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A Deeper Look at SBI Card IPO and the Credit Card Business

Credit-card-SBI-IPO.jpg

SBI Cards and Payment services (SBICPS), subsidiary of SBI filed its DRHP with SEBI for its upcoming IPO. The DRHP is voluminous and runs to about 500 pages. We dissect the issue and business of SBI Cards in this post.

The Issue

The equity share capital of the company as on the date of filing the DRHP is 93.23 Cr shares of Rs 10 each. 74% of this or 68.99 Cr shares is held by SBI(promoter) and 26% or 24.24 Cr shares by CA Rover Holdings, an affiliate of the Carlyle Group.

Carlyle Group entered the business in 2017 by buying out stake of GE Capital, who had been associated with the company for over two decades. GE Capital’s stake sale was bought by both SBI and CA Rover. CA Rover paid Rs 2,000 Cr for its 26% stake, valuing the company at Rs 7,700 Cr at that point.

Below is how the shareholding has changed over the last two years

SBI Cards SHP

Source: DRHP

The company will sell 14% of its equity in the IPO. The details of this issue are

  • Fresh issue of shares to the tune of Rs 500 Crs
  • Offer for sale (OFS) of 13.05 Cr shares which includes
    • Employee reservation portion of 18.64 Lakh shares and
    • SBI shareholders reservation portion of upto 1.30 Cr shares. Investors can apply in this category if they hold SBI shares on the day when the DRHP has been filed with SEBI

SBI will sell 3.72 Cr shares or 4% and CA Rover 9.32 Cr shares or 10%. The company hasn’t given any details about the price at which it is going to offer its shares. It is however estimated that the 14% stake sale will fetch the company anywhere between Rs 8,0009,500 Cr. This pegs the value of the company in the range of Rs 58,000 – 68,000 Cr. At these valuations CA Rovers stake will be valued at about 15,000 – 17,700 Cr. It will make 7-9X on its investments made couple of years back.

The fresh issue of shares is 500 Cr, these will be used to strengthen the company’s capital base and ensure its compliance with RBI directives. SBI Cards is registered as NBFC – ND – SI (non banking finance company – systemically important non deposit taking company).

Update: SBI shareholders bidding in the shareholder reservation portion can also bid under the net offer (offer less the employee and shareholder reservation portion) and these will not be treated as multiple bids. However if the shareholder bids over 2 lakhs in the share holder reservation portion then they cannot bid in the net offer, these will be treated as multiple bids.

Credit Card Industry Landscape : India

Credit cards fall into the unsecured loan category, the other loans which fall into this segment are personal loans and consumer durable loans. The unsecured loan market at the end of FY19 was estimated to be Rs 5 trillion. 73% of this comprises of personal loans, 22% credit cards and 5% consumer durable loans.

Unsecured loans have been the fastest growing category in retail credit, registering a 28% CAGR in the FY14-19 period.

Delinquency in personal loans is in the range of 0.5-0.7%, credit cards 1.5-1.8% and consumer durable loans 1.5-2%.

Some of the salient features of the credit card market in India are

  • Credit card spends in FY19 amounted to Rs 6 trillion, registering a 32% CAGR over the last 5 years. Spends are expected to 2.5X (15 Trillion) by 2024
  • Number of credit cards issued – 47 million at the end of FY19. Numbers/Volumes have grown by 20% CAGR over the last 5 years. Cards outstanding at the end of October, 2019 – 53.4 million
  • Average annual spends per credit card – Rs 1,44,000, registering a growth of 12% CAGR over the last 5 years
  • Sales of credit cards happens mainly through distribution channels like Banca (selling at existing bank customers) and open market (malls, petrol pumps, airports, retail stores etc.)
  • Credit card penetration (average number of cards per 100 people) in India is low – 3% in FY19 as compared to other countries. On the other hand debit card penetration in the country is at 65%

 

 

  • Credit card originations among millennials (people below 30 years of age) has increased over the last 4 years from 19% to 35%, share of customers below age of 25 has increased 10X in the same period

 

  • Demonetization, digitalization, cash less society, development in the e commerce space and improved payment infrastructure (POS terminals and payment gateways) have lead to the faster growth of credit cards over the last few years

 

 

Competitive Intensity: Indian Credit Card Market

There are 74 players offering credit cards in the India. HDFC Bank, Axis Bank, ICICI Bank and SBI Cards dominate the market, 72% of the cards outstanding* (volume) in FY19 are with these 4 players. In terms of credit card spends – 66% of the total spends are held by these players.

SBI Card and BOB Card are the only credit card issuers who are NBFCs while the other issuers are banks. Borrowing costs of NBFCs are higher that what it is for banks, this is because they do not have access to low cost deposits.

Below tables depict the trend in credit cards outstanding and total spends for key players in the industry.

 

Observations from the above tables

  • The 5 players have 78% and 75% of the market in terms of cards outstanding and total spends
  • Total spends have increased by 32% CAGR, from Rs 1.5 trillion to Rs 6 trillion
  • Cards outstanding have grown by 20% CAGR, from 19 million to 46 million 
  • HDFC Bank has maintained its leadership position on both the cards outstanding and total spends front in the entire period
  • The growth in SBI’s outstanding cards and total spends has been the 2nd highest. While its cards have grown by 23% CAGR, its total spends have registered a growth of 44%. Growth in average spend per card has been the highest for SBI
  • Axis Bank has been the biggest beneficiary amongst all the players. Its outstanding cards and spends have grown by 34% and 48% CAGR. Its market share has nearly doubled from 7% to 13% in outstanding cards and from 6% to 10% in credit card spends
  • Growth in outstanding cards in the case of Citibank has been poor at 2%, however total spends have grown by 15%. The average spend per card is the highest for Citibank – Rs 1,99,881 in FY19 amongst all the players
  • Axis Bank and Citibank are 10% and 9% of total credit card spends in FY19. Axis outstanding cards have grown by an impressive 34%, however its average spend per card in FY19 is the second lowest – Rs 1,21,220/card 

 

Observations from the above charts

  • Number of transactions have increased a CAGR of 27%, from 421 million to 1414 million 
  • Axis Bank has recorded the highest growth in the number of transactions. Transactions have increased from 27 million to 168 million, registering a growth of 44%
  • Average spend per transaction has grown in single digits for all the players
  • SBI recorded the highest growth of 8% CAGR in the average spend per transaction. The average spend on an SBI card was Rs 3,708 in FY19
  • Citibank average spend per transaction degrew by 2%. Spend per transaction in FY19 stood at Rs 2,227, the least amongst all the players

One of the sources of how a credit card business makes money is the outstanding credit card balances that customers do not pay on time and roll over the outstanding amounts. The credit card company charges high interest rates on these outstanding dues. About 50% of the revenues for a credit card company are from this stream.

The above chart shows a trend of the average outstanding balances of 4 players. Data for Citibank is not available.

Observations from the above chart

  • HDFC Bank has the highest outstanding per card in FY19, combine this with the highest cards outstanding and this results in a deadly combination. The average outstanding receivables of HDFC Bank at the end of FY19 was Rs 44,000 Cr
  • HDFC is way ahead of the other players. The outstanding per card of HDFC is 1.6X of SBI, 1.94X of ICICI and 1.74X of Axis Bank 
  • ICICI has seen the fastest growth in its outstanding per card – 12% CAGR. However even after the highest growth, its outstanding per card at Rs 18,514 is the lowest amongst all the players

The IPO Candidate: SBI Cards

SBI Cards started its operations in 1998, the business started off as a JV between SBI and GE Capital. GE Capital sold its stake to SBI and CA Rover Holdings in 2017. In April, 2018, SBI Business Process and Management Services, a company providing back end payment and processing services to SBI Cards was merged with the company (SBI Cards).

The company is the second largest player in the Indian credit card market. Its market share in total cards outstanding and total spends stood at 18% and 17% respectively at the end of FY19.

The credit card portfolio of the company includes SBI branded cards and co branded credit cards. It offers four primary branded credit cards – Simply Save, Simply Click, Prime and Elite.  Co branded credit cards are issued in partnership with players in the travel, fuel, fashion and healthcare industries. Some of its co branded partners are Air India, Apollo Hospitals, BPCL and OLA Money.

The company issues cards with Visa, MasterCard and RuPay payment networks. These companies provide access to SBI Cards to their payment networks and SBI Cards in turn pays royalties and fees to these payment networks.

Behind the Scene : What happens when a cardholder uses a credit card?

Before we proceed on looking at other aspects of SBI Cards, let us look briefly at what happens when a cardholder purchases goods or services using the company’s credit card.

Once a customer swipes the card on the POS machine at a merchant establishment, the acquirer sends the transaction details through a payment network to the issuer. The acquirer is a bank that gives the POS machine to the merchant.

The issuer approves the transaction and sends the confirmation back to the acquirer through the payment network. In the case of online payments, there are payment gateways/ payment aggregators which send transaction details through the payment network to the issuer.

The issuer pays the transaction amount to the network net of interchange fees. The payment network holds back a certain sum and pays the acquirer, the acquirer pays the merchant net of merchant discount fee.

Brief on the key players in the ecosystem

CC Ecosystem

Interchange fees in India are set by payment networks such as MasterCard and Visa. There are regulations by the RBI on interchange fees on debit cards, any regulations on credit card transactions in the future will impact revenues of credit card companies.

Revenue Model

SBI earns its revenues from two sources

  • Interest Income
  • Fee Income (Non Interest Income)

Let us break up these sources of revenues in detail below.

Interest income is earned when cardholders roll over their dues, in other words the company earns interest income on its assets (receivables) when card holders do not make payment in full when they are due.

The company classifies its receivables into 3 categories

Types of Receivables

Revenues from interest income were 51.1%, 53.2% and 56.4% of total revenues in FY19, FY18 and FY17 respectively.

Revenues from interest income are half, this implies that lot of card holders do not make payments on time. There are also few charges which card holders are not aware and this adds to the income of credit card companies.

An Aside: Don’t Rollover Your Credit Card Bills!

Credit card IPOs may be good business, but as a customer, you have to be really careful and never let a due date go by without paying your bill in full!

For instance if I have a due of Rs 10,000 that needs to be paid on the due date, which is on the 30th of every month. If for some reason I do not make the payment in full and pay only 8,000 on the due date, leaving an outstanding of 2,000. I will not only be charged interest on 2,000 but also on any transaction from the previous 12th as well! Assume a transaction of 5,000 has been done on the 15th, after the bill date of 12th but before the due date of the 30th, interest will also be levied on this amount. The only way to avoid interest is to settle the outstanding amount 7,000 (5000+2000) in this case.

In the case of cash withdrawals from ATMs, transaction charges are charged for withdrawals. In addition interest is charged not only on the cash but also on any outstanding dues at the time!

And the interest rate is a ludicrous 2.5% a month or more! (Sometimes even as high as 3.5% a month)

The bottom line is to pay your credit cards in full on the due date. And don’t withdraw cash from your credit card, ever. (Use a debit card instead)

But this is a huge business for SBI Cards, earning around 50% of their revenues this way. In fact, if you think about it, an outstanding of Rs. 20,000 cr. earns them Rs. 3,000 cr. in interest a year, which is a pretty high interest component.

Income From Fees

Income from fees and services is the major component of fee income. These are earned by levying various fees and charges to its cardholders.These can be broken down into three sub categories

Fee and Income Services

Revenues from this category were 44%, 42% and 39% of total revenues in FY19, FY18 and FY17 respectively.

The other sources from where SBI generates revenues in the fee category are

Service Charges – Consists income earned from commission from selling of third party products, brand association fee charged to partners and transaction revenue

Business development incentive income – SBI earns business development incentives from payment networks under long term contracts. The incentives are dependent on increases in credit card spends, cards outstanding and new product launches

Insurance commission income – Income earned by selling insurance products to cardholders

The company also earns other income, these are not from the business operations. These consist primarily of income from investments/FDs, recovery from bad debts written off, liabilities and provisions written back and tax refunds.

Let us look at how the numbers stack up for these sources of revenues over the last 3 years

Observations from the above table

  • Revenues are equally split between interest and fee income in FY19, this was not the case in FY17 where interest income constituted 56% of total revenues and fee income 43%
  • Operating revenues have grown by 45% CAGR, from 3,346 Cr to 6,999 Cr
  • Income from fee & services have grown by 53% CAGR, whereas growth in interest income is 38% in the same period
  • There has been impressive growth in the service charges and business development revenues, 54% and 57% CAGR, however this is on a low base

Other income which is not part of the above table was 288 Cr in FY19, this has grown by 52% CAGR in the FY17-19 period

The latest 6 monthly revenues – September 30, 2019 versus that in 2018 are as below

The other income has increased by 147%, 313 Cr as on Sep 30,2019 versus 127 Cr a year ago.

The income from fee & services has three sub categories as discussed above. Revenues from this segment can be broken down as below


 

More than 50% of the fee and services revenues come from spend based fees. Spend based fees as discussed earlier primarily consists of interchange fees. The interchange fees is dependent on the card spends and outstanding cards.

More than 30% of the fee and services revenues come from instance fees. Instance fees are earned by levying range of charges, some of them are late payment fees, cash withdrawal fees and statement retrieval fees.

Spend based and instance fees have grown by +50% CAGR in the FY17-19 period. Total revenues from fees & services have grown by 53% in the same period.

In the six months ended September 30,2019 revenues have increased by 43%.

On the profitability front, the company’s net profit in FY19 was 863 Cr. PAT has grown by 52% CAGR in the FY17-19 period. Profits for 6 month ended September, 2019 were 726 Cr an YOY increase of 93%.

Cost Structure


 

The costs of the company are variable in nature. 55% of the costs in FY19 were operating and other expenses. Looking at the breakup of the operating and other expenses we see that sales promotion expenses constitute bulk of the operating costs. Impairment losses and bad debts form 19% of the costs and as the credit card receivables grow these expenses should also increase. Together these expenses form 75% of total costs in FY19. These costs are variable in nature as they are dependent on the card outstanding and card spends.

Fixed costs – employee benefit expenses, depreciation and finance costs constitute 25% of the total expenses in FY19.

Receivables & NPAs

NIMs

Portfolio Quality
Source: SBI Cards DRHP

Receivables at the end of September 30,2019 were 23,038 Cr, drivers of the receivables are the cards spends and outstanding cards, however the collection process and time it takes to collect monies from cardholders also determine the receivable balance at a point of time.

We can see from the above table that about 30% of the company’s loan book are from term loans or EMIs. This implies that 60% of the loan book is split between revolver loans and transactor loans. Transactor loans do not make any money for the company and interest rates on revolver loans are higher than term loans. The average yield on the company’s receivables is in a narrow range of 21-22%, this means that the increase in interest income is on the back of increase in loans/receivables that the company has provided to its card holders. NIMs have been in the 15-16% range.

Gross NPAs are stage 3 advances, these advances have evidence of impairment as on the reported date and expected credit loss is calculated for these accounts.

Gross NPAs have been in the range of 2.34% – 2.81% and Net NPAs in the 0.76%-0.94% band.

ROE Profile

Source: SBI Cards DRHP

ROAs have been in the range of 4-4.8%, there has been a spike in September 30,2019. ROEs on the other hand have moved in a band of 28-31%, there is a spike seen on this as well for the September 20,2019 period.

Key Metrics

Key Metrics

We also want to highlight the below

Royalty

Source: SBI Cards DRHP

The company pays a royalty fees to SBI for using its logo. The royalty fees is 2% of net profits or 0.2% of total income, which ever is higher.

The second development is recent in nature. The company entered into a Bank Distribution Agreement on November 20,2019. As per the agreement, SBI Cards will pay SBI fees for using its premises (bank branches) for developing its business. SBI will also provide referrals of its customers and provide other facilities like providing a drop box at SBI branches.

RISKS

The Credit card receivable portfolio falls in the unsecured retail category. Managing credit risk is the holy grail in running a credit card business. We have seen instances in the past where a slow economic growth can severely impact the collections of credit card companies.

Take the case of Barclays cards business in India. The company set up its card business in 2006 when the economy was growing at 9.5%. It was aggressive in expanding its business and in a push to acquire customers credit card limits were much higher than at other banks. The party did not last beyond 2009, when the company ended up with huge NPAs and its credit card business for up for sale.

This brings is to the question of what are the key factors on which a credit card business thrives? and a slowdown in these factors will hamper the credit card business.

Economic growth and specifically parameters like consumer confidence, unemployment rates, consumer spending and demand for credit are important drivers of a credit card business. Slowdown in any of these will hamper the business, like in 2009 loan defaults had risen due to job losses in the IT and BPO sectors, which heavily impacted unsecured lenders.

Distribution and scale are key factors. A weaker distribution channel will increase costs and in a down turn hurts companies.

Regulations also can spoil the party for credit card companies. For instance in 2009, there was an RBI guideline that restricted credit card companies from harassing customers for recovery of dues. In addition recovery agents had to undergo 100 hours of training at IIBF(Indian Institute of Banking and Finance). This slowed down the recovery process.

In the current set up interchange fees for credit cards are not regulated, however this is not in the case of debit cards. Any move to regulate the interchange fees will impact revenues

Interest rates of credit cards are not regulated and do not move with the interest rates in the market. Interest on revolver loans is high 36-44% and term loans 20-22%, any move to regulate the interest rates that these companies charge will have a severe impact.

The company receivables are short term in nature and its source of funding are commercial paper, non convertible debentures and working capital loans from banks. Any mismatch between the receivables and company paying its debt can lead to liquidity risk.

Payment landscape in India is changing. Initiatives like JAM (Jan Dhan, Aadhar and Mobile) have facilitated a move to digital transactions. Demonitization has also lead to people moving towards digital transactions.

There has been an emergence of UPIs and payment wallets, which have helped in moving to a cash less setup. While the selling point of credit card companies in the free credit period (50 days) which these platforms do not offer, we cannot rule out any disruption in this space. We need to keep an eye on the developments in the payment landscape in the country.

UPI volumes in FY19 were 5,353 million as compared to 18 million in FY17. Volumes for H1FY20 stood at 4,966 million. Spends on UPI were Rs 8,770 billion in FY19 as compared to Rs 60 billion in FY17. Spends for H1FY20 was Rs 9,034 billion.

What happened to the Barclays card business?

It was shut down, the performing portfolio was bought by Standard Charted bank and the stressed asset portfolio by Kotak Mahindra bank in 2013.

Final Thoughts

Players in the payment ecosystem are enjoying tailwinds and there seems to be a long runway for this. In addition to initiatives like JAM and emergence of UPI and payment wallets, growth in e commerce has had a very big role to play in move towards digital transactions. Credit cards account for 30-35% of the payment value on e commerce platforms, this will increase as companies now offer the option of paying by cards on delivery.

Credit card penetration is low in India, companies that have scale and stronger distribution network can expand to smaller cities. Cards issued to NTC (new to credit) customers is growing rapidly. NTC customers are defined as those who have got their bureau record for the first time. NTC customer base has increased by 20% CAGR over the last three years to reach 3 million at the end of FY18.

Payment infrastructure has drastically improved, the payment infrastructure facilitates seamless payments. POS terminals have grown by 27% CAGR from 1.1 million in FY14 to 3.7 million in FY19. It is expected that there would be 5 million POS terminals by 2021. Emergence of payment aggregators/facilitators have also helped.

SBI Cards having a strong parent backing, been in the business for two decades and having a strong distribution channel and scale will certainly benefit from the developments taking place in the payment ecosystem.

The question that we as investors need to ask is – Will we make money by investing in the company? and what are we paying? 

We do not know the price/valuation at what the shares are going to be issued. However as we had mentioned at the start of the post, the company will sell 14% and this is expected to fetch anywhere between Rs 8,000 – 9,500 Cr. This pegs the value of the company in the range of Rs 58,000 – 68,000 Cr. Profits for FY19 were 863 Cr, the PE at these valuations is in the range of 67-78X.

The profits for 6 months ended 30 September, 2019 were 726 Cr.  If the company were to put up a similar performance in the rest of the year, the PE at these valuations would be 40-47X. A word of caution though – extrapolation like this may be injurious to your wealth.

The average ROE for the last three years has been 30%. Profits have grown by 52% in the same period. Higher ROEs with this kind of profit growth is a deadly combination. If you think about it, in two years, if the company generates 30% ROE and reinvests it, the total PAT will become more than Rs. 2,200 cr. – which is nearly three times the FY19 numbers. For a company doing 3x earnings in three years, and with the market growing fast, and with the ability to reinvest at the same ROE, you might find it difficult to get a lower P/E.

Of course, the risks remain: that they will be replaced by a UPI/new tech led payment landscape, and that they could have heavy NPAs if there is a huge retail drop in sentiment.

With the recent frenzy seen in IPO subscriptions it may not be a bad idea to apply for 1 lot in the IPO and decide after listing if positions have to be built up.

*Outstanding cards is the sum of all credit cards issued, including temporarily suspended credit cards that may be reactivated in future, net of cancelled and deactivated credit cards.


NOTE: There is no other relationship between Capitalmind and the above company. Please do not consider this article as a recommendation, It is purely for informative purpose only.