The recent announcement by Shriram group to merge Shriram City Union Finance Limited (SCUF) with Shriram Transport Finance Company Limited (STFC) would result in a rise in STFC’s exposure to riskier asset segments, according to Fitch Ratings.
This, along with management’s plans for higher growth by the combined entity, could heighten STFC’s risk appetite and raise asset-quality risks, cautioned the credit rating agency.
Any rise in risk appetite following the merger could subsequently pressure asset quality and credit costs, it added.
“We believe execution risks will be elevated, notwithstanding the two businesses being sister companies. The core rationale for the combination is to boost growth, supported by cross-selling opportunities,” said Siddharth Goel, Associate Director, Fitch Ratings.
Aimed at different markets
The agency, in a report, noted that each business targets different market niches with differentiated lending products which require tailored underwriting skills.
Fitch underscored that STFC’s used commercial vehicle (CV) underwriting requires vehicle-valuation expertise and a feel for freight market dynamics, whereas SCUF’s varied products - small business, two-wheeler, rural housing, and gold loans - need altogether separate risk assessments.
Furthermore, the management’s plan to introduce more technology into its processes is untested, having depended until now on manual procedures. “That said, senior management continuity in the combined entity should help the company navigate its transition to a much larger and more diversified operation,” Goel said.
STFC’s CEO would become the vice-chairman of the combined entity, while SCUF’s CEO will be the CEO of the combined entity. Both have been part of the Shriram group for more than two decades.
Fitch said STFC’s ratings currently benefit from its dominant 30 per cent share in used-CV financing in India.
Meanwhile, although SCUF’s size is material relative to STFC (equivalent to 29 per cent of STFC’s assets), its market positioning is less of a strength, with no prominent competitive advantage in its main lending segments, the agency added.
Cross-sell: Higher risk appetite
Referring to the management targeting market-share gains in small business loans and two-wheelers, based on cross-sell opportunities to STFC’s customer base, Fitch opined that an excessive focus on growth may lead to a higher risk appetite via less stringent risk underwriting.
“We view the merged entity’s blended asset-quality profile as somewhat weakened from the addition of SCUF’s portfolios. Its unsecured personal, small business and two-wheeler loans typically carry a greater risk of credit fluctuations. This is although pro-forma combined asset-quality metrics appear similar to that of STFC,” Goel said.
Fitch assessed that the merged pro-forma gross non-performing loan (NPL) ratio of 6.9 per cent at end-March 2021 is marginally lower than STFC’s 7.1 per cent, while the combined average credit cost of 2.4 per cent over FY18-FY21 was similar to that of STFC.
The agency observed that any scale benefits from the merger are only likely to be visible in the medium term, if executed well.
STFC will also absorb Shriram Capital Limited, its non-operating holding company, and the merged entity will be renamed Shriram Finance Limited.