Detailed Rationale

CRISIL Ratings’ rating on the long term debt instruments of Shriram City Union Finance Limited (Shriram City) continues to be on ‘Rating Watch with Positive Implications’ and the rating of commercial paper is reaffirmed at ‘CRISIL A1+’.

 

Ratings were placed on watch on December 13, 2021, following the board of directors of Shriram Transport Finance Company Limited (Shriram Transport), Shriram Capital Limited (Shriram Capital) and Shriram City approval for the merger of the entities with Shriram Transport. The resultant entity (post the merger subject to necessary approvals) is expected to be renamed as ‘Shriram Finance Limited’. Further, Shriram Housing Finance Limited (Shriram Housing), currently a subsidiary of Shriram City, will become a subsidiary of the merged entity, Shriram Finance Limited (85.02% shareholding).

 

The rating action factored likely improvement in the credit profile of Shriram City as it would be equivalent to the merged entity, Shriram Transport. Therefore, the long-term ratings have been placed on 'Watch with Positive Implications'. The merged entity will be one of the largest NBFCs in India with consolidated assets under management (AUM) of Rs 1.65 lakh crore based on reported financials as on March 31, 2022. The business risk profile of the merged entity will be also benefit from diversity in product segments, larger branch network and potential for cross sell within the customer segment. Further, CRISIL Ratings also expects the integration impact to be minimal as the merger is within the Group entities with similar policies for human resources, business practices, systems and management. In terms of profitability, the merged entity’s proforma return on managed assets (RoMA) is estimated at 2.2% for fiscal 2021 and 2.1% for fiscal 2022. In comparison, on standalone entity basis, Shriram Transport’s reported RoMA stood at 2.0% for fiscal 2021 and fiscal 2022 while Shriram City’s RoMA was at 2.8% and 2.6% for similar comparable periods. The merged entity’s adjusted gearing is also estimated at 4.2 times as on March 31, 2022 as compared to 4.4 times and 3.7 times for Shriram Transport and Shriram City respectively.

 

CRISIL Ratings notes that the Hon’ble National Company Law Tribunal (NCLT) has by common order sanctioned the scheme and the group has filed all necessary documents with relevant authorities. The rating watch will be resolved and final rating action will be taken once the details of merged entity ‘Shriram Finance Limited’ are received. On resolution of the rating watch, the rating on the new instrument is unlikely to move by more than one notch.

 

The current outstanding ratings of Shriram City continue to reflect the healthy capitalisation levels, earnings profile supported by strong pre-provisioning operating profit (PPOP) margins, Shriram City’s strong market position and its linkages to the Shriram Group. The ratings are constrained by the asset quality challenges with the underlying borrower profile and the concentration of exposure in a few states.

 

As on September 30, 2022, the consolidated AUM of Shriram City Union Finance stood at Rs 42,663 crore of which 35% was loans to MSMEs, 21% was two-wheeler loans (including used 2W), 10% was gold loans, 15% was loans under Shriram Housing Finance Limited, 13% was personal loans and remaining was auto loans and loan against property (LAP). On standalone basis, the AUM was Rs 36,117 crore as on September 30, 2022, of which 42% was loans to MSMEs, 25% was two-wheeler loans (including used 2W), 12% was Gold loans, 15% was personal loans and remaining 6% was Auto loans and LAP.

 

Consequent to redemption, CRISIL Ratings has withdrawn its rating on Debentures of Rs 37.3 crore (See Annexure 'Details of Rating Withdrawn' for details) in line with its withdrawal policy. CRISIL Ratings has received independent confirmation that these instruments are fully redeemed.

Analytical Approach

For arriving at its ratings on Shriram City, CRISIL Ratings has combined the business and financial risk profiles of Shriram City and its subsidiary, Shriram Housing Finance Ltd (Shriram Housing). This is because of common management and the financial support that the latter receives from Shriram City and the overall Shriram group. With the completion of the merger, the credit profile will reflect the combined business and financial risk profiles of the erstwhile Shriram Transport and Shriram City as well as Shriram Housing.

 

Please refer Annexure - List of Entities Consolidated, which captures the list of entities considered and their analytical treatment of consolidation.

Key Rating Drivers & Detailed Description

Strengths:

* Established competitive position in SME and two-wheeler segments

Shriram City has well-established market position in SME loan and two-wheeler financing segments. In the SME loan segment, the company is a leading financier among retail NBFCs. The company has grown significantly in the unique space created from its legacy chit fund ecosystem. The main characteristics of SME loan portfolio are that the borrowers have limited documentary income proof and the ticket size is small at average of Rs 10 lakh-Rs 15 lakhs. Shriram City has also been expanding in SME space beyond its chit fund ecosystem, thus leading to faster growth rate in the segment. This SME portfolio, at Rs 15,092 crore as on September 30, 2022 (14,718 crore as on March 31, 2022 and 15,069 crore as on March 31, 2021), was one of the highest among retail NBFCs. In the two-wheeler financing segment, the company is among leading players in the sector with a portfolio of Rs 9,013 crore (including pre-owned of Rs. 881 crore) against Rs 8,789 crore as on March 31, 2022 (incl 1,025 crore of used TW). It finances about 90,000 vehicles per month (pre-covid) and competes with large players including private sector banks. These two segments account for around 67% of the standalone loan portfolio.

* Healthy capitalisation

Shriram City has healthy capitalisation underpinned by sizable absolute net worth (standalone) of around Rs 9,749 crores and a tier 1 and an overall capital adequacy ratio of 26.2% respectively as on September 30, 2022.  In addition, Shriram City's gearing (standalone) remains comfortable at 3.3 times as on September 30, 2022 (3.4 times as on March 31, 2022). Further, the net worth to net NPA (calculated per Indian Accounting Standard or Ind-AS) remains adequate at around 8.5 times as on September 30, 2022 (8.4 times as on March 31, 2022, and 9.3 times as on March 31, 2021) thereby providing adequate cushion against inherent asset quality challenges arising from borrower and product profiles. CRISIL Ratings’ expectation of continued healthy capitalisation of Shriram City factors in the likely equity support from the Shriram group if required.

 
Shriram City's subsidiary Shriram Housing's capitalisation is also comfortable with a networth (per IndAS) of Rs 1,223 crore and adjusted gearing of 4.8 times as on September 30, 2022 (Rs 1,158 crores and 4.0 times as on March 31, 2022). Shriram Housing's total capital adequacy ratio (CAR) stood at 27.3% as on September 30, 2022 (30.9% as on March 31, 2022). Overall, the healthy capitalisation is expected to be maintained over the medium term, driven by substantial accruals and expected support from Shriram group, if required.

 
* Healthy earnings profile

The company's healthy earnings profile is driven by focus on high yielding product and customer segments.  Earnings have been historically supported by high yield portfolio varying between 14-28% for various portfolios. Consequently, profitability has remained above the industry average over the past few years. Shriram City's return on assets improved to 3.3% (annualized) in H1 FY23 as compared to 2.9% in fiscal 2022 (on standalone basis). The pre-provisioning operating profit margin (PPOP margin) has been comfortable at above 6% for H1 FY23 and fiscal 2022 and historically has been between 6.4-8.2% in the past 5 fiscals between 2017 and 2021, which is expected to provide cushion for the credit cost which was at 2.2% for H1 FY23, 2.4% for fiscal 2022 and was between 2.4-3.7% in the past 5 fiscals.

* Benefits derived from linkages with Shriram group

The company benefits from access to the Shriram group's established branch infrastructure, clientele, management, systems and processes, and investor base. The group has been in the financing business for over three decades, with a strong market position in commercial vehicle finance (through Shriram Transport Finance Company Ltd), retail finance, and chit fund businesses.  Shriram City has expanded its target customer segment beyond its traditional chit ecosystem. Nevertheless, a large portion of its clientele in the small enterprise loan segment comprises the group's existing customers or referrals by its existing customers.  This facilitates acquisition of customers with established track records while reducing the cost of origination. Shriram City's management is largely drawn from the Shriram group's other businesses and is experienced in the small-ticket retail-finance segment in the semi-urban and rural areas. The group's brand image with retail investors enables Shriram City to source adequate retail funds to meet its growth requirements. CRISIL Ratings believes Shriram City is strategically important to the Shriram group and will continue to benefit from its linkages with the group, given its focus on providing financial services to under-banked segments

 

Weakness:

* Exposure to inherent asset quality-related challenges arising from lending to borrowers with modest credit profile

The company's retail financing business remains susceptible to inherent challenges related to asset quality arising from lending to borrowers with modest credit profile and relatively under-banked customers, despite having in place good credit appraisal and monitoring practices. Primarily the focus is on offering small enterprise financing to self-employed customers in semi-urban and rural areas. The non-regular income pattern and lack of financial flexibility of these borrowers cause higher delinquencies.

 

However, owing to strong understanding of the SME borrowers, the 90+ days past due (dpd) remained range bound over last few years. The monthly collection efficiency[1] was impacted in April and May 2021 with the onset of second wave. However, the collections have picked up from July 2021 with collection efficiencies reaching about 100%. The asset quality metrics in Q1 of fiscal 2022 were impacted by the lower collections and the gross non-performing assets (GNPA)/ Gross Stage 3 assets increased to 6.91% as on June 30, 2021 from 6.37% as on March 31, 2021. With the collections returning to normalcy, the GNPA improved to 5.93% as on September 30, 2022 which includes the impact as per the revised guidelines for NPA recognition. The overall restructuring in Shriram City (standalone) was about Rs 301 crore, equivalent to 0.93% of the portfolio as on March 31, 2022. Any material disruption in the collection efficiencies from incremental covid related disruptions and therefore any pressure on the asset quality metrics remains a key monitorable.

 

* High geographical concentration in lending portfolio

The company is focusing on offering small enterprise financing to customers beyond the chit fund clientele and is expanding in hitherto untapped geographies; Although the segment of borrowers has some credit history, this is an untested market for Shriram City. In view of this, CRISIL Ratings believes that asset quality performance, mainly in the small enterprise financing segment, remains susceptible and will remain a key monitorable over the medium term. While the company remains concentrated in the three states of South India namely Andhra Pradesh, Telangana and Tamil Nadu, it is working on expanding into newer geographies with the share of Northern and Western parts of the country together constituting 35.5% of standalone AUM as on March 31, 2022.

[1]Collection Efficiency = Total Collections including Overdues (excluding Prepayments) / Scheduled Billing for the month

Liquidity: Strong

Analysis of Shriram City's asset liability maturity profile as on June 30, 2022, shows cumulative positive mismatches in the upto 5 year bucket. The company continues to receive funding from banks through term loans, securitization/direct assignment and through NCDs.  The company has continuously managed to tap various borrowing sources having raised over Rs 13,895 crores in fiscal 2021 and Rs 14,786 crore in fiscal 2022. The company has also been able to raise funds via retail deposits consistently. The ability of Shriram City to continue to raise funds from diversified sources and competitive borrowing costs is expected to continue to remain adequate going forward as well.

 

As on September 30, 2022, the company had liquidity in form of unencumbered cash and bank balances of Rs 4,559 crore in addition to unutilized credit lines of Rs 2,150 crore, which comfortably covered around 3 months of debt repayments assuming zero collections. They have total debt payments (including working capital lines which are typically rolled over) of around Rs 3,226 crore till December 2022. Additionally, the liquidity profile is expected to be supported by collections.

Rating Sensitivity Factors

Upward factors

• Successful completion of the merger with no material impact on the merged entity’s financials will result in the overall credit profile of Shriram City to be equivalent to that of the merged entity
• Reduction and sustainability in standalone GNPA below 5%
• Increase in scale of operations while maintaining profitability (RoMA) at the current or higher levels

 

Downward factors:

• Increase in steady state gearing of above 5 times
• Deterioration in asset quality metrics or collection efficiency levels
• Inability to raise funds from diversified sources on consistent basis and at optimal costs

About the Company

Incorporated in 1986, Shriram City is a part of Shriram group of companies. It is registered with RBI as a systemically important, deposit taking, non-banking finance company (NBFC-SI-D). It predominantly operates in the retail financing segment with a focus on small enterprise loans, two-wheeler financing, gold loans, housing loans and others (auto and personal loans). Its assets under management (including housing portfolio) stood at Rs 42,663 crore as on June 30, 2022 of which the standalone AUM stood at Rs 36,117 crore, while the housing portfolio under Shriram Housing stood at Rs 6,546 crore. The company has pan India presence with 1021 branches as on September 30, 2022, of which 64% are situated in South India.

Key Financial Indicators: (Standalone)

As on/for the period ending/year ending	Unit	3 months ended June 30, 2022	March 31, 2022	March 31, 2021
Total AUM	Rs.Cr.	36,117	33,186	29,571
Total income (net of interest expenses)	Rs.Cr.	2,393	3,998	3,605
Profit after tax	Rs.Cr.	672	1,086	1,011
Gross NPA (ECL Stage-3)	%	5.9*	6.3*	6.4
Adjusted gearing	Times	3.3	3.4	3.2
Return on assets	%	3.3	2.9	3.1

*As per new norms

Any other information: Not applicable

Annexure - List of Entities Consolidated

Names of Entities Consolidated	Extent of Consolidation	Rationale for Consolidation
Shriram Housing Finance Limited	Full Consolidation	Subsidiary