If ever there was a borrower suited to the social bond format, then it is surely India's Shriram Transport Finance Company (STFC).
Focused solely on the financing of commercial vehicles, the company's remit is all about supporting those at the bottom of wealth pyramid to lift their income levels. And its very name Shriram (Lord Rama) references the Indian deity who represents virtue (dharma) and the fulfilment of moral obligations.
It was, therefore, particularly fitting that it was the BB+/BB+ rated credit, which executed the world's first social bond of the year and the decade when it raised $500 million on January 9.
The 2020's will be a decade when investors will increasingly have to get used to juggling a dual remit whenever they examine a company's balance sheet and use of proceeds. They will no longer be solely concerned about making money. They will also need to check whether proceeds are being used for a social good.
Promoting positive social outcomes is the key takeaway from the International Capital Markets Association's (ICMA) Social Bond Principles, which were first issued in 2017.
STFC argues that this is its whole raison d'etre given that most of the drivers applying for loans do not have access to official credit channels; only informal moneylenders who charge nearly triple its rates. After STFC's drivers pay off two- to three-year loans on pre-owned commercial vehicles, they are typically able to decuple (10 times) their monthly incomes from the previous $130 to $200 level.
Issuing a social bond has also proved a savvy move for STFC at a time when India's non-banking financial companies (NBFCs) are still finding it difficult to access domestic credit themselves after Infrastructure Leasing & Financial Services (IL&FS) blew up in September 2018.
As CEO, Umesh Revankar, explains in the Q&A below, the group is actively diversifying its funding sources to tap every possible investor base. Adding a social label to its bond enabled it to tap into new pools of capital.
The group has not released detailed figures about the proportion of dedicated ESG investors that participated. But the distribution stats do show that 90% went to asset managers and insurers, up from 81% when it first came to the market with a conventional bond in 2019.
A four-times oversubscription level was also a positive outcome in a crowded market. Here Revankar explains the rationale behind its social bond and how it wants to continue blazing a trail for Indian NBFCs in the international bond markets.
Q Where did the idea of doing a social bond come from?
A We got the idea about a year ago when we did our first roadshow for a conventional bond. An ESG investor mentioned that we’d be a good fit. After that, we did some preliminary research and realised that our strategy aligns with the government’s Priority Sector Lending directive. This states that 40% of adjusted net bank credit should be set aside for sectors such as agriculture, micro and small enterprises, low income housing, student education and so on.
The government’s directive has many similarities with ICMA's Social Bond Principles, which issuers used a guideline for use of proceeds. So, we decided that a social bond would be a good way to promote ourselves.
We followed up by seeking advice from a group of banks to put the mechanics of a deal in place. This final stage took about one to two months in total and included getting an independent limited assurance report from KPMG and a second party opinion on our social bond framework from Sustainalytics.
Q You say that your strategy is aligned with the government’s Priority Sector Lending directive. Was it easy to establish a social bond framework covering use of proceeds, monitoring and reporting, etc?
A Most of our portfolio fits the criteria, but there are some exclusions, which need to be taken account of. We set up an internal committee to monitor them and ensure that we don’t end up funding them.
There are about 12 to 15 exclusions in total. Our main business is lending to small businesses in the commercial vehicle market – we needed to make sure is that these vehicles are not used in the mining sector, for example.
Q What questions did you receive on the roadshows?
A We did a roadshow in Singapore, Hong Kong, London and the US. The questions were all basically about use of proceeds and how we’ll monitor the exclusions.
Q The distribution statistics show that 50% of the deal was placed in the US. Were you surprised by that ratio?
A Yes, we were quite surprised. But US investors liked our story and they could see how well our existing bonds had traded.
Q Will you be returning to the international bond markets again this financial year?
A No we won’t. We’re now very close to our fiscal year end at the end of March.
Over the past fiscal year, the regulations allowed us to automatically raise $750 million without prior approval from the Reserve Bank of India (RBI). We did that in April and July through a $500 million bond deal followed by a $250 million one.
We then sought approval to raise a further $750 million. The social bond accounts for $500 million of that. The rest came from multilateral and export credit agency (ECA) sources.
Q What’s your international fundraising plan for the next financial year?
A We anticipate raising the same amount of money again. What we’d like to do is build on our existing success by diversifying our funding sources further.
We’d like to look at Singapore dollars and euros, but it will depend on the appetite in each market. Right now, we’re finding very strong demand in US dollars, but we know that the many of the world’s top ESG investors are in Europe.
We’d also like to lengthen our maturity profile to fit our lending profile. At the moment, it’s a little over three years. The next step is aim for four to five years in the offshore markets. It’s not possible to go longer than that at moment because the cost of capital is too high.
Q And what about social bonds?
A We definitely want to keep issuing in that social bond format. Most of our portfolio is eligible and it draws in a wider pool of investors, so it makes a lot of sense for us.
Q So where does that leave you in terms of foreign vs domestic currency in terms of your funding split?
A Overall, we don’t want to go over 20% of our total equity. Foreign currency borrowings are currently about 10% of the total.
Q Do you find that domestic and international bond investors have different priorities?
A They both ask similar sorts of questions relating to our business strategy. International investors are less familiar with the ins and outs of the Indian economy, so they also want a view on that. They’re also much more focused on corporate governance issues.
Q Do you think international bond investors understand India’s NBFC sector? It’s still very new to them given that you executed the first-ever bond only in February 2019?
A It’s still a new concept so it’s been important to explain how NBFCs differ from one another. There’s a very basic split between the specialist NBFCs like us and the wholesale ones, which lend to large-scale projects.
The latter did very well to start with because their overall management costs were lower, and they enjoyed high growth rates. They were able to show a very strong bottom line.
But the mismatch between their long-term lending and short-term funding finally caught up with them. That part of the sector has faced some real challenges since IL&FS.
By contrast, specialist NBFCs like Shriram Transport, have reported steady state growth for a number of years. We also enjoy good margins.
Q And yet the fact is that the whole sector has experienced a liquidity squeeze since IL&FS got into difficulties, followed by Dewan Housing Finance (DHFC). How difficult has it been, and do you see conditions easing now?
A After IL&FS defaulted our cost of borrowing went up about 75bp. It is now slowly coming back down again.
The RBI has cut interest rates by 135bp since August and that’s put pressure on the banks to reduce their lending rates to the NBFC sector, which they’ve done incrementally.
During the October to December quarter, I’d say our cost of borrowing came down about 10bp to 15bp. We think it will come down by a further 10bp to 15bp this quarter.
After that it’s a case of watch and wait. Back in October, the RBI said that it would continue with its accommodative stance as long as inflation remained within its target 2% to 6% band. The recent figures, which have just come out for December, show a spike to 7.35% largely because of food price inflation, especially onions and rice.
Then there have been fears that rising tensions in the Middle East will impact India since we’re a net oil importer. However, the government will be able to hold inflation expectations regarding oil.
Food price inflation also tends to be fairly short-term for about one to two months. I don’t think inflation will remain at high levels.
Q What impact will all this have on your growth rates?
A We’re in a good position because we’re able to pass on higher costs to our customer. Higher costs don’t impact our net interest margins. We’re also fortunate that we’re a deposit taking NBFC, so we have an advantage over many others in the sector.
Q What’s your current overarching business strategy?
A We want customers to upgrade their vehicles. There’s also a push towards electric vehicles (EV), plus those which run on liquefied natural gas (LNG) and compressed natural gas (CNG).
I think we’ll start to see these kinds of vehicles grow quite rapidly in next three years. We’ll definitely be part of that change.
At the moment, EV, LNG- and CNG-fuelled vehicles are a very miniscule part of our portfolio. But we’ve put in a lot of preparation in anticipation of this changing.
There’s huge potential for India’s three-wheeler fleet to go electric and the government will give special encouragement. I’d like to see 10% of our fleet either be electric, LNG or CNG within the next three years.
At that point we’ll be able to do a green bond as well as a social one!