Five Star Business Finance - Financing Bharat!

Incorporated in 1984 by Mr VK Ranganathan, Five Star Business Finance in its previous avatar was mostly a “me too” local low ticket auto/secured lending financier around Chennai. In 2002 his son in law, Mr LakshmiPathy Deenadayalan (Pathy) took over the reins of the company and transformed it into the business finance company it is today. In 2002, Five star finance’s portfolio mainly comprised of 2/3 wheeler & consumer goods financing with high NPA’s and no significant advantage over the more established players in the region. Pathy realized that this was not sustainable and spent the next 8-10 years trying, testing & perfecting a new business model moving away from conventional auto (2/3 Wheel ) finance to a business finance company. Five star business Finance (FSBF) currently is a non-deposit taking NBFC (used to be a deposit taking NBFC, surrendered the license) providing secured business loans to micro-entrepreneurs and self-employed individuals, each of whom are largely excluded by traditional financing institutions. Over 95% of the loan portfolio comprises loans with ticket sizes varying between ₹0.1 million to ₹1.0 million, with the median ticket size being between 3-5 lakhs and an average tenure of 5-7 years.

In simple words, FSBF offers business loans to micro/small entrepreneurs (think small shop keepers, mechanic shops, hardware traders, welding job / work units etc.) in tier 3 – tier 7 cities. These businesses are largely unbanked and are excluded from most formal sources of financing. The only option these Micro entrepreneurs have is the local money lender (FSBF’s main competitor apart from a few small firms CSL etc.), and therefore these customers to a large extent are not very price sensitive (Read high yields 22-24% and therefore wide spreads 12-13%)

This is different from a microfinance institution in 2 important ways. Firstly the lending is asset backed & secondly loans are made to individuals instead of SHG (self-help groups) etc. The main collateral for these loans is a self-occupied (Pakka) house, with an RCC foundation.

Additionally, a rising interest rate environment does not have a significant impact on FSBF’s business, firstly because of the wide spreads (low customer price sensitivity), and secondly as they grow & season their asset book and establish more credibility in their business model, the higher their credit rating gets and therefore the lower their cost of funds in the commercial debt markets, as evidenced by their declining overall cost of funds in the past 2 years despite a rising interest rate cycle.

In 2014, FSBF stepped on the growth pedal after perfecting its lending model, by raising private equity capital, professionalizing the management structure & investing in strong IT systems so that the company could grow at a faster clip & orchestrate their operations at scale.

Growth – Since 2017 the company has grown its top line 15x, Grown its book 12x and PAT 23x. All this while maintaining a reasonable asset quality with an average GNPA 1.5% and NNPA 1% (excluding temporary shocks such as Demon, Covid, GST implementation etc.)

There is a lot more one can write about their personnel strategy, their cluster-based growth strategy etc. The mechanics of how they keep their asset quality the way it is etc. But in the interest of keeping this short (and not a 70-page report :blush:) so as to introduce this company to the VP community, I have chosen not to get too deep in the weeds in this first post. The important data points have been captured in the table above. Additionally, I have curated a set of informative videos (7+ hours of video) below, for those interested in gaining a significantly deeper understanding of the business.

Key Risks -

  1. Five star’s business model is heavily labor dependent. Unlike other NBFC’s which employ large data sets, AI & ML etc. to arrive at a loan decision almost instantly, Five star can not do that because of the company’s customer profile. Five star’s customer rarely has any documented cash flows or sources of income. A five star employee therefore has to physically verify the customer’s cash flows & the nature (character) of the customer by spending a few days at the customer’s business, talking to neighbors, visiting the customers home etc. to make qualitative assessments such as, do they own a refrigerator at home, what’s the size of their TV, does the wife wear jewelry etc. to arrive at an evaluation of the living standards and thereby the income of a potential customer. This methodology is based on the principle that, if a person claims to have a certain income, then the 2 main areas that they will spend said income on is their own home and on their overall living standard. This high dependence on labor & their subjective opinion on a customers living standards and therefore the ability to repay is a big risk in their business model. Five star finance mitigates this risk in several ways. First - They do not silo the origination team and the collections team. By making the loan originator also responsible for collections ensures that there is minimal scope for corruption, further the employee’s variable compensation is tied to the repayment profile of the customers he/she brings in. Additionally they are trying to make this process of evaluating subjective living standards as objective as possible. For ex- if a customer claims to be earning 3 lakhs per year for 7-10 years, they should own assets / goods worth at least 3-4 lakhs, and these items have to be documented (This excludes all items obtained through inheritance, mainly the house). Lastly the ultimate risk mitigator is the collateral. Having the customer’s own, occupied home as collateral and getting reregistration done of the property helps minimize default risk, as evidenced by the low NPA numbers over the past 7 years despite a stupendous growth in their loan book & several macro and micro shocks.

  2. Geographic concentration risk - Nearly 80% of Five Star’s business currently comes from the states of Tamil Nadu, Karnataka & erstwhile Andhra Pradesh. In order to mitigate this, they are trying to diversify the portfolio by entering the central Indian market but this will take time. Learning the local laws, customs, borrower profile, land record rules etc. and institutionalizing it takes 24 months (per management). So at least for the next 2-3 years a large portion of the book would be concentrated in the south.

In conclusion, Five Star business finance is basically a sub-prime LAP lender & is trying to disrupt the “money lender” / Loan Shark market in India. They have been able to execute extremely well thus far. They have grown their book by 50x in less than 7 years, have weathered the most serious shocks in the lending business (Covid / Demon) successfully and are on the cusp of a major geographic expansion. The company does not have any major “organized” competitor (There are several companies doing low ticket 8-12 lakh housing finance but none in the 3-5 Lakh business finance segment). In my opinion the company should do well in the coming positive macro cycle & does therefore deserve a closer look.

Significant Shareholders – Matrix Partners, TPG Capital, KKR (recently sold in the IPO) & Several others.

Disclosure: Invested. May increase/decrease allocation in the future, biased. Do your own due diligence before investing.

Reference Videos:


Some Potential risks to be added -

  • Cash Flow from Operations is negative. The cash flow was only positive on account of positive Cash Flow from Financing Activities.

  • Promoter holding is very low - 34.87%

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Not sure if the CA in your name refers to chartered accountant or something else, but correct me if I’m wrong, there seems to be a fundamental misunderstanding of the Cash flow statements for a lending company.

  1. In financial (lending) companies its not the CFO (positive or negative) that reflects the strength of the business unlike in manufacturing firms etc. Lending being the primary operating activity it is expected that growing NBFC’s will lend out money (that will reflect as a negative cash item “loan advances”) below the “cash flow from operations” sub heading (Pic below). What is important, is to ensure that this negative CFO is matched by the CFF and CFI line items, otherwise the firm will burn through the cash on the B/S. If you look at a Bajaj Finance or take your pick of any lending NBFC, they all have negative CFO’s. And this is by design, it is not a flaw. That’s how GAAP/IFRS accounting works. If they have a positive CFO that should be a reason for alarm in my view :slight_smile: and not a negative against the company. Bajaj Finance’s CFO below.

  1. As for the promoter holding being low - Again, this is because of the nature of a lending business. In order to fund growth and maintain Tier 1 capital above the regulatory requirements, almost all lending companies have to dilute stakes periodically. And this dilution overtime results in a smaller promoter holding. Bajaj finance seems to be an exception here with a holding greater than 50% but if you look at all the other peers, a Shriram finance or an Aavas etc. It is difficult to grow the book stupendously without diluting. If they try to do this they will be severely over leveraged (8-10x book value). I think over leveraged financial companies are a bigger risk than an “optically” low promoter holding of 35%.

Anyways, I don’t think its of any benefit to anyone if this page becomes a crash course in accounting :slight_smile: .

Lets try and dig deeper in to their business to poke holes at the operating model of Five Star, to identify risks and operating challenges of lending sub prime in India. Things I am still struggling with include

a. How good is the collateral & how liquid is it? Are homes ranging from 4-10 lakhs in tier 6 cities good collateral ? Or is the low LTV an optical illusion. Are these homes liquid? I am trying to find data points regarding the same.

b. As an add on to the previous point, what is the state of land records in Tier 3- Tier 6 cities in India? If these are still antiquated and not digitized could this potentially be a ceiling to future growth? Land records being a state subject in the constitution, is that why Five star has mainly focused on the southern states so far, which have digitized/ considered to have less ambiguous land records?

c. Their lending model being labor intensive because of the customer profile and the amount of manual on ground checks that are required prior to lending, how scalable is Five Star’s business? They have demonstrated incredible growth (growing 50x) in the past 7 years, but what would it take (in terms of employee head count & back end technology stack) to add 300k-400k new customers annually without compromising on asset quality?

d. Why is a Five Star or an Aptus etc. averse to leveraging more than 3-4x of book? It’s definitely not because of CRAR requirements. What do they know that we don’t? Are they concerned that if they leverage beyond that, a negative shock could wipe out book value? If so, is that a sign of fragility? Shouldn’t their collateral & low LTV help in recovery even if they do leverage beyond a 3-4x?


Thank you for enlightening us on this topic. Had very little idea about the finance companies. And yes I am a Chartered Accountant but its not necessary that everyone has knowledge in every field.


Institutions initiating coverage is a good sign. :slight_smile:

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A recent interview of Mr Laksmipathy Deenadayalan, upping the guidance to 35% growth from 30%, for the next 3 years. Implying a 2.5x top & bottom line growth in 3 years.

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Large growth canvas, geographical expansion to drive growth: Five-Star operates
in a business that, has large growth potential: secured lending to
small businesses primarily in Tier 3 to Tier 6 towns (85% of branches) with a
granular portfolio (average loan outstanding of INR 0.25mn) with EMI-based
products. Over the last 2 decades it has developed a strong model of customer
acquisition, collateral-based lending, and collections in this segment. As Five-Star
expands to newer geographies away from southern India (94% of AUM
currently), we see AUM growth at 33% CAGR over FY23-25E. Its strong branchled acquisition model has delivered 55% CAGR in customer acquisition over the
past 5 years.

Enviable asset quality track record, collections model: Although it operates in the
informal income segment, Five-Star’s asset quality track record has been strong
through economic cycles. While early delinquencies are relatively higher because
of its presence in this segment (0-30DPD at 5.99% and 30-90DPD at 9.15%),
Five-Star’s focus on self-occupied residential property (SORP) as collateral ensures
that eventual loss rates are minimal. This has helped it maintain strong asset
quality even during crises such as Covid-19 and demonetisation. A razor-sharp
focus on collections keeps credit cost low (we expect credit cost to average
c.1.0% over FY24-FY25E).
Strong return metrics; premium valuations to sustain: Five-Star has also
demonstrated its ability to reduce funding cost as it has achieved scale and
boasts of over 50 lenders with a long-term credit rating of ‘AA-‘. This bodes well
for the company’s spreads over the medium term. A high yield portfolio,
controlled opex and low credit cost should help sustain Five-Star’s strong return
metrics. While near-term RoE is suppressed due to high capital adequacy (67.2%
Tier 1), we expect RoE to expand to 17.9% by FY25E and forecast earnings
CAGR of 29% over FY23-25E. We value Five-Star at 3.3x FY25E P/BV and initiate
coverage with a BUY rating and TP of INR 680. Five-Star’s inability to execute
growth plans while maintaining asset quality in newer geographies and sharp
broad-based deceleration in economic activity are key risks .

Strong growth led by customer acquisition and branch expansion
Five-Star’s AUM has grown at a robust CAGR (compound annual growth rate) of c.47% from
FY18 to FY23. This growth has primarily been driven by the acquisition of new customers
while maintaining a steady average loan outstanding. The number of live accounts has also
grown at a CAGR of around 55% during this period, while average loan outstanding has
been relatively stable at INR 0.25mn-0.3mn. This highlights the strength of Five-Star’s
business model, which focuses on expanding through new customer acquisition rather than
relying on higher ticket lending to existing borrowers.

Increase in branch network and penetration:
Five-Star initially operated as a Chennai-based NBFC but has successfully expanded beyond its
local market. It expanded its branch network from six branches in Chennai to 39 branches
across Tamil Nadu between FY10 and FY15. From FY15 to FY18, it further expanded to 72
branches in the states of Andhra Pradesh, Telangana, and Karnataka. As of Mar’23, Five-Star
has expanded its presence to 213 branches in these three states. During this period, the
contribution to AUM from these states increased to 60%. Recently, Five-Star has expanded
into Madhya Pradesh, Chhattisgarh, Maharashtra, and Uttar Pradesh. The company adopts a
strategic approach of contiguous expansion in geographies with substantial demand and
maintains robust asset quality by leveraging neighbouring branches, local credit evaluations,
and hiring staff with strong local networks.
The management has guided for sustaining the branch addition run-rate at 50-60 branches
per year. Further, at least 80% of the new branches will be in south India and the balance
20% in non-South regions. The company has highlighted that while there is sufficient
opportunity to grow in south India, it has started to add some branches in non-South regions
as well with a view to establish presence and get an understanding of the geography – given
these regions are expected to be growth drivers 5-6 years down the line.

Increase in fleet on the street:
The second lever is increase in the number of officers per branch. When a branch is
successful, instead of putting up a new branch, Five-Star adds more people to the existing
branch. This is done with a view that given Five-Star is already familiar with the area and has
existing customers in the area, new business can be easily shored up in the existing branch.
Thus, the number of officers has constantly increasing from 5.3 business and collections
officer per branch in Mar’18 to 10.7 business and collections officers in Mar’23. The
management has indicated that over time the number of officers in a branch will continue to
rise steadily, leading to an increase in the potential business opportunity from the existing

Operating leverage to start playing out
While Five-Star will continue its branch expansion strategy in newer geographies, for existing
geographies where it already has a successful branch it has a policy of adding more
employees to the existing branch rather than opening a new branch. This practice helps
improve cost efficiencies at the organisation level.
Thus, even with the target opening of 60 new branches per year, we expect the productivity
of branches/employees to improve continuously. We expect the AUM per branch to go up
from the current c.INR 185mn to c.INR 250mn by FY25E on the back of increase in number
of employees per branch and also AUM per employee (though number of clients per
employee is expected to remain ~85-100, disbursement ticket size is expected to increase,
leading to increase in AUM per employee).


Another great set of numbers by Five Star. Asset quality & collection efficiency numbers improved further.

Looks like the thesis is playing out. :crossed_fingers:

Disclosure - Invested, biased


The company seems to be using a different definition of town classification -

  1. Company presentation footnotes say tier 6 <50k population
  2. Census classification suggests tier 6< 5k

Is #1 correct or an error in their presentation. If correct then their presence seems to be largely in big towns instead of small ones

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