Which NBFCs do we choose to work with? (Part 1)
As we are talking to more and more users, a common question that comes across is how do you guys choose the NBFCs? As these are not branded NBFCs like Bajaj, Mahindra, etc. The question is valid.
So How do we choose the NBFCs to work with?
Well, we call it magic sauce, but we are not KFC/ Coca-cola to hold onto the secret formula. Instead, we want our users to know what we do, how we do and why we do it when we do something.
Therefore, we decided to write a series of posts on how do we choose the NBFCs.
By now, you would know that our core investment philosophy:
- Fixed/ Steady/ Predictable returns.
- Secured by real assets like gold, real estate, and vehicle, etc.
- Bankruptcy Protected
Now, would we do every asset that falls under this?
Obviously No! There are many more filters!
We make sure that all deals are bankruptcy protected. However, we will work only with NBFCs, which we think will not go bankrupt.
If NBFC runs smoothly, the money is going to flow back smoothly. So how do we judge whether NBFC has a higher/lower chance of going bankrupt?
The first thing we check is leverage. What is the leverage? How is leverage calculated?
Leverage = Debt/equity.
An NBFC has a 1000 Cr Loan book, and it has equity of 250 Cr. it means NBFC has taken 750 Cr debt.
In the above case, leverage is 750/250 = 3.
Why is leverage important?
Any sudden event may cause some losses to NBFCs. In such cases, the equity absorbs the loss. Thus, it acts as a cushion or shock-absorber.
If leverage is less, NBFC would lose some equity but survive the loss.
If leverage is high, then losses can wipe out the equity, and NBFC would go bankrupt.
Consider an event like covid, which causes, say, 5% losses across all NBFCs.
There are three NBFCs with 600 Cr loan book but different leverages: 3,4,5
Notice how if the leverage is already high, after a 5 % loss, it increases dramatically.
Note that NBFC can have a maximum of 5.66 leverage. If NBFC goes beyond 5.66 leverage, RBI will intervene, and NBFC may lose the license and have to shut down the business.
So as a safe side, we work with NBFCs with leverage of 4 or less.
Beyond 4, it becomes too risky for our style. 3–3.5 is our sweet spot, and less than 3 is a party!
Our next deal is going live this Wednesday( 23rd Dec). It is a gold loan portfolio of NBFC named KanakaDurga. KanakaDurga has a leverage of 3.4.
So leverage is the first filter that we use. Then what’s our next filter?