Prudent Financier

'First impression is the last impression’ goes the age-old adage. And it seems like Mumbai-based IIFL Holdings, had left an indelible mark on one of its institutional broking clients, Fairfax Financial back in 2007. Owned by Indian-origin billionaire Prem Watsa, the Canadian investment giant bought into the financial services company by picking up a 9% stake in 2011. It further increased its holding by 26% in 2015 via an open offer thus becoming the largest shareholder with a 35.44% stake. 

Chandran Ratnaswami, the MD of Hamblin Watsa Investment Counsel, who oversees the firm’s investment portfolio in Asia, attributes this rising confidence in IIFL to the man at the helm — Nirmal Jain. “We were impressed with Jain as an entrepreneur. He built this business from scratch without any family connection and only aided by his sheer ability and drive. This has been the strongest driver behind our investment in IIFL,” says Ratnaswami, who also represents Fairfax as a non-executive director on the IIFL board. 

In 1994, Jain was the head of research at broking firm Motilal Oswal. The division was set up as an independent unit called Inquire. After spending about a year, Jain thought of starting something of his own and that led to the beginning of his entrepreneurial journey. In less than 25 years, he has transformed his one-man show into an admirable, full-fledged financial services firm with a market value of Rs.19,000 crore. A weighty testament to IIFL is attracting Prem Watsa, one of the most revered value investors in the world, as his prime investor. 

Portfolio building
IIFL as we know it today has gone through a metamorphosis. Jain set up an independent research house called Probity Research and Services in 1995, which transformed into a broking firm by 2001. This formed the foundation for the one-stop financial services shop, we know as IIFL today. 

IIFL hit the limelight in 1999, when the research house released a report on the IT sector that became quite the rage, given that it coincided with the peak of the dotcom boom. Much to Jain’s dismay, the report gained in popularity but that did not reflect in the subscriber base. He recalls, “We had 100 subscribers, but our reports were being read by several thousand people. In utter frustration, we decided to put all the reports on the internet for free hoping that a large reader base would attract advertising revenue.” 

This marked the beginning of India Infoline. The team comprised 50-60 research analysts. However, the team soon realised that solely relying on ad revenue wasn’t a financially viable option. Apart from these teething problems, the research house was hit by the dotcom bust at the turn of the millennium. It nearly drove the company off the edge. “Our cash balance had come down to Rs.4 crore-Rs.5 crore, we only had fuel to last a few months,” R Venkataraman, co-founder and MD, IIFL Holdings recounts the difficult period. 

Jain and Venkataraman were quick to pivot. Online broking was becoming the preferred mode of transaction in the US, and the duo picked up the trend early on by launching a technology-driven broking platform on a pilot basis in 2001. “People were not willing to pay for information, but they would pay for transactions. We decided to have a technology-driven platform as it was clear that for the next 20 years, technology would influence everything,” Jain explains. By 2002, the company was a full-fledged online retail broker — the online broking platform was called 5paisa, five paise being the brokerage fee for a transaction. India Infoline positioned itself as a discount broker at a time when most of the brokers were still offline firms. It also began distributing insurance and mutual fund products. 

As luck would have it, between 2003 and 2008, the market witnessed a strong bull run. The benchmark Sensex gained 5x during this period and the broking business grew rapidly. IIFL’s equity brokerage income grew from Rs.8.55 crore in FY03 to Rs.590 crore in FY08 — an impressive gain of 69x. Bulk of this income came from retail broking, but IIFL had by then taken a big stride in the institutional broking business. That was the second turning point which paved the way to expand its capital market business with gusto. 

Indeed, if IIFL did the unthinkable by crashing brokerage to five paise to build its retail broking business from nothing, it did a repeat in institutional broking by hiring from the most coveted institutional broking firm in the country. In 2007, IIFL hired top executives from foreign brokerage CLSA to set up its institutional broking business by offering them eye-popping equity — ultimately, this would mean a 10% dilution in equity — as sign-on bonus. 

It was an aggressive move to put it mildly. But it put IIFL in a different orbit. Venkataraman recalls that recruiting a team from CLSA that knew each other for over a decade helped the institutional broking business to hit the ground running. “If we were to separately hire head of research, head of sales, head of equity, etc. and also make sure that they gelled well with each other, it could have taken a while in building the business,” he says. What Venkataraman does not say but means is that they got access to ready clients who could contribute to revenue straight away, as the team could service clients just as any other established broking setup.     

Ratnaswami recalls engaging with IIFL’s newly-appointed institutional team. “We have never been traders. So, we always used few brokers. We knew the team from CLSA, their research has been outstanding. They deal with some of the best and biggest global investors out of the US and Europe. They are still very good today when it comes to doing block deals,” he says. H Nemkumar, president of institutional equities for IIFL, says that the company has relationships with 400 institutional investors — global and domestic — and the list includes all the top mutual funds, insurance companies, sovereign wealth funds, private equity funds and pension funds. “This gives us a strong hold,” says Nemkumar.

Having understood the power of people and incentives, Jain applied the same approach to wealth management. In April 2008, Karan Bhagat, who was earlier with Kotak Bank, was on the lookout to branch out on his own which is when he met Jain. Having cracked both retail and institutional broking, the only missing piece was wealth management for high networth clients and an offer was made, accepted and acted upon within a month’s time, with IIFL holding a 76% stake in the wealth subsidiary and the rest handed to employees. Venkataraman says, “We didn’t waste time in drafting a long letter. The entire MoU was signed on a single sheet.” 

Girish Kulkarni, MD of Suyash Advisors, who knows Jain well from his IIM-A days hints at the same thing: Jain’s people strategy has played a pivotal role in catapulting it to the big league in the businesses it entered. “Jain has an eye for talent, but more importantly, he has been able to get talented executives on board offering them the right incentives that has really enabled the company to grow quickly,” he says.  

Just like in the institutional business, the rewards in wealth management were unsurprising. IIFL enjoys a dominant position in the wealth management space today, being the one of the most preferred private wealth advisors for HNIs. Over the last four years, the assets have grown at a pace of 33% CAGR. Today, the wealth business manages Rs.120,100 crore worth of assets for 10,000 HNI families and contributes Rs.250 crore to the bottomline. “The strategy has always been to focus on new wealth that has been generated by selling stock options, selling of businesses or sale of land along with industrialists who have amassed large portfolio through dividends,” describes Bhagat.

Having a strong broking business coupled with a steadily growing wealth business, only meant a natural progression into investment banking in 2012. “If you are doing such a stellar job in the secondary market and have a strong distribution franchise across retail, HNI and institutions, then you should be able to replicate the same on the primary side,” reasons Nipun Goel, president, IIFL Investment Banking. Goel joined the financial services firm after a 14-year stint at DSP Merrill Lynch, followed by two years at Nomura. In FY17, IIFL’s investment banking team closed 21 transactions. The team was involved in capital raising and advisory transactions worth Rs.37,700 crore during the last fiscal.   

Lending to last
While IIFL grew its capital market business steadily alongside leveraging its distribution to sell financial products, even after obtaining a NBFC license in 2006, it abstained from consumer credit, sticking only to financing against shares. Retail finance was nowhere on the radar until the company was approached by a foreign financial services for a joint venture. As fate would have it, the foreign company never signed the agreement and IIFL went ahead with the venture anyway in 2007. 

In 2014, Jain and Venkataraman appointed Rajashree Nambiar, who was South Asia head for retail products at Standard Chartered, as CEO for its NBFC business. Under Nambiar, the NBFC’s AUM has doubled from Rs.11,000 crore to Rs.22,000 crore. Profit has grown at a healthy pace of 22% CAGR. “Our fast paced growth is a direct result of the entrepreneurial freedom we enjoy here,” says Nambiar, who finds the culture in IIFL a sharp contrast to the multinational bank she comes from. 

In FY17, IIFL clocked profit of Rs.420 crore, on a consolidated basis. Compared to peers such as JM Financial, Edelweiss and Motilal Oswal, IIFL has already transitioned into a majority retail portfolio, which includes home finance, gold loan, commercial vehicle, micro-finance. Apart from 1,112 NBFC branches, IIFL has more than 1,200 broking service locations that can be used to distribute products to its retail customers. The NBFC branches are present in 600 locations, well dispersed in metros, tier II and tier III cities. 

It is this large retail presence and portfolio that differentiates IIFL from its peers. Credit Suisse pegs 86% of IIFL’s loan book to be catering to retail credit. Meanwhile, JM Financial and Edelweiss have only 15% and 32%, respectively, focused on retail credit. The note points out that Motilal Oswal has 100% retail book, but the scale of its retail book is smaller as it is only into home loans. Retail book takes time and effort to build, but it pays off in the form of higher yields. If the credit due diligence is proper, a retail book tends to pose lesser asset quality risks compared to a wholesale book. So far though more than 90% of IIFL Finance’s loan book is secured lending and is supported or backed by physical collateral. 

Jain is counting on home finance as the next big growth driver. Both the government’s affordable housing push and higher yields (about 120 basis points) in the business makes it a lucrative segment to tap. From what was a small team comprising 100 employees, the home finance vertical has added 1,500 more over the past three years. One can sense the enthusiasm in Monu Ratra’s voice even over the speaker phone. The CEO of IIFL Housing Finance joined the company in 2014 from Indiabulls Housing Finance where he was the national sales and mortgage head. Ratra says, “When I joined, the mandate was to focus on home finance and within that on affordable housing. Today, housing finance has crossed Rs.5,500 crore from Rs.500 crore-Rs.600 crore, outstripping the non-housing finance book (including loan against property and construction finance) which has grown to Rs.6,700 crore from Rs.4,000 crore.” The average ticket size of home loan finance currently is Rs.26 lakh.

But IIFL wants to dig even deeper, makings loans of even smaller sizes. Recently, IIFL Housing Finance launched a product called Swaraj where the average ticket size is Rs.10 lakh-Rs.11 lakh. Swaraj is marketed as a product for customers with an irregular source of income such as a vegetable vendor, a milkman or an autorickshaw driver. While Swaraj accounts for 5% of the home loan book, Ratra foresees it accounting for 15-20% of the book going forward. To crack this market, IIFL is actively tying up with both government and private projects. “In the future, the government is going to be a major supplier of properties in the affordable segment. We have been engaging with housing boards in the states of Chhattisgarh, Gujarat, Haryana, Andhra Pradesh, and Tamil Nadu,” says an enthused Ratra. IIFL Home Finance enters into tie-ups with state government and finances the end-users that opt for homes in projects set up by the housing boards. In some cases, like in the case of Rajasthan, IIFL has tied-up with the developer as the project is a public-private partnership. “Recently, the AP Housing Board, has identified 70,000 beneficiaries. Even if we get a small percentage of this, it is a significant number for us,” he adds. 

Even as IIFL painstakingly builds its retail portfolio and has ambitious growth targets, it is also steadily securitising loans to boost growth even further. “About 30% of our loan book complies with priority sector lending (PSL) norms. IIFL sells off some of its PSL loans to banks at lower yields compared to the yields at which they are originated. For instance, home loans that are originated at 10-10.5% are sold down at 7.5%. It gives us a 3% spread and adds to our net interest margin.” IIFL’s CFO Prabodh Agarwal explains. Today, 13% of IIFL’s loan book is securitised. Agarwal adds that over the next 18 months, the company aims to take up that number to 20%. 

Shareholder is king
IIFL’s changing business profile has altered its complexion considerably — and it only looks better. The lending business accounts for 55% of IIFL’s profit, while wealth management accounts for 30% of the company’s bottomline and the remaining 15% is contributed by capital market related activities, compared with five years ago when it was still a capital market focused company with 60% of the profit coming from financing and investment income and 33% from equity brokerage. The ideal next step for IIFL would be to convert to a bank so it can garner low-cost deposits, making the model even more lucrative, but its application for a banking license has been rejected twice. That still does not take away the charm out of the IIFL story, because the one thing that has been constant through its transformation from a broker to full-fledged finance company is its sharp focus on shareholder return. 

Jain and Venkataraman have been steadfast about investing only in businesses that are return on equity (RoE) accretive. “If your balance sheet is not high quality, you can get into big trouble,” says Jain. For instance, the reason IIFL Holdings stayed away from starting its own insurance business despite being one of its largest distributors was the long gestation period that the insurance business required. “We were the largest non-bank distributors for ICICI Prudential for a long time — 2006-2008. But, we still decided not to get into insurance underwriting because it is a capital-guzzling business and we don’t know what impact it would have on RoE. In an insurance underwriting business, you have to invest for a long time before you break even,” Jain says. 

With that principled stance, the story can only get better going forward. IIFL’s strong and increasing retail presence already sets a robust foundation for future growth. With a collection infrastructure already in place, operating leverage will come into play, and as it has a bouquet of financial products to offer, there is tremendous scope to cross-sell to retail clients. Bank or non-bank, the next five years for IIFL may well be better than the past five. Prem Watsa, after all, is not playing for short-term gain.