Recent investments by foreign players in Indian nonbanking financial companies, or NBFCs, possibly indicate greater overseas interest in a sector that allows access to a large unbanked population and is subject to less onerous regulation compared to banks, analysts say.
Japanese megabank Sumitomo Mitsui Financial Group Inc., or SMFG, on July 6 announced a deal to buy 74.9% of Fullerton India Credit Co. Ltd. from a Temasek Holdings (Pte.) Ltd. unit for about $2 billion. The deal is a part SMFG's expansion strategy in Asia, as the group aims to capture growth opportunities in India's financial services sector serving retail customers and small and medium-sized enterprises. The megabank intends to eventually convert Fullerton India Credit into a 100%-owned subsidiary.
"India's NBFC sector offers plenty [of] growth opportunities, given the underpenetrated retail market and superior profitability prospects," said Nikita Anand, credit analyst at S&P Global Ratings. "Typically, NBFCs have higher margins compared to the banking sector because their assets are riskier, which translates to better return on assets and return on equity," she said.
In May, private equity firm The Carlyle Group Inc. announced a plan to invest up to 31.85 billion rupees in PNB Housing Finance Ltd., leading a consortium of foreign investors seeking to buy 40 billion rupees of preference shares and warrants in the Indian home lender. The deal is currently awaiting a court decision after the Securities and Exchange Board of India, the markets regulator, objected to the proposed transaction.
M&A activity in India's NBFC sector — both by number of deals and aggregate transaction value — has picked up this year. As many as 21 deals were announced between Jan. 1 and July 9 with an aggregate transaction value of about $7.1 billion, according to S&P Global Market Intelligence data. Foreign players accounted for at least $2.5 billion of the deals so far this year.
The number of deals announced so far in 2021 already dwarfs the total 19 transactions worth about $200 million in 2020. While the COVID-19 pandemic may have slowed dealmaking last year, the year-to-date amount is already more than the combined total of the previous three years, the data shows.
Social objectives
Investors, including from overseas, may seek out well-managed Indian NBFCs, Anand said. "It also fulfills social investment objectives because many NBFCs serve rural areas and unbanked customers," she said.
India still has a large unbanked population with 190 million adults without a formal bank account, according to the World Bank's Global Findex database. NBFCs can often reach these customer faster, as traditional banks often lack the ability to reach outside of their branch hinterland. India's shadow lenders have also been plagued with high-profile failures of companies such as Infrastructure Leasing & Financial Services Ltd. and Reliance Capital Ltd. However, India's NBFC crisis reduced valuations in the sector, making some of them more attractive for local and international buyers alike.
International investors in India's NBFC space include both private equity firms looking for deals as well as companies with long-term strategic intent. In 2019, funds managed by The Blackstone Group Inc. bought a majority stake in Aadhar Housing Finance Ltd. The Indian lender is now seeking to list via a planned initial public offering.
International investors are keen to tap the economic growth potential that the nation with the world's second-biggest population offers, said Chris Mallin, London-based founder of CMMP Advisory, who has been analyzing and investing in Indian financial services since the early 1990s.
However, foreign investors may be more interested in companies with "highly disruptive, tech-led strategies" than existing banks and NBFCs with legacy challenges. "Private sector banks successfully disrupted the industry over the past few decades. The key question is who are the future disruptors of Indian financial services and will they disrupt the disrupters?" Mallin said.
Regulatory oversight
The capital requirements for NBFCs are less stringent than for banks, an added attraction for potential investors. However, India's central bank has, in recent years, increased its regulatory oversight over the sector due to the potential spillover effects of troubles in the sector on the nation's financial system. NBFCs and housing finance companies are the biggest receivers of bank funds, according to the Reserve Bank of India.
Credit extended by NBFCs rose 8.8% in the fiscal year that ended in March 2021, after slowing in the previous year, the reserve bank said in its biannual Financial Stability Report published on July 1. Despite the pandemic, the sector's net nonperforming loans ratio fell to 2.7% last year, from 3.4% in the fiscal year ended March 31, 2020.
Investors may also be interested in NBFCs that focus on personal credit, microfinance, affordable housing and vehicle finance — sectors that are expected to see high growth in the coming years, according to an analyst at Indian broker Emkay Global who declined to be identified by name due to company policy. "Consumer credit is also likely to see a major surge as customers become more tech savvy," the analyst said.
The biggest M&A deal in the Indian NBFC space was Piramal Enterprises' $4.68 billion proposed purchase of Dewan Housing Finance Corp. Ltd. earlier this year. Other notable deals in the sector in recent years include Bandhan Bank Ltd.'s $3.50 billion acquisition of GRUH Finance Ltd. in 2019.
"The retail lending segment should attract more players going forward. However, we could see some niche players taking an interest in the wholesale lending space as well, either through their own balance sheets or through funds," said Krishnan Sitaraman, senior director at CRISIL, a unit of S&P Global in India.