Northern ARC Capital

Diversified tech driven financial services platform

Serves fast growing but high risk retail unserved lending segment

Northern ARC Capital is a diversified financial services platform catering to the diverse retail credit requirements of the under-served households and businesses in India. Over the last 15 years, the company has facilitated financing of over Rs 1.73 lakh crore touching 10.18 crore lives across India. The business model is diversified across offerings, sectors, products, geographies and borrower categories.

The company has developed domain expertise in enabling credit across six focused sectors - micro, small and medium enterprises (MSMEs) financing, microfinance (MFI), consumer finance, vehicle finance, affordable housing finance and agricultural finance.

The company caters to this retail credit market through a multi-channel approach that includes i) Lending, ii) Placements and iii) Fund Management, through proprietary technology stack enabling streamlined and efficient digital financing solutions.

Lending

The company is a systemically important non-deposit taking non-banking finance company registered with the RBI. It extends financing to Originator Partners (large network of financial institution partners, technology platforms and other entities that act as business correspondents to originate financial exposure) in the form of loans or investment in their debt to enable on-lending to the retail customer (Intermediate Retail Lending).

The company also extend loans directly to under-served households and businesses (Direct to Customer Borrowers) in the MSME, MFI, consumer and vehicle finance sectors through a ‘phygital’ (physical plus digital) approach with infrastructure network of 316 physical branches spread across 671 districts in 28 states and seven union territories and 50 select Originator Partners.

AUM has jumped 30% yoy to Rs 11710 crore end March 2024 with direct customer base trebling to 16.09 lakh end March 2024 from 4.66 lakh end March 2022. The direct to customer AUM surged 72% to Rs 5833 crore, accounting for 49.8% of AUM and indirect AUM rose 5% yoy to Rs 5877 crore end March 2024. The disbursements of the company increased 26% to Rs 14885 crore in FY24.

The company has a diverse lender base comprising banks, offshore financial institutions, NBFCs, development financial institutions (DFIs) and high net-worth individuals (HNIs). Its credit rating was upgraded to AA- (Stable) by ICRA and India Ratings in 2023 from A+ credit rating for all long -term facilities.

Placements

Through technology platform, Nimbus, the company works with a large network of investors across different investor classes who uses a platform to access opportunities to invest in under-served sectors (Investor Partners) including through Placements channel which includes structure and syndicate financing through a variety of debt, credit-enhanced debt and portfolio financing products for Originator Partners. The company also credit enhance/ co-invest in transactions as required to achieve the target credit rating and/or provide comfort to Investor Partners. This differentiates the company from other facilitators in the market. Placements volumes stood at Rs 11756 crore in FY24, down from Rs 13064 crore in FY23 and up from Rs 7326 crore in FY22.

Fund Management

The Fund Management channel is operated through subsidiary NAIM. Based on contributions received from Investor Partners, NAIM manages debt funds that invest largely in the sub-set of Originator Partners and mid-market companies in line with the investment mandate of the respective funds. In August 2021, NAIM obtained its registration as a portfolio manager from SEBI to conduct PMS and launched its first PMS fund in FY2023. The fund deployment volumes rose 6% to Rs 2683 crore and fund AUM increased 3% to Rs 2858 crore end March 2024.

In-house technology stack

The company has built an efficient and scalable business model, supported by proprietary end-to-end integrated technology product suite customized to multiple sectors. Its in-house technology stack consists of:

(i) Nimbus, a curated debt platform that enables end-to-end processing of debt transactions;

(ii) nPOS, a co-lending and co-origination technology solution based on application programming interfaces (API),

(iii) Nu Score, a customized machine learning based analytical module designed to assist Originator Partners in the loan underwriting process and

(iv) AltiFi, an alternative retail debt investment platform.

The differentiated credit underwriting processes and risk models have helped the company deliver strong asset quality and risk adjusted returns consistently across business cycles and macro events. Risk models are supported by a substantial data repository comprising over 35.17 million data points end March 2024 on portfolios across multiple sectors and qualitative field-level insights that aid credit assessment and monitoring.

The company has one of the lowest gross non-performing assets (GNPA) of 0.45% and net non-performing assets (NNPA) of 0.08% end March 2024. CRAR stood at 18.26% with Tier I ratio of 18.07% end March 2024.

The company stable cost of funds at 8.8% in FY2023 from 8.6% despite sharp increase in RBI repo rate. The cost of funds rose marginally to 9.2% in FY2024, while the company has improved NIMs to 8.3% in FY2024 from 6.5% in FY2023 and 5.5% in FY2022.

The Offer and the Objects

The initial public offer (IPO) consists of fresh issue to raise Rs 500 crore through issuance of 1.90 crore equity shares at the lower band of Rs 249 per share (face value Rs 10 per share) and 2.01 crore equity shares at the upper band of Rs 263 per share.

The issue includes an offer for sale (OFS) of 1.05 equity shares for raising 262.55-277.00 crore from the investors Leap Frog Financial Inclusion India (II) 3844449 equity shares, Accion Africa-Asia Investment Company 1263965 equity share, Eight Roads Investment Mauritius II 1746950 equity shares, Dvara Trust 1344828 equity shares, 360 One Special Opportunities Fund 1408918 equity shares and Sumitomo Mitsui Banking Corporation 923210 equity shares.

The company does not have any identifiable promoter.

The issue is to be made through the book-building process. It will open on 16 September 2024 and close on 19 September 2024.

The issue includes a reservation of up to 590,874 shares for employees with a discount of Rs 24 to the issue price.

The net proceeds from the fresh issue will be used for augmenting the capital base to meet future capital requirements. The issue will bring the benefits of listing the equity shares on the stock exchanges, including enhancing brand image among existing and potential customers and creation of a public market for the equity shares in India.

Strengths

The company has created large ecosystem of partners and data and technology platform leading to strong network effects and a scalable and diversified platform. It has built an ecosystem of 328 Originator Partners, 50 Retail Lending Partners and 1158 Investor Partners end March 2024.

In-house technology solutions and architecture drives a scalable and sustainable business model that enables to expand and scale business and drive growth in revenue.

There is vast market opportunity to lend in under-served households and businesses segment. Government initiatives have expanded the formal financial inclusion for underserved Indian population.

The Indian retail credit market has grown at a strong pace over the last few years and is expected to further grow.

The large potential for growth in the retail credit market, particularly in the rural and semi-urban areas.

Robust risk management based on domain expertise, proprietary risk models and data repository driving asset quality to one of the best levels.

A diversified presence across India mitigates the impact of any adverse geography specific risk events including natural disasters.

Sectoral diversification helps in mitigating the effects of slowing demand for credit in standalone sectors owing to cyclicality, events or regulatory changes affecting such sectors, and in maintaining the health of portfolio.

Diversification of portfolio is also governed through exposure ceilings and closely tracked by risk management committee.

The company maintains a well-diversified funding profile that is underpinned by established relationships with lenders and investors, proactive liquidity management system and strong credit rating.

Strong ESG Framework integrated into the business model with focus on creating sustainable impact and climate smart lending.

Weaknesses

The business operations involve direct and indirect exposures to relatively high credit risk borrowers in the under-served households and businesses. Such borrowers are perceived as higher credit risk to the company, its Retail Lending Partners and Originator Partners due to vulnerability to adverse economic conditions, unestablished business models, limited or no access to formal sources of credit, lack of adequate collateral, informal employment, lack of credit history or geographic remoteness.

A significant portion of investments are in credit facilities and debt instruments that are unsecured. The proportion of unsecured loans and investments stood at 42.55% end March 2024 compared with 39.73% end March 2023 and 33.12% end March 2022.

The microfinance, consumer finance and certain products in the MSME finance sector are unsecured and are susceptible to higher levels of credit risks.

The business is highly dependent on relationships with Originator Partners, Retail Lending Partners and Investor Partners for operations. Top 10 originator partners accounted 30.3% of GTV, top 10 investor partner for 25.3% and top 10 retail lending partners for 17.5% in FY2024. These partners are independent entities that have their own interests, strategies, and challenges. They may compete with the company or with each other.

The business model might involve conflicts of interest between interest of the company and its customers and partners.

The company source significant portion at 59.3% of disbursements on partnership base model and rely on partners for a variety of support and ancillary functions. The arrangements with Retail Lending Partners and DSAs are typically on a non-exclusive basis.

The company relies significantly on technology platforms and systems for business and operations.

Loans and investments in assets rated in the BBB category or lower or may not be rated is higher at 37.7% of assets end March 2024. Such assets may be illiquid and may not be able to liquidate in planned manner.

Valuation

Northern ARC Capital is diversified financial services platform with healthy financial track record. The company has recorded strong 48% CAGR growth in revenues and 34% jump in net profit for FY2024 from FY2022. AUM of the company has increased at 2-year CAGR of 28% in FY2024. The company also maintains one of the best asset quality among the NBFCs.

In April 2024, the company raised Rs 332 crore through issuance of 84.91 lakh compulsorily convertible preference shares (CCPS) to International Finance Corporation at issue price of Rs 391 and conversion ratio of 1.156 leading to per share prices of Rs 338.25. The IPO price is lower at Rs 249-263 per share.

EPS on post-issue equity works out to Rs 19.1 for FY2024. At the price band of Rs 249 to Rs 263, the P/E works out to 13.1 to 13.8 times of EPS for FY2024.

Post-issue, the book value (BV) will be Rs 197.8, while adjusted BV (ABV) net of net NPAs works out to Rs 197.3 per share at the upper price band. The scrip is being offered at price to Adj BV multiple of 1.3 times at the upper price band.

Among peer NBFCs in the microfinance, MSME and consumer finance space, MAS Financial Services is trading at P/ Adj BV multiple of 2.6 times, Creditaccess Grameen at 3.1 times, SBFC Finance at 3.4 times, Five-Star Business Finance at 4.3 times, Bajaj Finance 6.2 times and Cholamandalam Investment and Finance at 7.5 times.

In terms of PE, Creditaccess Grameen is trading at 13.9 times of EPS for FY2024, MAS Financial Services at 20.4 times, Five Star Business Finance at 26.3 times, Bajaj Finance 32.5 times, SBFC Finance at 38.0 times and Cholamandalam Investment and Finance at 38.7 times.

On profitability front, the ROA of Northern ARC Capital was healthy at 2.6% in FY2024. Among the peers, the RoA of Cholamandalam Investment and Finance was at 2.2%, MAS Financial Services 2.7%, SBFC Finance 3.5%, Bajaj Finance 3.9%, Creditaccess Grameen 5.1%, Five-Star Business Finance 7.2%.

ROE for Northern ARC Capital was muted 9.7% for FY2024 on post issue basis and fresh capital raising. RoE of SBFC Finance was also low at 8.5% due to capital raising, while that of MAS Financial Services was at 12.1%. RoE of Five-Star Business Finance was at 16.1%, Cholamandalam Investment and Finance 17.5%, Bajaj Finance 18.8% and Creditaccess Grameen 22.0% for FY2024.

Northern ARC Capital has posted strong 30% year on year growth in AUM to Rs 11710 crore end March 2024. The AUM of Cholamandalam Investment and Finance surged 44% to Rs 153718 crore, Bajaj Finance 34% to Rs 330615 crore, Five-Star Business Finance 39% to Rs 9641 crore, Creditaccess Grameen 27% to Rs 26714 crore, MAS Financial Services 25% to Rs 10126 crore and SBFC Finance 38% to Rs 6822 crore end March 2024 over March 2023.

The GNPA ratio of Northern ARC Capital was one of the best at 0.45% end March 2024. Among the peers, the GNPA ratio of Bajaj Finance was at 0.9%, Creditaccess Grameen 1.2%, Five-Star Business Finance 1.4%, MAS Financial Services 2.3%, SBFC Finance 2.4%, Cholamandalam Investment and Finance 3.5% end March 2024.

The NNPA ratio of Northern ARC Capital was also the lowest at 0.08% end March 2024, while that of Bajaj Finance was at 0.4%, Creditaccess Grameen 0.4%, Five-Star Business Finance 0.6%, MAS Financial Services 1.5%, SBFC Finance 1.4% and Cholamandalam Investment and Finance 2.3% end March 2024.