Arman Financial Services Limited (531179) Earnings Call Transcript & Summary

But this is typically our experience that when we go to a new place for at least the first 12 months to 18 months, you don't really run into any credit issues. So the first time you go in is usually a honeymoon period, I guess?

Okay. Okay. Got it. Got it. And sir, my second question is, how do you see the change in the borrowing mix, wherein if you see your share of bank mix and DA that has gone up. So any broad strategy, any change over there that you, see?

In the borrowing?

Yes, in the borrowing mix.

So if you look at it, let's say from '23 to '24, I think the borrowing dependence on the banking increased and in fact, the borrowings from larger NBFCs have considerably gone down during the financial year '24. And last few quarters and for the future, I think we are scaling up our NCD -- retail NCD as a promising way to borrow money and that should kind of go up from something like 12%, 13% to a sizable 20%, 25% maybe.

And so I think almost 41% of our overall borrowings are coming from banks. But the second largest borrowing is from -- believe it or not, is off-balance sheet debt, which is direct assignments.

Which is also banks.

Which is also banks only, of course. And in that case, we are getting quite a bit of -- quite a good rate, you can call it. The effective rate is -- all said and done is very attractive to do these DA transactions. I don't know what this year will look like. I'm guessing that DA demand will be as much as it was last year, I'm guessing. But I think the third largest will probably be the NCD, the listed NCDs or retail NCDs, whatever you call it. So wherever we are -- wherever we get a rate advantage and somewhat reliability of funds, that is where we try to borrow from. Of course, that goes without say, but...

The next question is from the line of Ashlesh Sonje from Kotak Securities.

A couple of questions from my side, sir. I see that you now have a fairly wide presence in the Microfinance business in more than half a dozen states. Just to get your philosophical perspective, in your view, does the Microfinance business operate in different ways across different states? Or in other words, how much customization do you need to make to your operations when you enter a new state based on the behavioral patterns of customers in that state?

So that is actually an excellent question. And like all complicated questions, the answer is that it depends. The good part about Microfinance is why it's somewhat easier to grow than other form of businesses that it is easily replicable. So my systems that work in Gujarat will largely work in Jharkhand, even though culturally, those 2 economically, culturally, socially in every way, these are very different states. But I would have to adapt my credit underwriting policy depending on which areas I'm operating. And that not only depends on state-to-state, but it depends on district-to-district also. And in fact, if you go to the branch level, that depends on -- even on a village-to-village level, right, depending on the different occupations and communities and other areas that people operate. So while the processes are extremely generic across India, the overall underwriting policies and risk factors to consider are tailored on a state-to-state level, if that makes sense.

Sir, and secondly, on the commentary which you made around collections seeing some pressure across different areas. Can you just give some more insight on what are the challenges, which you are facing, and which states in particular are seeing those challenges?

See, I mean, without sugar coating things, Microfinance had an amazing run post-COVID. I don't think anybody would disagree with that. The regulatory environment was fantastic, the margin caps were removed, funds were available, overall operating costs were under control, borrowing costs were under control and the asset quality was fantastic. It was better than anybody expected. Now as a result of growing extremely well in the last 2 years, there have been certain pockets that they have been overlevered. There have been certain customers that have been overlevered. Now I'm not going to say I'm holier-than-thou and say, I have nothing to do with this and others are being more aggressive. I mean, we are all swimming in the same pool. And so what effects, one player will affect the industry. So it's nothing to be overly concerned about. But certainly, as MFI players, we have to take stock of the situation, maybe accepted that no honeymoon can last forever and we are getting back on track. Things are getting back regular. The gains that we saw in the last 2 years post-COVID, the demand has kind of caught up overall. And so I don't know if that kind of answers your question in a very roundabout way. But largely speaking, my guess is that most of the problems are caused due to certain customers borrowing more than they can afford.

[Operator Instructions] The next question is from the line of Ayush Agarwal from MAPL Value Investing Fund.

Sir, my first question is that when I look at 3 years ago, like this question is for Aalok-bhai specifically. The average ticket size was around INR 28,000, and today it stands at about INR 47,000 -- INR 46,000, INR 47,000. So...

Mr. Agarwal, may I request that you use your handset, please. Sir, your audio is slightly muffled as well, sir.

Is this better?

Yes, sir, please go ahead.

All right. Sir, I was saying that -- I was talking about the MFI specifically. When I look at data 3 years ago, our average ticket size was about INR 28,000. And currently, it stands at about INR 46,000, INR 47,000. So would like to understand if there are change in strategy when it comes to MFI and we are more okay with higher ticket size the MFI lending because earlier, we wanted to keep it down and maybe move the customers to MSMEs when they grow in size? So your thoughts on this will be helpful.

No, see, overall, the ticket sizes in the industry have been increasing. Specifically for us, we started -- when I started Microfinance in 2010, it was INR 10,000, 1-year loan. And then the ticket sizes started going up, overall, the demand started going up more. Customers were not satisfied with just INR 10,000. And so as the ticket size went up, the tenure went up. And so we switched to a 14-month product, post which we switched to a 18-month product. And now we are at a 24-month product. So the overall goal has been always to keep the EMIs at a affordable rate or at an affordable level. That being said, yes, the overall ticket sizes on average have increased faster than they normally do post-COVID. That is just the new market reality and also the fact that post the new RBI regulations, wherein the restrictions were not put on total indebtedness, they were put on FOIR. The ticket sizes are a natural kind of cause of those new regulations. Also, let me -- I've always said this, but let me mention again that as MFIs we largely compete on 3 things. And the first one is not rates. So while we do compete on rates, our customers are not very, very rate sensitive. What number -- one thing that we compete on is service. And by service, the customer wants as hassle free of a loan experience as possible. They don't have time nor the knowledge, nor the inclination to jump through 20 hoops to get your loan. They want it as simply as possible. And once you disperse the loan, they want to repay it back as simply as possible as conveniently as possible. Number two, we compete on a quick turnaround. So our customers need the money yesterday. They don't need it today or tomorrow. They needed it yesterday. So I have to process my loan as quick as possible. And number three, what I compete on is ticket sizes. So as an MFI, I cannot be a complete outlier, I mean I cannot be in a situation where I am lending INR 20,000 and the industry is lending at INR 50,000 or INR 60,000. I have to find some reasonable balance between risk and being competitive or staying competitive. So that's where the ticket sizes have wound up. But it's fine. We don't see a lot of stress due to ticket sizes. I mean, we do a lot of data check. We do a lot of analysis. There is not a lot of correlation that we have found between customers that we have lent higher ticket sizes to versus lower ticket sizes to.

Got it, sir. That was helpful. Sir, second question is on the collection efficiency. Pre-COVID, it was around -- above 99%. And right now, I understand it's a post-COVID scenario. But do you see your collection efficiency moving beyond 98%, 98.5% in MFI -- maybe in a couple of years?

No. I mean that pre-COVID Microfinance of 99% is behind us. And let me also give you the disclaimer that people put a lot of emphasis on repayment rate, but apparently, every company has its own way of calculating repayments, and there is no standard accepted formula for repayment rate. But that being said, if you -- let's put repayment rate aside and talk about the bottom line, which is credit cost, right? If I'm lending INR 100, how much money am I going to not get back? And so earlier pre-COVID during minus demon and AP crisis and other times, largely, we were at about a 1% credit cost, 1%, 1.5% on average. Those days are unfortunately behind us. And you have to understand that when we started Microfinance, the total portfolio of the entire industry was INR 20,000 crores. Now it is something like INR 4.5 lakh crores. So earlier, we used to manage cherry picking the customers. Now that cherry picking, you'll have to kind of move slightly higher into the tree to -- overall to use that analogy, I guess. So on a steady state over the next, let's say, 3 to 4 years, I would say that on average, the credit cost should be about 2.5%, not to exceed 3%. But again, these -- take whatever I say with a grain of salt, some people say I'm too pessimistic, but that is the reality.

[Operator Instructions] The next question is from the line of Sanidhya from Unicorn Assets.

So my question is -- basically 2 parts to my question. One is just basic numbers and other is more on a philosophical side. So let's go on the numbers first. So our NIMs have like reached around 15% like quarter-wise or yearly as well and the yields have been significantly good for us. Whereas the collection efficiency is slightly deteriorated and versus the provisions that we have made have not very much increased. So how do you look at the whole scenario? So the NIMs are positive. There is collection efficiency a little bit negative. Provisions on the other hand, have been in line with the previous year. So I want your view on these 3 things together?

Okay. So that's the -- what is the philosophical question?

That's more on the...

This is the number question.

Yes, now this is the philosophical one only. So I want to understand how you see this. Like this is not the typical pattern that we see in the industry, either we see that the NIMs have been decreasing because of the credit costs and overall profitability is also hit when the collection efficiency and provisions are rising. But right now, this is some different situation. And even hearing you makes me think that what's actually is going on in the industry. So your view in this.

Why should NIMs be affected due to credit cost? NIM is a function of interest expense and interest income, right?

Yes. No, on an overall basis, I was just saying that on a -- like compared to the -- on an ROA basis, you can say that ROA is also increasing...

No, our ROAs are fantastic. Our ROEs are fantastic. I mean...

Yes.

Our NNPA is about 30 bps, which is -- might as well be 0. Over and above that, we have a management overlay of what, Vivek, about INR 20 crores, INR 30 crores?

So that's part of the INR 90 crores.

That's part of the INR 90 crores, okay. So I mean, we are covered more and more so -- than anything else. The -- see, you can run into a 20 bps issue here and there as far as repayment that is life. People love to have things smooth, especially the investor community love to see smoothness. But life is not smooth. You are going to run into peaks and valleys all the time. And it is what it is, but everything else is going in our favor. The regulation is in our favor. If credit costs rise even further, we are at liberty to increase our rates to offset that. We are expecting our lending cost to -- or borrowing costs to decline. Operating cost is under control, largely speaking. So NIMs are great, 15% NIMs. So we have very little to complain about, besides the fact that repayment rates have been going down for the last few months. It is what it is. You cannot have every variable in your favor. There is -- it's a business after all. Things are not always absolutely in your control.

No, right. So I was just thinking that why don't we take extra provisions, precautionary provisions if the efficiency is going down like it doesn't happen that we have to suddenly provision for a large chunk?

So as a person who's gone through 3 different types of crises and in my previous career one more, let me tell you that when the crisis does come, no accrual -- magic accrual number in your balance sheet is really going to help you. What's going to help you is stuff like how much cash you have in your bank account? How -- what is the quality of your team that you have? What was the underwriting standards that you used to disperse the money and many, many other factors. All that an accrual account does is smoothen the income. But otherwise -- so reserve and surplus is that only, right? I mean it's just that. It's a different reserve. So we do have a management overlay by the way. So that is already there. I don't want you to get too caught up on this, putting aside a slush fund. I mean these are just accounting entries. There is no real money line in the bank accounting except the cash in your bank. And these things are not going to help you in a crisis as far as operations are concerned, it's just going to smoothen the income, which is going to -- as I said in my previous answer, that everybody loves this smooth everything. And -- but anyway, I mean like I'm not opposed to it. I could do it. I just don't see the -- Vivek, I don't know, you can go ahead.

So again, if you look at the overall provisions, there are 2 factors that I would like to numerically look at. One is the GNPA and the net NPA. Now net NPA at a group level is sub-0.5% or it's 0.3%. So largely, you kind of covered up your nonperforming assets completely. And overall, the provisions at the AUM level is about 4%, which is, generally speaking, a fairly good provision as we look at the overall asset quality of the company. And we normally over the last -- I mean, it's not that we have had aggressive write-offs or early write-offs when we hit challenges. That's been a consistent way that we've kind of dealt with the portfolio through various challenges, be it demonetization, be it COVID, first wave, second wave so on.

My strategy has always been that never get yourself into anything that you cannot exit from. And so all of these policies about provisioning and ECL and everything, are like Board approved and gone through 3 different auditors and concurrent auditors and bankers and so on and so forth and everybody has accepted it. Now for me to change that policy and put in some slush fund in there, if I ever need to reverse it, I'm not going to manage doing it. So like never really do anything that you don't -- can't get yourself out of. I mean, that has always been my strategy. Again, I'm not opposed to it. What I can do is be extremely aggressive with provisioning write-off, which is what I'm doing right now, right? So there is -- just because I write-off something in the accounts that does not mean it's an operational write-off. My people continue to follow-up on it for a year or 2 years or as long as there is an expectation of getting some money out of it, whether it's legally or through collection or through follow-up or agencies or whatever it has to be, but I have never been in favor of this ad hoc. And I don't even think it's possible just for me to wake up and ask Vivek, "Vivek, what is the profit? Oh, it's INR 175 crores. Can you put aside INR 30 crores as an overlay over and above whatever is the ECL?" That's not even possible to do. I mean we are a listed company. We have policies, we have Board approved policies that we need to follow.

Very much, very much, that's great to hear. Secondly, I wanted to ask you that like on an aggregate level, the customers to whom we are offering a credit, like what do you think how many other players in the market are also offering the credit to the same customer? Because this came, because you were saying that looks like the customers are over leveraged. And secondly, just -- and to add-on that we are now expanding in different states. So should we expect the operational expenses to be a little higher going forward?

Yes. So to answer your second question first, yes, marginally operational expense, especially salaries initially might be higher. But by the end of the year, that catches up. So this is what typically happens, during Q1, it's slightly higher and by Q4, it settles down. So that's as far as operational costs. We don't expect that to be very, very different in the coming year as well. Your first question was about people borrowing from other MFIs, right, or other lending institutions?

Yes, same customer from the different...

So that is very, very common. I think only about 20% to 25% of the customers are new to credit or...

Unique to us.

Or unique to us overall. 75% of our customers would have another loan from some other institution, whether it is a Kisan credit loan or a tractor loan or a MFI loan or gold loan or what have you, right? It will obviously be there. Overall, what we try to do is assess their income, figure out what their EMI burden is for all the other loans and figure out whether they will manage affording our loan. So that is the goal here. Where the overleveraging part comes up is that the last thing which I said about figuring out their FOIR, that is easier said than done because our customers don't come with paperwork. It has to be a judgment call. So if my judgment says this guy is good for -- this guy's income might be INR 2 lakh a year and he's good for a total EMI burden of, let's say, INR 8,500. Some other MFI might say that he has an income of INR 3 lakhs, and he is good for a EMI of INR 12,500. So it just depends. Now all of these incomes are being reported to the credit bureaus. So I can -- not right now, but hopefully, in a couple of months, start seeing what the other people have been reporting this person's income to be, but it's very complicated, right? Because maybe through the SRO, the MFIs can kind of bundle together and figure everything out. But with the PSU banks and private banks and SFBs and stuff, and there are so many flavors of lenders nowadays, it will be extremely difficult to get everybody on the same page and going together. So that's basically the reality on the overleveraging. But the good part is, and not to -- is that there is no CEO or Managing Director or Founder or anybody that I have ever met says, "Close your eyes [Foreign Language]." I've never met anybody like that. Everybody has an interest in self-preservation. And so as a result of that, the hope is that you might be slightly more conservative, others might be more aggressive. But on average, everybody will think with a good head on their shoulder and good judgment will prevail in the long run, right? And that is true in the lending business, in the stock market business or whatever you call it. That is true all around.

Yes, understood. But I was just going through some other competitors. So they are -- many are shifting to now to weekly recollection model due to the same problem of collection efficiency. But do you think it would help us -- like we are thinking somewhere down the line to shift to weekly for some customers?

No, not as of now. I mean kudos to them that they are making an effort. But largely speaking...

What's your take on this?

I am a bit skeptical. Because -- not because I think weekly is a bad model, I don't think that at all. If you are able to have larger center sizes, it's possible to do it. Now to do larger center sizes, what you have to do is to create a variable center model. That means you create a smaller center and add-on more and more members into that center as time goes on. So in my case, with a static center model, the center sizes are too small for it to be operationally feasible from purely an operating cost perspective. So for me, I would have to change my model in both ways. I would have to basically start this perpetual model, number one. Number two, I would have to be okay with doing a lot of secondary or top-up kind of loans where you keep giving some newer loan to the customer to keep them interested. But I think in the long run, if you look at my typical rural customer, they are going to get sick and tired of coming weekly. This is 2024. Customers have plenty of choices to borrow money. If you're going to ask them that, "Oh, every Monday, you have to come here for half an hour, step away from your business, step away from your other activities and come and sit in a center and repay the money." I think the attendance is in the long run going to be abysmal. What we should be thinking about is how we can convert these customers into cashless. How we can avoid the centers in the first place. I mean these are actually quite interesting debates that we ourselves get into amongst peers, where somebody wants to remain traditional and say that we need to go back to basics and others are talking about saying that, "Well, there is no basic anymore. It's 2024. You have to think forward and nobody is really right or wrong in these situations." So for me, if I could do it, I would be happy to do a weekly model. I just don't think it will be feasible in the long run and -- maybe I am wrong about that.

Okay. Okay. And lastly, if you can just tell me that you were saying the INR 5,000 crores AUM you are aiming. So which FY you are thinking? '26? '27...?

Largely, I think we have shied away from giving those kind of specific guidelines.

Yes, give us a quarter or 2 to rework. I mean, originally, it was somewhere around about '26, '27 or something is what the guidance we were giving. But let us see where things settle down as far as credit cost goes, and we'll get back to you on this.

Ladies and gentlemen, that was the last question for today. I now hand the conference over to Mr. Mayank Mistry from JM Financial for closing comments.

Thank you all for joining the call today. And thank you to the management team of Arman Financial Services for giving us this opportunity to host the call. Thank you.

Thank you.

Thank you.

Thank you. On behalf of JM Financial, that concludes this conference. Thank you for joining us, and you may now disconnect your lines.