Five Star Business Finance Limited, NBFC-ND-SI providing secured business loans to micro-entrepreneurs and self-employed individuals, each of whom are largely excluded by traditional financing institutions. The company headquartered in Chennai, Tamil Nadu with a strong presence in south India and all of their loans are secured by the borrowers’ property, predominantly being SORP. Compared to peers with more than ₹30,000 mn in AUM Five Star Business Finance Limited have the fastest AUM growth, with a compound annual growth rate of 65.0%. They are among the three best for Gross Non-Performing Assets being NPAs that are 90+ Days-Past-Due as a percentage of AUM. While they have the best asset quality among lenders identified by CRISIL as engaged in extending MSME business loans, with other lenders Over 95% of their loan portfolio comprises loans from between ₹0.1 mn to ₹1.0 mn in principal amount. The company has provided loans to more than 185,000 customers in total. They had an active loan base of 176,467 as of March 31, 2021.

The offer comprises of offer for sale amounting to ₹27,519.45 mn and the company won’t be receiving any proceeds from the offer. The objective of the offer is to carry out offer for sale and achieve benefits of listing the equity shares on the stock exchange.

The company has seen significant growth in its revenue in FY21, rising from ₹4,089.08 mn in FY19 to ₹10,497.42 mn in FY21. The resilient performance in the revenue came due to increase in interest income and growth in AUM. EBITDA grew from ₹3026.92 mn in FY19 to ₹8,130.16 mn in FY 21. The company was able to increase its EBITDA margin from 74.02% in FY19 to 77.45% in FY21. The company's profit also increased from ₹ 1,564.14 mn in FY19 to ₹ 3589.94 mn in FY21.

Five Star Business Finance, is a shadow lender backed by prominent US investors like KKR and Sequoia Capital. In the run-up to its IPO, here's a list of its peers that are currently trading on the stock markets

According to CRISIL, the potential market for residential property-backed small business lending in India is approximately ₹22 trillion, with Uttar Pradesh, West Bengal, Bihar, Maharashtra, Rajasthan and Tamil Nadu collectively accounting for over half of such potential market. CRISIL also notes that while this potential market opportunity is significant. Five Star Business Finance Limited’s business currently operates within this market and has an underwriting model that caters to such customers, and as such, they are well-positioned for further growth within this market. They have the fastest AUM growth among the compared peers with more than ₹30,000 mn in AUM, with a CAGR of 65.0%, catering to the small business finance needs of unserved and underserved customers. While their AUM has grown to ₹44,453.81 mn as of March 31, 2021, from ₹4,935.88 mn as of March 31, 2017, at a CAGR of 65% their growth has primarily been volume led with consistent ATS and steady yields. Over the last two decades of operations in this particular product, the company’s success and growth are an outcome of their customer centric business model, where through their practices and policies, they can address specific issues faced by small business owners and self-employed individuals, and leverage their local presence to develop detailed and relevant local level knowledge. The company is able to identify local level opportunities, ensure careful customer selection, timely loan approval disbursals and efficient real time monitoring of collections.

Five Star Business Finance Limited has an underwriting model to provide secured financial solutions to small business owners and self-employed individuals and over the last two decades of operation in this particular product, are among the select institutions to have developed such a model in India. The model is customer centric and is underpinned by underwriting practices that triangulate the character, cash flow, and collateral of potential customers. This methodology of underwriting ensures they are able to evaluate both the willingness and the ability of the customer to repay the loan, despite the absence of traditional documentary proofs of income. This has enabled them to mitigate credit risk and successfully underwrite new loans while maintaining their asset quality.

While Five Star Business Finance Limited's underwriting model contributes to suitable customers being onboarded, they have also created a strong “on-ground” collections infrastructure to ensure that the company maintains a high asset quality. Many of their customers have previously borrowed from moneylenders or other such unorganized lenders, and although they have observed minor delays in the servicing of regular monthly instalments, which they view as a typical part of the repayment culture, such delays don’t necessarily translate into loan defaults. A key mechanism they use to prevent defaults in such circumstances is maintaining a strong collections infrastructure designed to keep the credit and repayment discipline of the borrower intact.

According to the CRISIL Report, less than 15% of the approximate 70 million MSMEs in India have access to formal credit in any form, and historically, there is a perception of high risk and prohibitive costs of delivering services physically that have constrained traditional institutions’ ability to provide credit to underserved or unserved MSMEs, small business owners and self-employed individuals. As a result, such borrowers are either self-financed or take credit from the unorganized sector and as such, this relatively untapped market offers huge growth potential for financial institutions such as theirs. Since starting as a Chennai based NBFC, they have demonstrated their ability to grow beyond their local market. The first growth phase was between FY2010 and FY2015 where they increased from six branches in Chennai to 39 branches across Tamil Nadu. Between Financial Year 2015 and 2018, they started to expand in the states of Andhra Pradesh, Telangana and Karnataka, growing from three branches to 72 branches during this period. Since then, they have further expanded to 139 branches across Andhra Pradesh, Telangana and Karnataka. They adopted a calibrated strategy of contiguous expansion across geographies where there is substantial demand for their offering and which has allowed for the maintenance of robust asset quality.

Five Star Business Finance Limited's 100% in-house sourcing, comprehensive credit assessment and robust risk management and collections framework allows them to identify, monitor and manage risks inherent in their operations. Catering primarily to small business owners and self-employed customers while maintaining asset quality requires a special skillset in absence of traditional income evidence, such that lending to these borrowers is based on an assessment of their income and cash-flows through various methods. Firstly, they ensure all of their loans are sourced in-house, either through their branch-led local marketing efforts i.e., door-to-door or specific referral marketing, repeat customers or through walk-ins. Further, as their customers are onboarded by their own officers and not by the third party selling agents who may or may not be working with multiple financial institutions, they experience a lower churn rate of customers throughout their portfolio. Their risk management framework includes a comprehensive audit mechanism of internal audits performed at a corporate level on a quarterly basis, regular branch level audits and management audits, which cover specific risk-based assignments. They have set up a Risk Management Committee to review and identify current and emerging risks, develop risk assessment and measurement systems and establish policies, practices and other control mechanisms to manage risks and develop risk tolerance limits, monitor positions against approved risk tolerance limits and report its findings to senior management.

Five Star Business Finance Limited has secured financing from diversified sources of capital, including term loans; proceeds from loans securitized; proceeds from the issuance of NCDs; issuances of principal protected market linked debentures; and proceeds from loans assigned; from banks, financial institutions, mutual funds and other domestic and foreign financial and development finance institutions to meet their capital requirements. Their cost of incremental borrowings reduced from 11.37% in Financial Year 2020, to 9.68% in Financial Year 2021. They have borrowed from 13 private sector banks, nine public sector banks, 14 NBFCs, one mutual fund, and 11 other entities; and their outstanding borrowings were ₹6,897.43 mn from private sector banks, ₹7,880.42 mn from public sector banks, ₹5,769.85 mn from NBFCs, ₹2,001.77 mn from mutual funds, and ₹5,993.07 mn from other entities, as of the same date. The company believes that they are able to access borrowings at competitive cost due to our stable credit history, strong credit ratings, equity capital position and low leverage, and our risk management policies.

• Company have had negative cashflows and incurred losses in the past and can continue to incur in future.

  Any downgrade in the credit ratings could increase the borrowing costs, affect the company's ability to obtain financing, and adversely affect their business.

  Company may face difficulties and incur additional expenses in operating in semi-urban and rural markets, where infrastructure may be limited.

  Interest rates volatility severely impacts the lending and treasury operations of the company.

• Using technology and credit rating model can help the company to focus on their risk management framework.

• Strategic investments in information technology systems and automated, digitized technology-enabled platforms can strengthen the company’s offerings and derive greater operational, cost and management efficiencies.

• Penetration in existing as well as newer markets can be beneficial for the company’s growth perspective.

• Non-compliance with the RBI’s observations made pursuant to its periodic inspections and violations of regulations prescribed by the RBI, could expose the company to certain penalties and restrictions.

• Failure from recovering full value of the collateral or outstanding amount of borrowing can affect the business and financial condition.

• Failing to maintain internal processes or system could cause operational errors or incidents of fraud.

• Indian small business finance industry is highly competitive and their inability to compete effectively could adversely affect their business and results of operations.

While Five Star Business Finance Limited has grown its operations in relatively newer markets, their operations have historically focused in the south Indian states of Tamil Nadu, Andhra Pradesh, Karnataka and Telangana. Such states contribute significantly to their AUM and they intend to continue to expand in these states in a contiguous manner, to drive greater and deeper penetration. Their business model is scalable and by drawing on the experience of their team, the company expects to be able to expand their operations efficiently, with low incremental costs. The company strategies include deepening the presence in their existing geographies through a combination of increasing the number of Field Officers and setting up new branches for states where they have no or very low existing presence, they will continue to review a number of factors including demographics and competitive landscape before establishing a branch. Their strategy remains to grow contiguously into such areas by gauging the business potential of a particular state and drill down into specific locations suitable for branch opening.

Five Star Business Finance Limited plans to continue to focus on small business owners and self-employed individuals and increase their market share. For instance, in terms of credit availability generally, CRISIL notes that there is a wide variation across states and within various districts in the same state, which indicates latent opportunity for providing banking services to unserved or underserved customers. In many locations, they have customers who are first time borrowers from the formal secured lending ecosystem. They have 25.09% of customers who were new to credit while the remaining customers were sanctioned higher ticket loans with higher tenors than they had availed earlier. They believe their underwriting model, which is based on their understanding of income assessment and collateral assessment for this customer segment, with limited reliance on documented income, is a key strength which would make customers prefer them over their competitors and which they intend to reinforce to achieve AUM growth.

Five Star Business Finance Limited's Average Cost of Borrowings was 11.48% as of March 31, 2021. The steady decline over the last three financial years is due to several factors, primarily their financial performance and improving credit ratings. A lower Average Cost of Borrowing enables them to competitively price their loan products and helps them grow their business and operations and increase their NIMs. The company has also diversified their funding sources by using instruments such securitization transactions, non-convertible debentures, and principal protected market linked debentures to ensure that their debt capital requirements are met at optimal costs. They intend to continue to diversify their funding sources, enhance limits from existing sources, identify new sources and pools of capital and implement robust asset liability management policies with the aim of further optimizing their borrowing costs and help increase their NIM. Further, they intend to expand and diversify their lender base, and seek to obtain funding from insurance, pension and provident funds, overseas lenders, external commercial borrowings and through the issue of commercial paper.

Five Star Business Finance Limited has made strategic investments in their information technology systems and implemented automated, digitized technology-enabled platforms and proprietary tools, to strengthen their offerings and derive greater operational, cost and management efficiencies. They have invested ₹160.01 million in their information technology systems and data science teams comprised of 23 personnel.

As Five Star Business Finance Limited increases their scale of operations and expand into new geographies, they intend to continue focusing on enhancing their risk management framework to maintain the credit quality of their loan portfolio. Their risk management initiatives will include obtaining a better understanding of the geographies in which they are present and the ones where they intend to expand to, improving the credit scoring models and algorithms that they have currently deployed, improving their collection techniques and their property underwriting procedures, as well as initiate portfolio analytics activities. They have an existing and comprehensive data lake which contains data from all the sub-systems being used by them to which they plan to add data from external and third party sources with a view to creating an internal single data source to aid in their data analytics and insight generation. Credit assessment is crucial to their operations since many of their customers are new to credit or belong to underserved segments of society with medium to low income levels.

Five Star Business Finance Limited believes that having a strong recognizable brand is a key attribute in their business, which will help them attract and retain customers, increase customer confidence and influences purchase decisions. Having a strong and recognizable brand will also assist them in recruiting and retaining employees. They intend to continue to undertake initiatives to increase the strength and recall of their “Five Star” brand to attract new customers.

The COVID-19 pandemic continues to spread across the globe and has since affected the world economy including India, leading to significant volatility and a decline in general economic activity. The pandemic has resulted in a reduction in their disbursements from ₹24,086.69 mn for the Financial Year 2020 to ₹12,450.54 mn for the Financial Year 2021. In addition, to alleviate the impact of COVID-19, the RBI issued guidelines relating to the COVID-19 regulatory package, providing a moratorium of three months on the payment of all principal amounts, Accordingly, they granted a five-month moratorium to all customers who were less than or equal to 90 DPD as of March 31, 2020, to the loan instalments. The moratorium was granted by them to 141,251 loans with a principal outstanding of ₹38,387.5 million payments from approximately September 2020, and the customer are granted time to return to more regular cashflows. The moratorium resulted in an extension of tenure for each loan by five-months; the original instalments falling due between the five-month moratorium were halted, with each borrower expected to restart their EMI.

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