Is FinTech InCred Really Incredible?

Last week, fintech enabled lending firm InCred raised $100MM, marking a sizable Series A for a company that is 3 years old. 

Big Bank Bucks

Looking to setup education loan lender SoFi’s equivalent in India, ex Deutsche Bank banker Bhupinder Singh quit his job to setup InCred. 

Like most startup founders, Mr Singh set out to disrupt an already existing market (education loans) with technology (data-driven creditworthiness). Unlike most startup founders, Mr Singh was able to rope in incredibly influential people to back a fledgeling firm. While most startups start with a small amount of capital, Mr Singh’s influence and track record allowed him something unusual.

InCred started with a seed round of $75MM, something most big startups would raise after years of operations.

InCred’s big bang start saw participation from former Deutsche Bank CEO Anshu Jain, who committed 10% of the fundraise. Mr Singh himself committed a significant amount of capital to the company. 

The new age fintech firm had started with all the necessary finances. 

Lend Me Your Years

The initial focus of InCred, which qualifies as a Non-Banking Financial Company (NBFC), was the educational loan market. 

Education in India has largely been subsidized by the government, recent decades have seen a significant uptick in quality private colleges. As fees in Indian educational institutions begin to rise, educational loans will become more relevant for students looking for quality education. 

While a lot of people, usually parents, spend a significant amount of their savings on their children’s education, the concept of taking loans for education is still not widespread.

At a $10Bn portfolio size, the education loan base would generate ~$1Bn on interest every year. While this number grew slightly slowly last year, it is attractive to new players who are inspired by another mammoth market. 

Safety in Numbers

Student loans tend to be “safer” as they are linked to professional success and the quality of the education.

Defining creditworthiness of a loan seeker is helped by the data of the institution that the seeker studies from. Non-performing assets (NPAs) in the form of education loans are 2% lower than the benchmark 11.5%

It is little wonder that the educational loan market is dominated by public sector banks.

The real potential, though, is visible in the $1.5Tn (yes) student loan base in the US, more than 100x the Indian market.

Most commentators claim that the US education loan industry pressures millions of professionals for years. In this excellent Netflix commentary on US student loans, it is revealing to see how life-altering educational loans are turning out to be. 

But the fact remains, it has the potential to be a massive market, with a manageable creditworthiness model. 

Look Ma, No Banks

Most public sector banks are notorious for being bureaucratic to deal with.

In technical parlance, that is poor customer experience. InCred’s business model is to be a user-friendly lender. It disburses loans in an efficient manner while assessing the creditworthiness of users using data

In its first year, InCred disbursed INR 400 Cr ($70MM) to 2500 customers, or 16 lakh INR ($20K) on average. While InCred began with a focus on educational loans, the company expanded quickly into the small business loan and housing loan segment. 

In the previous piece on Capital Float, I had expanded on how the small to medium business segment is a massive opportunity for financing. Due to archaic lending practices, businesses still lack access to capital, and it is a $200Bn loan base in India. 

House financing is a similarly sized opportunity, a $250Bn loan base that is majorly served by public sector banks. Driven by housing demand, it has grown by 15% or more every year. 

Driven by these larger markets, InCred would end up disbursing 1000Cr ($140MM) to 6K customers by end of 2017, or ~$10MM for each month of its existence. 

The run for the banks was on.

Rapid Lend Grab

InCred was not the only one eyeing the increase loan pie for the Indian consumer or business.

Apart from Capital Float, multiple players such as Aye Finance, Lending Kart and Faircent sprung up to the challenge for providing credit. The reason for going aggressively after the consumer was because of the business model of lending. 

Loans are products that result in long term commitments from consumers. Once a customer is locked into a loan, if the customer continues to pay, it is usually year(s) before the consumer will change the loan provider. This implies a significant lifetime value for customers who are locked in. 

For example, a 35L ($60K) loan with a 10% interest for 3 years is $18K of interest revenue lifetime value. With high costs of “switching”, it was imperative for companies to acquire consumers fast, and lock them into their lending systems. 

The loan portfolio for NBFCs on an overall basis thus grew 20% in 2018, but it would be a precursor to a winter of distress. 

Risk Losing Appetite

Late 2018 would be winter for financial services firms, especially NBFCs. 

Exactly a decade after Lehman Brothers went down under, IL&FS, an infrastructure leasing NBFC defaulted on its loan payments to Indian banks. The company, over a lifetime of financing infrastructure project, had racked up debt of INR 91,000 Cr ($14Bn) with a debt to equity ratio of 19

Even in the over-leveraged world of NBFCs, IL&FS was a big outlier, having a D/E ratio of 3x. The IL&FS crisis, just like the one at Lehman brothers, began to squeeze the entire NBFC industry.

Liquidity, or availability of capital, was drastically squeezed as capital providers became wary of NBFCs.

For NBFCs to disburse loans, they need to raise capital to disburse as by definition they do not take deposits. The cost of capital grew significantly. From a cost of capital of 8.3%, cost of financing for NBFCs grew to 9.5% due to the IL&FS crisis. 

The liquidity crunch would make business expensive for players like InCred. 

Working Capital

Players like InCred would have to raise capital to keep lending or they would stop growing.

The unit economics of loans would be as follows. Assuming your cost of capital is 8.5% and you are able to disburse a loan for 16%, the “net margin” you make is 7.5% on every INR of loan you disburse. Most NBFCs have a debt to equity ratio of 5x, implying that they can raise 5 INR of debt for 1 INR of equity raised. 

Lending off the debt they raise is known as balance sheet lending, the reason why InCred is raising capital.

For the total capital raised till date of $175MM, InCred can then likely disburse loans of 5*175 of $875MM off its balance sheet. 

Credit for Winning

Assuming that all the equity capital it had raised till 2018 end ($75MM) is now utilized, it would have likely disbursed 75*5 = $375MM of loans till 2018 end. This is a ~2.5x growth from the $140MM disbursed till 2017, as we noted earlier. 

Let’s assume an average lending rate of 18%, based on multiple NBFC rates. The interest margin, as we defined earlier, would be 18-9.5, or 8.5%. Thus, for $375MM of loans, the interest revenue would be 375*0.18 or $67.5MM, while the margin (net interest) would be $32MM. InCred is thus likely a $70MM business.

If InCred disburses a loan of INR 20L, or $30K, it is able to generate net interest of 9.5*30 = $3K per year. For a 3 year lifetime, the company makes $9K per customer. If the business is able to keep customer acquisition cost below $3K, or 1/3rd of LTV, it is a healthy business.

Assuming it has raised $100MM for 20%, the business is likely valued at 8x revenue. In terms of the loan book for ~$400MM, the business is valued at 1.25x the loan. This is in line with the valuation of Social Finance, the US lending company.

Given the recent equity raise, the future looks bright for InCred. Having diversified into multiple loan products, the company also has a full portfolio to get exposure to a larger set of the economy. It is also protected in case of a downturn in one of the segments. 

Despite troubled market conditions, InCred looks like it is beginning an incredible run, and its success will spur the economy.

B2B, B2C, Brand, Lending, Profile, Series E-G

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