InCred-KKR India Financial Deal: Necessity More Than Synergy
The merger of KKR India Financial Services Ltd., a corporate non-bank lender, and retail-focused non-banking financial company Incred Financial Services Ltd., may have been driven by necessity rather than synergies between the two businesses.
For KIFS, one of the two NBFCs run by American investment firm Kohlberg Kravis Roberts & Co. Inc in India, the deal helps it move on from a past marred with questionable underwriting decisions. For InCred, the deal could fuel its ambitions of becoming a bank with the backing of long-term capital.
The merger would effectively combine InCred and KIFS into InCred Finance, which will be led by Bhupinder Singh, founder and chief executive of the InCred Group. KKR will be the single largest investor in InCred Finance for now and will remain a long-term strategic partner to the business.
"The coming together of these two entities will create a tech enabled new-age financial services giant that is well positioned to capture the huge opportunities on offer in the Indian market," said Singh in response to BloombergQuint's queries.
A KKR spokesperson confirmed the signing of definitive agreements between the two companies in an emailed response.
The deal would help InCred grow its book and leverage on KKR’s association with other long-term investors, while it provides more time to KKR India on (clean-up of) its wholesale portfolio given the Covid environment.Gopal Agrawal, Head - Investment Banking, Edelweiss Financial Services.
The Black, White & Grey Of The Deal
The deal, which took months to conclude, is structured in a way which allows for some clawback in KKR India's shareholding if surprises emerge from the corporate loan book being transferred by KIFS.
As of now, according to an investor familiar with the deal, the shareholding will look something like this:
KKR, along with two other investors in KIFS— Teacher Retirement System of Texas and Abu Dhabi Investment Authority, will together hold a 35% stake in the merged entity InCred Finance.
Of this, KKR alone will hold about 15-16% in the consortium.
InCred's promoter entity, Bee Finance Ltd. (Mauritius), will get diluted from about 60% as on March 31 to about 40% post-merger.
In the combined entity, Singh will hold 26%, while about 11% will be held by Ranjan Pai of the Manipal Group and close to 2% by Anshu Jain, former senior executive at Deutsche Bank, via InCred's holding company Bee Finance.
The post-merger shareholding has been arrived based on back-of-the-envelope calculations, as per estimates given by the investor to BloombergQuint.
Singh, however, said that the exact shareholding in the combined entity will be finalised based on March 2022 numbers.
As part of the deal, the legacy book of KKR will be taken over by the combined entity, Singh confirmed.
Due diligence on the KIFS book was led by Singh, said the investor quoted above. InCred has taken the onus of recovery for only that portion of KIFS' loan book that has enough collateral cover and strong recovery prospects, this person said.
The remaining portion of KIFS' loan assets, which are perceived to be riskier, have been carved into a separate "grey" bucket. The recovery of these loans will be KKR India's responsibility over the next 18 months. Any write-off on that book will be adjusted with KKR's equity in InCred Finance, as per terms agreed between the two, the investor said.
Without confirming the exact size of this "grey" pool of loans, the investor said, KKR India's shareholding could go down by 5% if recoveries from this set of assets is lower than expected.
But a second person, who also spoke requesting anonymity, said that the KKR consortium expects its shareholding to remain around 35%. This person added that KKR has the ability to adjust its ownership upwards if it outperforms on its assets, or if Incred’s book underperforms, and vice versa.
KIFS, since 2018, has faced volatility in its business.
Between March and December 2019, KIFS wrote off about Rs. 1,045 crore in addition to provisioning against potential stressed accounts, as per a March 30, 2020 Crisil note. As a result, KIFS reported a pre-tax provisional loss of Rs. 1,516 crore in the nine months ended Dec. 31, 2019, compared to a net profit of Rs. 24 crore for the fiscal year ended March 31, 2019.
The company's gross non-performing assets rose to 6% as of December-end 2019, Crisil noted.
Since July 2019, the NBFC has secured asset realisations and prepayments worth Rs. 3,740 crore, the second person quoted above said. Of this, Rs. 1,280 crore in pre-payments happened over the past 18 months, the second person quoted above said.
The company had a gross loan book of Rs. 1,490 crore and a balance sheet of Rs. 2,151 crore, as of June-end. Its gross leverage stood at 1.07%, the second person said. KIFS was rated AA/ Stable by Crisil, with no rating downgrade by the agency since Oct. 2019.
The current level of NPAs on KIFS' book was not available.
The deal, according to Hemindra Hazari, an independent banking analyst, seems to be a convoluted way to clean-up KIFS loan book over a period of time.
"KKR India, through this arrangement with InCred, seems to be deferring its losses instead of booking them upfront by either selling the stressed corporate loan portfolio to asset reconstruction companies or writing it off," he said.
The move undermines KKR’s credibility as a global investor, as instead of cleaning up its own balance sheet, it resorted to a convoluted set-up that, quite evidently, transfers the risk to the new entity.Hemindra Hazari, Independent Banking Analyst
However, according to the second person quoted above, the deal does not mark KKR's exit from the business. KKR will remain involved in the business as a long-term strategic partner, he said.
Agreed, Singh. "They (KKR) will join the merged entity's board and give us the benefit of their experience of best in class practices around the world," he said.
InCred's Leap Forward
From here on, InCred will mostly be driven by Singh, a veteran of Deutsche Bank.
Over time, the legacy corporate book will be wound down and the focus will return to retail and small business lending. The lending focus for the combined entity looking ahead will continue to be what it is for InCred today— retail and small business lending, Singh said.
By the time the merger is consummated by the NCLT (National Company Law Tribunal), retail and small business loans will comprise over 80% of the merged entity's loan book with risk metrics and capital adequacy that are amongst the very best in the industry. Given the very low gearing of the firm, (we) will have a lot of runway for future growth.Bhupinder Singh, Wholetime Director, CEO & Founder, Incred Group
The InCred-KIFS merger, the investor cited earlier said, will also pave way for Singh's ambitions to turn the entity into a bank.
Singh, he said, has "big ambitions" of applying for a bank licence and taking the company public. InCred's link with KKR would open up opportunities to raise funds from global capital markets and long-term institutional investors, he said.
As of June 30, InCred Financial had assets under management worth Rs. 2,553 crore, falling marginally, due to the impact of Covid second wave, from Rs. 2,634 crore as on March 31, 2021, rating agency Crisil noted in an Aug. 10 note.
Of the total AUM, personal loans formed 32%, secured school financing 22%, student loans 13%, lending to financial institutions and escrow backed lending 19%, and anchor-backed business lines 11%, Crisil said, while rating the firm 'A'.
InCred's gross NPA rose to 3.95% as of the June 2021 quarter from 3.4% in March. Its net NPA rose sequentially to 1.8% from 1.7%, in three months ended June 30.
"Elevation in non-performing assets stemmed from challenges faced within personal loans and non-anchor business loan segments wherein the company also took write-offs of Rs 35 crore," Crisil noted, adding that the loan book is relatively new and "remains untested."
InCred's merger with KKR will put the entity on a stronger footing in terms of capital and growth, said Singh.
The merger will provide the combined entity with a very strong capital base. This will help us to capture growth in a number of areas where we see very attractive opportunities — student loans and school financing, small business lending enabled by digital partnerships, as well as small-ticket consumer lending based on the twin pillars of risk analytics and a digital first mindset.Bhupinder Singh, Wholetime Director, CEO & Founder, Incred Group