Fullerton India: Can Sumitomo Succeed Where Temasek Stumbled?

On Tuesday, Sumitomo Mitsui Financial Group Inc. agreed to buy a 74.9% stake in the firm for about $2 billion (about Rs 14,900 crore), effectively allowing Temasek to begin exiting the NBFC, currently a 100% subsidiary via Fullerton Financial Holdings.

According to two people familiar with the development, who spoke on condition of anonymity, Temasek has been actively exploring an exit from the business for the past two years. But it has taken a while to find suitors for the business at the desired valuation, one of the persons said.

Finally, it found an investor in Sumitomo Mitsui.

The investment, the company said in a July 6 press release, combines Sumitomo Mitsui's Asian push towards consumer and small business lending, with Fullerton's expertise in serving mass-market consumers and micro, small and medium enterprises in India. "SMFG and FFH will work together on the next leg of FICC’s growth," it said.

The deal, valued at roughly 3.5 times of Fullerton India's Rs 4,244 crore net worth as of March-end, has happened at a "rich valuation" that Temasek, otherwise, has found hard to get for the business in the past, the second person cited above said.

For a Japanese buyer, said Srinath Sridharan, an independent financial sector advisor, there is a great amount of comfort with having a seller like Temasek on the other end. "It ensures that the book is clean and the governance standards in the company are high. We should look at this as their entry into the Indian lending business through a platform," he said.

E-mailed queries sent to Temasek and Fullerton India on Tuesday went unanswered.

Fullerton India chose to focus on the high-margin unsecured lending business in India.

The non-banking financial company, which operates out of 648 branches across the country, gives unsecured group and personal loans to salaried and self-employed individuals in the urban and rural parts of India, while its remaining portfolio comprises secured mortgage loans to retail customers and MSMEs, along with vehicle loans.

The business proved to be a difficult one to crack. While growth was not tough to chase with the strong backing of institutional capital, asset quality remained a bugbear.

Between fiscals 2011 and 2021, Fullerton India's assets under management grew at a cumulative annual growth rate of 21% to Rs 20,858 crore, while its disbursements grew at 20% CAGR between fiscal 2011 and fiscal 2020 to Rs 16,584 crore, as per the latest data available on the company. The data for disbursement for FY21 was not available in the public domain.

"Comparatively, the NBFC (retail) industry AUM has grown at 16% over the last 10 years," said Karthik Srinivasan, senior vice president and group head - financial sector ratings at ICRA.

Early in its journey, Fullerton India faced strain after the global financial crisis, which led to an increase in delinquencies in India's relatively young unsecured lending market.

But by 2012, the NBFC had improved the asset quality of its book, although it reported a spike in delinquencies during the Covid crisis.

Gross non performing assets rose to 10% of its total advances as of March-end 2021 from just 2% a year ago. Comparatively, the gross NPA ratio for the NBFC industry stood at 6.4% at the end of fiscal 2021, as per RBI's financial stability report released on July 7.

The fall in asset quality, said rating agency ICRA in its June 30 note, was mainly due to a large proportion of unsecured loans in its portfolio. "A large proportion of the unsecured loans in the portfolio (57.2% as of March 2021) makes the asset quality more susceptible to economic cycles. This is owing to the lower recoverability compared to secured loans, wherein the collateral can be liquidated," it said.

Recently, Fullerton forayed into new product segments like loan against shares and developer funding to diversify its portfolio and increase the share of secured loans. "However, the inherent risks in these businesses, especially in the current credit environment, partly outweigh the benefits of these products," said ICRA.

The lender reported a net loss of Rs 1,157 crore in fiscal 2021, compared to a net profit of Rs 747 crore in fiscal 2020, the rating agency said.

Over the years, Fullerton India also had to knock on Temasek's doors for capital as credit costs remained high, the second person quoted above said.

Over the past six years, ICRA noted that the lender's parent had infused capital worth nearly Rs 1,550 crore, including a Rs 750-crore infusion in fiscal 2021, which helped the company maintain its capital buffer.

"With equity infusion and decline in loan book the adjusted gearing (borrowings divided by adjusted net worth) eased to 4.76 times as on March 31, 2021 from 5.49 times as on March 31, 2020," said ICRA in its note.

Despite the modest success of Fullerton India over the years, Sumitomo Mitsui's decision to buy into the business seems to follow the Japanese lender's plan to expand its presence in India.

“India is one of our focus markets where we believe in its high growth potential and want to build a deeper presence. As a long-term investor, we believe that the FICC platform’s innate strengths of multi-product focus, pan-India distribution, and strong management will enable us to build a comprehensive financial service offering in India," Jun Ohta, president and group chief executive of the Japanese lender, said in the July 6 statement.

Not everyone sees merit in this approach.

The rationale for the deal still remains unclear, said Hemindra Hazari, an independent banking analyst. "It is not clear why a foreign bank, which has the regulator's approval to be in India would want to buy a retail lending business here. Especially, when Sumitomo Mitsui has largely been doing corporate lending here."

Sumitomo Mitsui has a licence from the Reserve Bank of India to run its own banking business in the country. Currently, it lends to Indian corporates through its two branches in Delhi and Mumbai that were started in 2012 and 2017, respectively.

Hazari said the retail market is crowded and the effects of the pandemic are still playing out. "The franchise they are looking to buy has been struggling in the local market. Without a substantial footprint on the ground, it is unclear how this retail and SME lending business is likely to grow."

Sridharan sees it differently and suspects its part of a wider plan.

The Japanese firms, he said, enter a new market as a group rather than as an individual strategy, which is usually based on the success seen by the first entrant in terms of growth, and the experience with political and compliance risks.

"If Sumitomo Mitsui's entry is any indicator, we can anticipate many more Japanese firms entering the Indian financial services," he said.

Sumitomo's investment in Fullerton will improve profitability and diversify its overseas operations without any significant weakening its balance sheet, said Moody's Investors Service in a note on Wednesday. "However, with Sumitomo Mitsui Financial Group's international business accounting for around 40% of its risk-weighted assets as 31 March 2021, additional foreign acquisitions will challenge its ability to manage its growing overseas business alongside its strong domestic franchise."