Five-Star Business Finance Ltd Management Discussions

Annexure C

1. Macro Economic & Industry Overview

This year is a tale of 2 halves for the secured lenders – robust growth in the first half of the year followed by a slightly muted growth and some asset quality impact in the second half of the year on account of the trickling effect of the overleverage crisis. The overleverage crisis that hit the unsecured lenders hard for almost the entire year did cause some bit of impact on the secured lenders also, especially towards the later part of the financial year. Due to this, it became imperative for the lenders to focus on "Quality Growth" rather than growth at any cost.

The financial year 2024-25 has been an year of ups and downs, with various factors causing impact at times. As the RBI Governor states in his

April 2025 Monetary Policy address –

"The global economic outlook is fast changing. The recent trade tariff related measures have exacerbated uncertainties clouding the economic outlook across regions, posing new headwinds for global growth and inflation. Amidst this turbulence, the US dollar has weakened appreciably; bond yields have softened significantly; equity markets are correcting; and crude oil prices have fallen to their lowest in over three years. Under these circumstances, central banks are navigating cautiously, with signs of policy divergence across jurisdictions, reflecting their own domestic priorities.

The Indian economy has made steady progress towards the goals of price stability and sustained growth. On the inflation front, while the sharper-than-expected decline in food inflation has given us comfort and confidence, we remain vigilant to the possible uncertainties and weather disturbances. Growth is improving after a weak performance in the first half of the financial year 2024-25, although it still remains lower than what we aspire for."

The Governor also highlighted the possible risks that may materialise in the medium term. "The medium-term outlook, however, remains challenging, with downside risks from possible intensification of geopolitical conflicts, sporadic financial market turmoil, extreme climate events and rising indebtedness. Stretched asset valuations, fragilities in the less regulated non-bank financial intermediaries, and threats from new and emerging technologies also add to the evolving uncertain outlook."

However, not all is gloomy as we can glean from the Governor himself in his foreword to the Financial Stability Report 2024 (FSR) "As the year

2024 draws to a close and a new year dawns, the global economy exhibits resilience in the face of formidable headwinds from political and economic policy uncertainty, persisting conflicts and an environment of fragmenting international trade and tariffs. Brightening the global prospects is the likelihood that the decline in inflation will continue and align with targets during the year ahead, allowing purchasing power to recover. As monetary policy gains headroom to further support economic activity, financial conditions can be expected to remain easy and contribute to an improvement in the trajectory of global GDP from a prolonged phase of low growth. Robust labour market and sound financialsystem too provide congenial conditions for this turnaround."

Despite some headwinds especially on the geopolitical front, there are tailwinds in the form of declining inflation, which will lead to more cash in the hands of the customers leading to higher purchasing power, which will then spur consumption, investment, savings, etc. The recent tax proposal to exempt incomes up to INR 12 lakhs is a welcome move, as it clearly signals the intent of the Government to spur investment and consumption which will then lead to better growth.

From the perspective of Indian Financial Institutions, the FSR clearly notes that "The Indian banking system has remained resilient with robust capital buffers, strong operational performance, and declining asset impairment. Macro stress tests indicate that banks aggregate capital would remain above the regulatory minimum even under adverse scenarios. The NBFC sector witnessed robust credit growth while maintaining strong balance sheet and profitability".

From a macroeconomic perspective, real GDP for the country is expected to grow at 6.5% for FY2024-25, as mentioned by the RBI Governor in his Monetary Policy address delivered on the 9th of April 2025. At a macroeconomic level, India remains the fastest growing major economy of the world, with strong investment and public consumption underpinning economic performance. The domestic financial system is fortified by healthy balance sheets of banks and non-banking financial companies (NBFCs), and relatively low volatility in financial markets.

Despite the moderation in the real GDP growth from 8.2% and 8.1% of H1 and H2 of FY2023-24 respectively to 6.0% in the first half of the current financial year, the structural growth drivers remain intact, which will lead to a stronger growth in the second half of the financial year change in stance of the Monetary Policy Committee from "Neutral" to from "Accommodative" also augurs well for the growth of the Indian economy.global

The resilience of the domestic banking system has been bolstered by robust capital buffers, strong earnings and sustained improvement in asset quality. The common equity tier 1 (CET1) ratio, which represents the highest quality of regulatory capital, stood at 14.0 per cent, well above the regulatory requirement of 8 per cent (including the capital conservation buffer). The banks net interest margins (NIM) and profitabilityalso remained solid. Consequently, their returns on assets (RoA) and returns on equity (RoE) rose to 1.4 per cent and 14.1 per cent, respectively, in

September 2024.

There was good news for the Indian banking system from an asset quality perspective as well. Buoyed by falling slippages, higher write-offs and steady credit demand, the gross nonperforming assets (GNPA) ratio of scheduled commercial banks (SCBs) fell to a multi-year low of 2.6 per cent. Alongside, net non-performing assets (NNPA) ratio declined to 0.6 per cent, aided by strong provisioning. Additionally, the special mention accounts 2 (SMA-2) ratio, which is a lead indicator of asset quality, is also displaying low potential impairment.

As regards NBFCs, they have been the conduits who have been taking credit to the large unserved and underserved segments, where banks did not have the ability to take a direct exposure. As prudential increases in risk weights on NBFC lending to certain consumer credit categories as well as on bank lending to NBFCs took fuller effect, NBFCs loan growth moderated further during H1:2024-25 to 6.5 per cent (h-o-h) in

September 2024. The impact was particularly visible in the upper-layer

NBFCs (NBFC-UL) segment, which comprise primarily of NBFC-ICCs with high share of retail lending in their loan book. Middle-layer NBFCs (NBFC-ML), excluding government-owned NBFCs, however, maintained robust loan growth, especially in retail loan portfolios.

Overall, NBFC sector remained healthy with sizable capital buffers (CRAR stood at 26.1 per cent in September 2024), robust interest margins and earnings (NIM at 5.1 per cent and RoA at 2.9 per cent) and improving asset quality (GNPA at 3.4 per cent of gross loans and advances and SMA-(1+2) at 3.5 per cent). Write-offs, however, show a rising trend, with a few outlier NBFCs showing significantly higher write-offs.

Times have remained uncertain for a few years now with sporadic disruptions happening now and then. This financial year also witnessed another disruption in the form of government intervention in Karnataka. The Karnataka Government introduced the Karnataka Micro Loan and

Small Loan (Prevention of coercive actions) ordinance, 2025 in the month of February 2025 with an intent to protect and relieve the economically vulnerable groups and individuals, especially farmers, women and womens self help groups from the undue hardship of usurious interest rates and coercive means of recovery by Micro Finance Institutions or Money Lending Agencies or Organizations operating in the state of Karnataka and for matters connected therewith and incidental thereto.

While the Ordinance clearly excluded any banking or Non-Banking Finance Company (NBFC) registered with RBI from its purview, there were field level issues faced by banks and NBFCs in the form of intervention by law enforcement and the consequent disruptions brought by such issues. This resulted in some asset quality stress in the Karnataka portfolio and also had an impact on the portfolio growth since most of the financial institutions decided to go slow on Karnataka disbursements.

Such state level interventions coupled with macroeconomic headwinds makes these times quite challenging. It becomes imperative for financial institutions to show resilience during these times for them to emerge stronger from such crises.

Regarding the growth potential for the NBFCs in the coming years, CRISIL notes that the growth in assets under management (AUM) of non-banking financial companies (NBFCs) is set to moderate to 15-17% in the current and next fiscals, a 600-800 basis points (bps) decline from a strong 23% growth seen last fiscal, as they navigate the dynamics of the evolving operating and regulatory environments and recalibrate strategies.

While the expected growth will still be above the decadal average of ~14%

(fiscal 2014-2024), it will moderate from that seen in fiscal of three factors. First, rising concerns around household indebtedness and asset quality risks will have a bearing on growth strategies in specific retail asset segments such as microfinance regulatory compliance requirements have intensified with focus sharpening on customer protection, pricing disclosures and operational compliance which will necessitate process recalibration. And third, the access to diversified funding sources, a crucial determinant of growth, especially given the slowdown in bank lending to NBFCs, will differ across NBFCs.

All these bring to the fore, the criticality of having a strong Compliance framework and robust risk management framework so that institutions are able to navigate these challenges.

Five Star is registered with RBI as a Non-Deposit taking NBFC categorised as middle layer NBFC as per RBI (Scale Based Regulation) Directions,

2023. The Company is in the business of providing Secured loans to

Small Business customers and Self-employed individuals who are largely ignored by the formal financialecosystem. The Company was incorporated in 1984, pivoted into secured lending around 2004 and has been operating in this segment for more than 2 decades. The first decade of operating in this segment was a phase of learning during which the Company learnt and fine-tuned its business and underwriting models before embarking on a phase of fast yet strong growth.

The Company has chosen the model of lending against an asset which is probably closest to the borrowers i.e. self-occupied residential properties. For this borrower segment, this asset perhaps represents their entire life savings and hence they would not default on the loan for frivolous reasons lest they lose their life savings. This ensures robust asset quality, even during difficult states and 1 union territory and has a borrower base of more than 4.5 lakhs as on March 31, 2025.

As per a study (albeit a little dated) done by International Finance Corporation (IFC) in November 2018, the debt demand of MSMEs is INR

69.3 trillion. Out of this, only INR 10.9 trillion is met by formal sources while the balance comes from informal sources such as family, friends, chit funds and moneylenders. This clearly shows that there is a huge demand from this population, who are probably wanting to graduate to the formal ecosystem for the first time in their lives but are not of the opportunities available to them. Hence it becomes important to have the reach through physical infrastructure so that these borrowers can be tapped. As they are first time borrowers to the formal financial ecosystem, their financial literacy levels are low, they tend to be quite unsophisticated, their timely repayment behaviour tends to be a little sketchy and hence they need to be educated on the loan product being offered and ensure their repayment behaviour remains strong, which are challenges confronted by the financial institutions.

However, they are able to clearly perceive the advantages of formal borrowing where the interest rates are far cheaper than moneylenders, they get to amortise their loan over a defined term and the recovery practices are not coercive. Almost all of your Companys borrowers are into providing essential services, either through a shop or by means of being a self-employed individual, which practically extinguishes cashflow vulnerabilities on account of macroeconomic disturbances. 2024onaccount

Another facet of these borrowers, who are borrowing from financial andunsecuredloans.Second, institutions to extinguish their debt from unorganised institutions, is that there will be a lower propensity in these borrowers to take repeat debt. Their primary intention is to avail funding from formal sources so that they are able to get out of the debt trap of unorganised institutions, from whom they had availed moneys to set up their shops / businesses. Once they extinguish their debt, their internal accruals are sufficient to take care of their working capital requirements. This essentially means that financial institutions cannot be relying on the existing borrower base for the future also; it becomes imperative to source newer borrowers every year, which also acts as an entry barrier for newer institutions to enter this space.

As many borrowers graduate from the unorganised system and do not have documentary proofs of their incomes, traditional underwriting methodologies would be ineffective, and it becomes essential to tailor an underwriting approach that would help the company understand their cashflows. Five Star addresses this challenge by evaluating 3 Cs – Character, Cashflow and Collateral, which ensures that your Company is able to evaluate their intention to repay (character), ability to repay (cashflow) and have a fallback even during bad times (collateral).

While cashflow evaluation and collateral valuation are fairly straightforward, though even these present challenges in the form of very less documentary evidence, character evaluation is much trickier. The

Credit Bureau report serves as the starting point for character evaluation as it shows the repayment behaviour of the borrower on the product loans, he / she may have taken from other institutions in the past. But this is not sufficient it becomes necessary to use other surrogates to understand the intentions of the borrower. Five Star evaluates this through Neighbourhood checks, Trade checks, etc, which helps us to understand the borrower behaviour, family circumstances, any negative traits of the borrower and his / her family, etc. Good amount of time is spent by multiple teams to understand and establish the intent of the borrower. At the heart of underwriting is also the need to impart financial literacy to the borrowers. Making them understand the loan product, interest rate and other charges, timely repayment behaviour are important aspects which help in maintaining a robust asset quality and also help avoid potential customer complaints / disputes.

Cashflow evaluation in the absence of documentary evidence also poses a challenge. It is a lot easier to understand cashflows when there are documents to substantiate but the borrowers of Five Star are people from the lower end of the pyramid and hence, they do not have typical income documents such as bank statements, IT returns, etc to demonstrate their incomes. In such a scenario, we use other means to understand the cashflows – the evidence could be the lifestyle and living conditions of the borrower or the assets that the borrower has created for himself / herself and his / her family. Through thorough checks of the borrowers workplace, his / her residence, lifestyle, etc, the company is able to arrive at a plausible cashflow which will stand support to the loan repayment.

One of the fundamental learnings for the Company over the last 2 decades is to not get into unsecured loans when lending to this borrower segment.

It is extremely important to make the borrower have a significant in the repayment of the loan, failing which the asset quality would suffer. Towards this, your Company gets the borrower to mortgage a strong collateral in its favour and such mortgage is also registered in the sub-registrar office, making it foolproof. This ensures that even during periods of crises, the borrower pays up on a Five Star loan despite being a defaulter with other institutions.

While a robust underwriting is of paramount important to nip the risks in the bud, it is not fully sufficient to ensure strong asset quality. Along with strong underwriting, there is a need to have a strong collections infrastructure so that the Company is able to take appropriate actions in response to the demands of the situation. While the sourcing officer is responsible for collections also till a particular loan vintage, the Company has also built a strong collections team which would take over the loan post that vintage and ensures that every penny till the last instalment is collected from the borrowers on time. Your Company continuously keeps evaluating its strategies and makes changes as may be necessary especially when situations change. The collection actions to be undertaken are clearly documented and the appropriate level of branch and Head

Office involvement is ensured.

Your Company has also built a strong legal recovery team led by a senior person as the Chief Legal Officer, which takes over deep delinquent / NPA loans and undertakes necessary legal actions to settle the loan or bring the loan back to being standard. The legal teams organisation structure is thoughtfully made to have the right balance between resources at the branch level and resources at the HO level.

Onboarding the right borrowers after a careful evaluation, providing the right quantum of loan at the right terms and conditions, securing the loan through mortgage of one of the strongest collateral, and having the right collections and legal infrastructure have collectively ensured superior asset quality for your Company.

Growth is very important for every Company; else it leads to stagnation. However, growth for the sake of growth is not only useless but positively dangerous. Your Company focuses on "Quality Growth", whereby the growth achieved by your Company comes with a strong asset quality. This is evident from the growth trajectory of your Company over the last decade or so.

As can be seen from the graph above, your Company does not indulge in reckless growth. When the situation is conducive, growth tends to be fast and strong but when situation becomes challenging, the pullback of growth is palpable. This is clearly seen in the 2 years of COVID and in the current financial year, when prudence took precedence over chivalry and heroism.

Post COVID, your Companys growth showed strong traction but the overleverage crisis coupled with disruption in Karnataka resulted in a slowdown in the current financial year. As already stated, it is important to have "Quality Growth", which may not have resulted if your Company would have indulged in high disbursements during the current financial year. Notwithstanding the growth number, your Company has the infrastructure in place to press the pedal of growth once things turn better.

During the current financial year, your Company disbursed close to 1.4 lakh loans and increased the borrower base. The number of loans increased from about 3.86 lakhs to about 4.61 lakhs, as shown in the chart below. Over the last 5 years, the net addition of loans done by your Company stands at about 3.2 lakhs, which adds to the franchise value.

During the year, your company also opened 228 branches taking the total to 748 branches as of March 31, 2025. This follows the "Split branch strategy" that was adopted during the last financial year, whereby bigger branches are split into multiple branches along with transfer of some accounts to the new branch. This was a strategy adopted with a view to have a prudent risk management across all the branches. Having an optimal number of accounts in a branch helps the branch address any challenges that may emerge viz. collection challenges, attrition challenges, etc. The new branch gets adequate space to onboard new accounts and this concept also helps provide career progression to the employees of your Company. Out of the 228 branches opened during the year, 80 were completely new branches and 148 were split branches.

The state-wise split of branches as of March 2025 is given below.

The combined effect of increased loans and increased branch infrastructure resulted in your Companys getting close to INR 12,000 Crores of AUM as on March 31, 2025.

One of the other actions taken by your Company during the current financial year is to achieve some increase in ticket size, which helps in multiple ways: 1. Inflationary increases in ticket size are a must to attract the right borrowers to take loans from the Company. Right ticket size is also important to remain competitive in an environment where other players try to provide more loans to the same borrower.

2. The drop in lending rates by over 200 bps starting November 1, 2024 gives an avenue for your Company to source price sensitive borrowers who are also of better quality. This was a clear focus especially during the last quarter and it help push up the ticket size of incremental disbursements during the last quarter.

3. Increase in ticket size would continue to be a lever of growth for your

Company. By moving to relatively higher ticket sizes, the borrower profiles tend to be better, possibility of your Company being bucketed with MFIs / other small ticket lenders is avoided, and all of these help in better collections and stronger asset quality. Hence your Company would continue to focus on increased ticket size, without compromising on any of the responsible underwriting tenets.

Your Company prides itself on being a responsible lender, not just in terms of underwriting practices but also in terms of pricing and other aspects. The cost of debt raised by your Company had seen a sharp drop over the last few years by about 200 bps and there was a clear intention to pass on this benefit to the borrowers. However, various events played out in the last few years which made it difficult to drop interest rates viz. rising interest rates, changes in risk weights, scarcity in liquidity, etc.

However, for all disbursements made from November 1, 2024, the interest rates were lowered on an average by about 200 bps. Your Company also moved to a risk-based pricing model whereby based on borrower profile and end-use, the interest rates were determined. This ensured that borrowers with lower perceived risk got a lower interest rate and vice versa. Your Company would continue to keep a tab on the interest spread

(difference between lending and borrowing rate) and take appropriate decisions at the right time.

Amongst the 3 parameters of Growth, Profitability and Quality, Asset

Quality is of topmost priority to Five Star. One of the fundamental tenets of the company is to prioritise collections over incremental business. The ability to maintain strong collections efficiency and robust asset quality even during difficult times is a distinguishing facet of the company. The

Company shall compromise on growth during tough times but there is no compromise on collections or asset quality. This has been proved crisis after crisis and the strong asset quality of the Company over the last many years is a testament towards this.

While there are many models existing in the financial services industry,

Five Star believes in having accountability and expertise as the twin factors towards achieving excellence in collections. Expertise bereft of accountability shall not yield the desired results and neither would accountability without expertise. Towards this, your Company has made the sourcing officer responsible for collections up to a certain vintage, which ensures strong accountability. Post this specific vintage (when the propensity to default may increase), the accounts are transferred to the collections team which has the right expertise to manage collections even on difficult accounts. Different measurement yardsticks are laid out for both these teams, which act as the right motivation and ensures good level of collections and strong asset quality.

The graph below depicts our Current and 1+ portfolio for the last 5 years, and the data is self-explanatory.

While there has been an uptick in the delinquency numbers as of March 2025, it has to be understood in the right context. When the industry went through immense pain due to the overleverage crisis, the uptick in delinquency for your Company seems relatively low. Many of the other lenders, especially unsecured loan providers, have seen an uptick in delinquencies and credit cost substantially higher than what has been experienced by your Company. Given the strong underwriting coupled with relentless collections focus, your Company is very confident of coming out of this crisis in flying colours. We will continue to expend efforts to ensure that the current portfolio improves in the coming years.

The Company continuously keeps evaluating its strategy and would take appropriate actions as it befits the situation. It is important to keep the collections effort of business officers minimal so that they can focus on bringing in quality accounts to facilitate the growth of the Company. At the same time, moving accounts continuously to the collections team would mean linear increase in the number of collections officers, which does not work well from a cost perspective. So a fine balance needs to be maintained between these 2 and your Company shall constantly strive to strike the right balance which would lead to quality growth of your Companys loan portfolio.

The Company had also restructured a small portion of its portfolio as part of the COVID second wave; however, the proportion of the restructured book stands at a very marginal level (0.30% of the overall AUM as of March 31, 2025) as on date. This portfolio has been steadily decreasing with settlements happening on these loans without any major compromise on the IRR. Based on the performance till date, do not expect any major losses emanating out of this portfolio. In fact, we also carry a very sizeable provision on this book (we carry a provision of about 45% on this book), which we believe, would be more than sufficient to offset any potential losses on this portfolio.

The table below gives the stage-wise details of loan portfolio as of March 31, 2025:

One of the significant digital repayments. As financial the borrowers are largely first-time borrowers to the formal financial ecosystem for a size and nature of the loan that they have taken from your Company, they have been habituated to making repayment of their EMIs in cash. Over the last 12 months, your Company undertook significant efforts, through educating the borrowers coupled with the carrot and stickachievementsofyour Companyduringthecurrent approach (in the form of incentives and penalties), to ensure constant increase in the proportion of digital payments. The efforts of the Company have borne fruit, and we have seen a significant uptick in the digital payments over the last few years, as can be seen from the data below.

3.1 Branches: The number of branches as at the end of March 2025 was at 748 as against 520 as at March 2024.

3.2 Portfolio growth: Five Stars Consolidated AUM increased from INR 9,640.61 Cr in FY2024 to INR 11,877.04 Cr in FY2025¹, which translates to a growth of about 23% for the year.