By Jindal Haria

India Ratings and Research (Ind-Ra) has assigned NeoGrowth Credit Private Limited's (NeoGrowth) proposed INR500mn non-convertible debentures (NCDs) a rating of ‘Provisional IND BBB’ with a Stable Outlook.

The rating reflects NeoGrowth’s ability to sustainably implement a merchant finance-centred business model while capitalising on the fast-growing digital payment ecosystem. NeoGrowth benefits from an early-mover advantage in this segment, considering digital technology is already in place for credit monitoring and risk management. Also, the company capitalises on its promoters’ experience of over 20 years in the payments industry. Its investors are focused on financial inclusion and longer investment tenors than those of private equity firms and mutual funds. They made an equity investment of INR1.1bn in June 2016.

Moreover, the rating reflects the higher risk profile of its borrowers, unsecured nature of its loan products, untested borrower behaviour in stress and limited track record.


KEY RATING DRIVERS

Capitalises on Low Capabilities of Merchants: NeoGrowth’s core borrower segment (i.e. retail merchants) faces challenges such as low profitability, excessive documentation and long bank loan turnaround time. The company’s credit assessment model is largely based on electronic sales patterns and borrower credit behaviour. NeoGrowth processes loans in a short period. Moreover, NeoGrowth follows a daily repayment model, where merchants’ sales transactions are carried out using debit and credit cards at its partners’ point-of-sale terminals. It monitors sales, borrower behaviour, payments and settlement behaviour daily across its portfolio.

Manageable Credit Costs: NeoGrowth operates at the higher end of the yield curve, where annual interest rates on most loans are in the range of 25%-35% on reducing balance (1HFY17: INR3.9bn loan book). In the long run, NeoGrowth will have to continually add new borrowers to continue to operate at these interest rates (about 65% merchant retention rate). Overdues for 15 days and above have remained at 2%-3% of the outstanding portfolio. Ind-Ra expects the company’s credit costs to remain at 2%-3% in the medium term. Ind-Ra’s stress tests indicate profitability buffers would absorb 10%-15% merchant mortality in the discretionary segment (about 50% of the company’s portfolio) by about FY19. To expand its portfolio to about INR20bn by FY20, NeoGrowth plans to acquire 7%-10% of addressable merchants with point-of-sale terminals. Addressable merchants were estimated to have stood at 0.3m-0.4m in 4QFY16.

Diversification of Funding Sources Likely to Pose Challenge: NeoGrowth had high borrowing costs of about 14.3% in 1HFY17, considering its main lenders are non-banking financial companies (NBFCs). The company plans to diversify its sources of funding by using structured products and accessing other development financial institutions until bank loans form a higher portion of its liabilities. The company has tied up its financing requirements up to March 2017. In Ind-Ra’s assessment, funding could be challenge for NeoGrowth’s expansion owing to the nature of its loan assets. At existing levels of borrowings, liquidity is comfortable due to the short tenor of its loan assets (90% of its loan portfolio have a tenor of less than two years). In the longer run, liquidity will depend on NeoGrowth’s ability to raise higher tenor liabilities continually to fund assets. Ind-Ra expects the company to have a lower leverage (1HFY17: debt/equity 1.94x) than those of similar rated peers because of its borrower profile.

Declining Operational Costs Key to Profitability: NeoGrowth faces operational risks, where the merchant could replace NeoGrowth’s point-of-sale terminal or prompt customers to pay by cash, resulting in NeoGrowth’s loss of visibility about borrowers’ cash flows. Such risks are partly mitigated by its daily monitoring model. Although alternate payment channels such as e-wallet and unified payment interface could pose a threat to the current business model, the company’s experience in non-cash payment channels could help it address this threat. Ind-Ra expects NeoGrowth’s operating cost as a percentage of average loans to decline to about 8% in FY19 from 25% in FY16 on account of an improvement in operating leverage.

In the last two years, the company installed credit assessment and monitoring systems, hired a field team, appointed experienced management members and set up a network of agents and branches. Operating leverage could improve return on assets to 3.5%-4% by FY19 from about -0.9% in FY16. The company started making profit in 1HFY17, with a profit before tax (not adjusted for prepayment expenses of INR12.5m) of about INR15.9m.


Adequate Capital
: NeoGrowth plans to maintain a minimum capital adequacy ratio (CAR) of about 20% and a Tier 1 capital of about 15% (September 2016: INR1.51bn equity capital, 37.4% Tier 1 capital and 37.4% capital adequacy ratio). Considering its asset profile, Ind-Ra expects NeoGrowth to maintain higher capital levels than those of its peer-rated NBFCs on an ongoing basis.


RATING SENSITIVITIES

Positive: Sustained growth in operational scale and portfolio while maintaining credit quality, diversification of funding sources, ability to raise longer tenor debt while maintaining adequate short-term liquidity, and strong capital and operating buffers would enable the company to move down the borrower risk curve, leading to a positive rating action.

Negative:
Unsustainable increase in credit costs, capitalisation falling below or nearing minimum regulatory requirements and net loss in a financial year could lead to a negative rating action. Moreover, the company’s inability to consistently reduce operating costs or an unsustainable leverage could lead to a negative rating action.


COMPANY PROFILE

NeoGrowth is an NBFC with 11 branches that primarily lends to retail merchants. Its loan portfolio stood at INR3.92bn at the end of September 2016.



SOLICITATION DISCLOSURES

Additional information is available at www.indiaratings.co.in.The ratings above were solicited by, or on behalf of, the issuer, and therefore, India Ratings has been compensated for the provision of the ratings.

Ratings are not a recommendation or suggestion, directly or indirectly, to you or any other person, to buy, sell, make or hold any investment, loan or security or to undertake any investment strategy with respect to any investment, loan or security or any issuer.

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Analyst Names

  • Primary Analyst

    Jindal Haria

    Director
    India Ratings and Research Pvt Ltd Wockhardt Towers, 4th floor, West Wing Plot C-2, G Block. Bandra Kurla Complex Bandra (East), Mumbai 400051
    +91 22 40001750

    Media Relation

    Mihir Mukherjee

    Manager Corporate Communications and Investor Relations
    +91 22 40356121