By Mukta Malhotra

It is going to be a replay of the familiar. The NBFC sector is about to witness a major shakeout. Initially, it was during the Nineties that the NBFC sector saw some restructuring activity. And now, there are signs all around to tell an NBFC-watcher that the sector is in for another bout of consolidation. During the last two years, asset size of NBFCs has shrunk by as much as 20 per cent! Yes, it is shakeout time for the nation's teeming NBFCs. And many more NBFCs are going to be out of business very soon.

Room for a few
What are the chances of survival for the denizens of the nation's NBFC sector? Says Mahesh Thakkar, executive director of the Mumbai-based Association of Leasing and Financial Service Companies (ALFS): "My estimate is that around 20 to 30 NBFCs at the national level and 400 to 500 at the regional level will survive." That seems to be a conservative prognosis. Says Dilip Pendse, managing director of the Mumbai-based Tata Finance: "There will be only 10 national players. Very soon, the number of leasing, hire-purchase and loaning companies will not exceed 1,000."

There are quite a few others who feel the end is nigh. According to K V S Manian, chief operating officer of the Mumbai-based Kotak Mahindra Finance, there will be just 12 to 13 significant players and the others will have to become niche players. Adds S K Mitra, managing director of the Mumbai-based Birla Global Finance: "There will be just 15 to 20 NBFCs around. Regional players in the NBFC sector can only survive if they become boutique."

Survival of the fittest
The reasons for the coming shakeout are many. A major reason is that medium and small NBFCs are not able to mobilise public deposits. It is a dog-eat-dog scenario in the funds-based business. Only NBFCs which are financially sound and have access to low-cost funds can survive here. Put differently, an NBFC has to be large to survive the prevailing onslaught. Size is going to be a critical factor for survival. Says Manian of Kotak Mahindra Finance: "In the fee-based business, being among the top few is important and for investment banking one needs to be a top player."

Which NBFCs have the potential to survive? Says Thakkar of ALFS: "Only those NBFCs with a minimum net worth between Rs 5 and Rs 10 crore will survive." Consider these statistics: just about 500 NBFCs out of the 7,000 registered NBFCs have a net worth of Rs 5 crore and more. But, again even these 500 NBFCs are small compared to their counterparts elsewhere in the world.

The M&A option
Naturally, size and critical mass are essential for survival in the competitive NBFC sector. That means, NBFCs capable of surviving the shakeout are going to be either those promoted by large industrial houses or those which have unlimited access to low-cost funds. Then, what is the way out for the smaller fries? Consolidation, of course. In most countries, there are not more than 100 financial service companies and in a country such as Thailand there are just about 70 financial service companies.

Mergers and acquisitions are then inevitable in the sector. Quite a few NBFCs will die a slow and painful death. The ICICI take over of ITC Classic and Anagram Finance and GE Capital's acquisition of SRF Finance have only set the trend. This trend will gather momentum what with the RBI also favouring NBFC mergers.

Here is a foretaste of things to come. Scotiabank, the Canadian banking major, is looking at selective acquisition of NBFCs. Scotiabank is setting up a finance company in partnership with Ardee Finvest. HSBC is planning to float a consumer finance company and is considering acquisition of a few NBFCs.

Some sort of acquisitions have already been happening in the sector in the past two years -- acquiring NBFC asset portfolios are already on. Reason: with most NBFCs in the red, acquirers do not want to buy out entire companies with their liabilities. Says Pendse of Tata Finance: " We are interested in acquiring only the asset portfolios of good NBFCs."

Fine. But, asset portfolios of most NBFCs have already been bought. Says Mitra of Birla Global Finance: "We have already sold Rs 50 to Rs 60 crore of truck finance portfolio to GE Caps and Citibank. And we have acquired car finance portfolios worth Rs 80 crore from 15 different companies since we want to focus on retail finance." These portfolio acquisitions are a vital part of NBFC restructuring today.

A new focus
Such restructuring exercises can only gather momentum. Quite a few NBFCs have been changing their tracks, moving out of traditional activities, changing their asset profiles and veering away from wholesale financing. For instance, there are NBFCs which have moved out of car finance thanks to intense competition from foreign banks.

Refocusing is the name of the game. NBFCs are increasingly laying emphasis on niche products. For instance, the Kotak Mahindra group of finance companies has two separate ventures for car finance: Kotak Mahindra Primus, which is a joint venture with Ford Credit International focusing on finance for non-Ford passenger vehicles in India, and Ford Credit Kotak Mahindra Limited, which is a joint venture with Ford Credit International that focuses on finance for passenger cars from Ford.

Tie-ups like these are gaining ground. Sundaram Finance has tied up with Fiat for car finance and Tata Finance has in alliance with American Express for forex services. Birla Global Finance has tied up with Sun Life for distribution of financial services.Transforming into one-stop financial service shops is another strategy for the growth-hungry NBFCs. Says Pendse of Tata Finance: "If an NBFC wants to be a national player it should have a diversified portfolio. NBFCs can have an umbrella of financial services but can still address a niche market."

With the possibility that only a few NBFCs with the resource muscle and a distinct focus can survive, smaller NBFCs have to become niche players. Says Mitra of Birla Global Finance: "Among the smaller NBFCs, only niche players such as those serving coffee plantations in Kerala will survive."

Diversification
Quite a few NBFCs are looking at diversification for survival. Some have diversified into software while a few others have gone the dot-com way. For instance, Hinduja Financeis diversifying into software and other new economy businesses. And with reason. New economy businesses have low entry barriers, low gestation periods and can fetch handsome valuations in a short time.

Converting into banks is another option before top-notch NBFCs. Says Mitra of Birla Global Finance: "We are going to spin off our retail finance into a separate company. Later on, we might convert this business into a bank." Tata Finance is another NBFC that is toying with the idea of converting into a bank. Says Pendse of Tata Finance: "We are not only looking at converting the company into a bank, we are also considering the option of acquiring a bank and integrating with that bank."

As more public sector banks get set to tap the capital markets, banks are becoming increasingly de-nationalised. This offers NBFCs an opportunity to invade the banking territory through acquisitions. Says Manian of Kotak Mahindra Finance: "NBFCs can benefit from the consolidation that is going on in the financial services industry."

There is another possibility. NBFC groups can get a bank in their fold. Just like the 20th Century Finance group controlling Centurion Bank. Why, NBFCs such as Tata Finance are large enough to have banks under them. As the shakeout gains impetus in the NBFC sector, only fundamentally strong NBFCs will survive. There is going to be greater degree of integration among NBFCs and brand franchise should become more valuable. Says Mitra of Birla Global Finance: "Already, there is little difference between retail banking and NBFCs. With technology breakthroughs, need for banks will reduce." As the dividing line between banks and NBFCs get blurred, the coming shakeout in the NBFC sector can only expedite the process of financial disintermediation.