Five Star Finance shows unsecured lending is overrated


    Unconventionally traditional may seem like an oxymoron, but it fits Five Star Finance. There’s no better way to describe the Chennai-based non-banking financial company (NBFC). It has all the old-school trappings of a lender. From brick and mortar branches to 2,000 feet on the street that disburse Rs 3-4 lakh ($4,250 – $5,700) loans to small businesses. The unconventional part? Despite the relatively small loan sizes, Five Star still goes through the painstaking ordeal of taking property as collateral.

    A collateral-based model for such small-sized loans flies in the face of fintech logic. New age lenders like Capital Float and Lendingkart give similar businesses loans—even up to Rs 50 lakh ($70,900)—without the need for collateral. This sort of convenience has helped them grow at 150% year-on-year. The belief is that fintechs—unfettered by branches, collateral, hordes of employees to determine creditworthiness, and by using algorithms to underwrite loans, can achieve far greater scale. Which is why investors have made a beeline for companies like Lendingkart and Capital Float.

    The Journey Begins

    Five Star once looked set to fall in the heap of also-rans—the majority of India’s 11,000-plus NBFCs with loan books of less than Rs 1 crore ($142,000), it has seen an astonishing rise over the last 15 years.

    For the first twenty-odd years of its existence, it had a loan book of less than Rs 1 crore. This was cranked up to Rs 100 crore ($14.1 million) over the following eight years. And then, an explosion. In the next seven years, it grew 20X. Despite its cumbersome model.

    Its success has also drawn in some serious investment. Morgan Stanley put in Rs 114 crore ($16.1 million) in 2016. Then, in July 2018, global alternative asset firm TPG led a $100 million investment round in Five Star. This was TPG’s first punt on a medium-sized NBFC, pumping in around Rs 425 crore ($60 million). Their earlier investments were in Shriram Group and Janalakshmi Financial Services, both of which had a loan book of over Rs 10,000 crore ($1.4 billion). All told, Five Star has raised a total of Rs 1,000 crore.

    NBFCs as a sector have had a great run by taking credit where banks couldn’t go. The bigger NBFCs have grown at 25% for the last five years, with smaller ones growing as much as 30-40%. But the liquidity crisis brought on by the fall of infrastructure lender IL&FS has hurt microlending and brought uncertainty to the sector. “A lot of NBFCs will get consolidated or be marginalised as there is still some real danger of some large NBFCs going under,” says Nidesh Jain, an analyst at investment bank Investec. Five Star, armed with its funding war chest, won’t be one.

    Instead, this PE money is set to be the match that lights Five Star’s rocket fuel. It is expecting to disburse a total of Rs 2,100 crore ($298 million) by the end of March 2019. It plans to nearly double that to Rs 4,000 crore ($567 million) by the end of 2020. This won’t be unprecedented either—Five Star has been doubling in size over the past three years. This trend, it expects, will carry on over the next two years as well. It has also managed profitability. All while spurning the rules most fintechs believe are critical to success. What gives?

    The niche

    Even though there is more demand for finance than companies can ever meet, for lenders it has long been about finding a niche. A niche nestled in the intersection of a creditworthy segment, a large enough population in that segment, and the costs needed to service them. Banks have occupied the space for loans above Rs 30 lakh ($42,500) with collateral. Microfinance institutions have picked the segment for loans of less than Rs 1 lakh (~$1,400) with no collateral. Top NBFCs have filled most of the space in between, targeting customers in need of loans between Rs 10-30 lakh.

    This leaves the Rs 1-10 lakh segment, which Five Star calls home. Indeed, this segment has the most whitespace, and is also where most new age NBFCs and fintechs cut their teeth in their quest to avoid competition. Banks, typically, do not bother with this space, especially not with the added onus of collateral. “Banks’ thinking is why should they take so much effort to lend Rs 3 lakh ($4,250) when with that same effort they can give a Rs 30 lakh loan,” says Rangarajan K, Five Star’s CEO.



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