Inside the playbook of a new Shriram

The pre-merger group companies were not known as aggressive lenders. And as a merged entity, Shriram Finance wants to grow at a pace it can sustain.

“We would like to remain profitable, instead of claiming the top position,” said YS Chakravarti, the managing director and chief executive officer of Shriram Finance.

Chakravarti knows the organization, and its culture, all too well.

The genesis of today’s Shriram group lies in a company founded by R. Thyagarajan, his friend AVS Raja, and brother-in-law T Jayaraman. The trio set up Shriram Chits, a chit funds company, in 1974. Chakravarti began as a trainee at a Shriram Chits branch in Andhra Pradesh, in June 1991, working his way up over the next three decades. As the head of the ₹1.9 trillion non-banking financial company (NBFC) today, he has a tricky job at hand.

Shriram Finance wants to diversify the business, beyond its stronghold of financing pre-owned commercial and passenger vehicles—a legacy of what used to be the group’s flagship business, Shriram Transport Finance. Prior to the merger, Shriram City Union lent to small businesses, financed two-and four-wheelers, gave loans against gold and personal loans. Shriram Capital was the holding company.

While overseeing this diversification, Chakravarti also has to retain long-term customers while not letting go of the organization’s ethos to lend to the underbanked. Unlike other NBFCs, Shriram largely lends to small business owners. In fact, a majority of the lender’s gold and two-wheeler loans are to small businessmen and the self-employed. But this is a double-edged sword. Bad loans are higher in this customer cohort. Improving the asset quality is an imperative.

Last, Chakravarti also has to work towards a ratings upgrade for the company, which would allow it to access cheaper funds. The higher the rating, the better the implied risk profile and finer the pricing on loans and bonds.

A slow and steady approach to growth is the need of the hour. Mint caught up with Chakravarti and Umesh Revankar, the company’s executive vice chairman, to understand the organization’s post-merger strategy. But before we tell you the inside story, let’s look at the Shriram group’s unique structure, and the recent exit of large investors.

A short history

Shriram Transport Finance was founded in 1979. And the group incorporated a holding company, Shriram Holdings Madras Pvt. Ltd, in 1993. This parent company remained unlisted.

Private equity fund TPG Capital bought a 49% stake in Shriram Holdings in 2005. Next, Shriram Transport Finance’s board approved a proposal to merge with its unlisted parent.

In the ensuing years, market interest around NBFCs grew. One interested corporation was billionaire Ajay Piramal’s flagship venture, Piramal Enterprises. After the Piramal group sold its pharmaceuticals business in 2010, it had the capital and believed financial services was a lucrative sector to invest in. It wanted to venture into both wholesale and retail lending.

In 2013, Piramal bought a 10% stake from TPG in Shriram Transport Finance. The following year, Piramal bought a 20% stake in Shriram Capital (prior to the three-way merger, it was the holding company for the financial services and insurance business) and a 10% stake in Shriram City Union Finance.

“We invested in Shriram because the ultimate objective would have been that Shriram’s retail business and our business of wholesale lending would be merged and it would have been a good fit,” Ajay Piramal told Mint.

However, he later realized that Shriram had its own unique culture, which was different from Piramal. “I felt that if we got together, rather than creating value for that entity, we would actually destroy value,” Piramal explained.

Piramal started selling its stakes in 2019 and completely exited this year, except for his stakes in Shriram’s insurance businesses.

Mint, in June 2019, reported that despite taking management control at the top, the Piramal group struggled to manage the vast workforce of Shriram group, with insiders not favourably disposed towards corporate control.

The Shriram group has a long-standing history where the ownership, at least partly, rests with the employees via the Shriram Ownership Trust, an employee trust, which holds a 35.8% stake in Shriram Capital Pvt. Ltd. Shriram Finance, today, is promoted by Shriram Capital Pvt. Ltd, earlier called Shriram Financial Ventures Chennai Pvt. Ltd, and the Shriram Ownership Trust.

The trust was founded in 2006. About 44 top executives in the company are part of the trust. A perpetual trust, it generates its own revenue, mostly by way of dividend. On retirement, its members get a cash benefit.

Thyagarajan, in an interview to Mint in December 2012, had explained the idea behind creating the trust. “No one individual can create wealth; it is in partnership with others (that) we do it. It was only fair to share the wealth that was created in partnership with employees,” he had said.

The 44 executives in the trust get the cash component of their retirement benefit over eight years and not immediately after superannuation. The idea is to ensure these executives build teams strong enough to sustain the growth of the organization, even after they are no longer associated with it.

Many executives would be busy working on the consolidation of the workforce now—one of Shriram Finance’s post-merger strategies. And again, this is a difficult trick to pull off.

Half of Shriram Finance’s loan book originates from rural areas and the remaining come from semi-urban and urban centres. A majority of its branches—52%–are in rural areas as well. Shriram Finance specializes in extending loans to those who do not have records banks traditionally have relied on. In fact, about two-thirds of its new customers do not have credit scores, or a prior record of credit from organized players. To overcome this challenge, the company uses an internal model that follows the trail of the potential borrower’s suppliers and buyers. That reveals the nature of business of potential borrowers and their ability to repay the loan.

As per Chakravarti, Shriram employees are encouraged to spend time with the borrowers and understand their business since the loan sanctions are not just based on credit scores.

“I cannot do the whole process with a new employee. I need people who are with me for some time, whom I can rely on,” Chakravarti said.

For instance, whenever Shriram City Union Finance entered a new territory, it started with two-wheeler loans. Small businesses loans followed, but only after six-seven years. That is because the company’s staff needed to be trained—cultivating human intelligence in this business takes time.

The merger is now expected to aid more effective use of resources in various geographies. Also, it addresses the concern Chakravarti underlined, which is the need for experienced employees.

Pre-merger, Shriram City Union had fewer branches (1,021) than Shriram Transport (1,854) and the merger allows the company to sell products of the former City Union across more locations.

“It is a slow process but with the addition of Shriram Transport branches, I have more manpower; I have people who have been with the group for five to 10 years,” said Chakravarti. People adept at selling used commercial vehicle loans will now be re-skilled into selling various other loans.

Licence to cross-sell

The strategy is not simply about branches trying to sell a variety of loans, or more loans, than they did in the past. The company now wants to cross-sell products to existing customers.

“We realized that Shriram Transport customers, who have been using vehicles for their captive use and not for hire, say a petrol pump owner, a rice mill owner or a vegetable trader, are borrowing somewhere else for their business needs,” said Chakravarti. The lender, therefore, wants to utilize its customer base to sell products like small and medium enterprise finance. As part of this strategy, the merged entity is offering gold loans at over 500 branches of the former Shriram Transport Finance and small business finance at another 200.

According to Chakravarti, expanding into other products would also allow it to venture into new geographies. So far, financing small businesses was predominantly done in south Indian states and Gujarat. Shriram Finance now wants to use the network of its former transport financier to push these loans elsewhere.

“The merger gives us an advantage in terms of newer geographies,” Chakravarti held.

The quality benchmarks

Both Revankar and Chakravarti stressed that one of the expected outcomes of the merger is a rating upgrade for the company. Like we mentioned earlier, a higher rating will allow Shriram Finance to access cheaper funds. While banks lend by taking deposits directly from the public, that’s not the case with most NBFCs. They have to borrow from banks and sell commercial paper. To be sure, Shriram Finance accepts public deposits, accounting for 24% of total borrowing as on 30 June.

Given the rising interest rate environment–India’s central bank has raised the repo rate by 250 basis points between May last year and this February— Shriram Finance’s cost of debt increased 7 bps to 8.89% in the June quarter.

“The first step was when Shriram City merged with Shriram Transport Finance. The City portfolio was upgraded from AA to AA+ because Transport was already AA+,” said Revankar. “The next objective is to get a further upgrade to AAA because we are now a multi-product company, less cyclical, and pan-India,” he added.

The rating of credit rating agencies typically ranges from AAA to D and indicates an organization’s ability to repay investors. AAA indicates that the default risk is very low.

While Shriram Finance has come closer than ever to consumer finance behemoth Bajaj Finance in terms of the volume of asset under management, it is yet to emulate its performance on asset quality.

As on 30 June, Shriram Finance has assets under management of ₹1.9 trillion and 7.5 million customers. India’s largest NBFC, Bajaj Finance, manages assets worth ₹2.7 trillion and has 73 million customers.

Since Shriram’s customer base is non-prime, the bad loans are higher. In fact, according to Crisil Ratings, the company’s ratings “continue to remain constrained by Shriram Finance’s modest asset quality”. Shriram Transport and Shriram City Union reported gross stage 3 asset ratio or bad loan ratio of 6.9% and 5.9%, respectively, as of 30 September 2022. The merged entity’s gross bad loans were at 6.2% of assets at the end of 2022-23. As of 30 June, this year, it was at 6.03%.

In comparison, as of 30 June, Bajaj Finance’s gross non-performing assets were at 0.87%.

Nonetheless, Crisil Ratings said in a note on 8 May this year that the entities have displayed “ability in the past to ultimately recover from these accounts, even post loan maturity date. Consequently, the overall credit costs have been range bound over the past three fiscals. However, ability to scale up the portfolio whilst improving asset quality metrics remains a key monitorable.”

Investors will surely monitor what Crisil underlines—as well as the company’s slow and steady approach.