, as the country continues to grow at a healthy rate of 7%, are attracting PE investors driven by three primary factors: Consumption-led credit boom and greater levels of “financialization” of the economy; flourishing NBFCs and alternate lending models; and healthy return on investments for PEs and VCs.
Over the past 3-4 years, while the global economy has struggled with sluggish growth, India has emerged as one of the bright spots with a 6.5%-plus growth rate, which according to Consensus estimates, is projected to continue for many more years. For any economy, the financial services sector acts as the fuel for growth and is a good proxy for domestic consumption-led growth.
With total domestic credit to the private sector at roughly 50% of the gross domestic product (GDP), compared to 170% in China and over 200% in the US, India has a long way to go. But with the government putting an architecture for sustainable domestic credit expansion, the “financialization” of the Indian economy is just starting. The insurance sector is also witnessing significant growth as under-penetration of the market, increasing disposable incomes, rising awareness and high medical costs, among others, have supported strong premium growth across general, health and life insurance.
Robust action by the regulators, including the Reserve Bank of India (RBI), Insurance Regulatory and Development Authority (Irda) and Securities and Exchange Board of India (Sebi), and the government, has only encouraged the channelization of domestic savings into the sector. The development of products and solutions to cater to the needs of Indian corporates, SMEs, MSMEs and the private citizenry, who increasingly need more options for credit, investments, insurance, payment mechanisms and access to capital, has only added to the excitement.
While the Indian banking sector has been reeling under the stress of non-performing assets, NBFCs have emerged with alternate lending models and have grown at over 19% CAGR since FY12. The growth is 2x of the banking credit growth during the same period, and is one of the major factors attracting PE/VC investors, and resulting in strong growth in housing loans, vehicle finance, real-estate, structured credit and MSME loans.
NBFCs have been able to bring down their capital cost by diversifying funding sources by raising a larger share of funds through bonds, NCDs, CPs, and securitization as well as PE funds, thus expanding margins and generating better returns. Use of alternative and tech-driven credit appraisal methodologies have also allowed NBFCs to target those traditionally underserved by banks. PE/VC investments are now acting as a growth driver, providing financial muscle and bringing in innovation and process improvements to the erstwhile staid business of “money lending.”
From the exit perspective, the financial services sector has been the best performing, both in terms of value and volume of exit between 2015 and the first half of 2018, with exits worth $6.9 billion recorded across 143 deals. It has also been the most successful sector for PE/VC-backed IPOs, with funds garnering $1.3 billion in offers for sale across 13 IPOs.
Three out of the top five IPO exits during 2015-1H2018 have been from the financial services sector. It also recorded the largest PE-backed IPO exit ever, with Fairfax exiting its 12% stake in ICICI Lombard for $557 million. From a returns performance perspective, PE-backed IPOs have, and are expected to, continue to fare far better than non-PE backed IPOs from their respective date of listing.
Vivek Soni is partner and leader for PE Advisory, EY.
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