Mahindra War Room 2017 Financial Services Caselet

MAHINDRA FINANCIAL SERVICES - LEASING BUSINESS CASELET

ACING THE FUTURE IN LEASING

For over 6 decades, Mahindra Group has successfully attained market leadership in
Utility Vehicles and Tractors across India and other parts of the world. Usually, Utility
Vehicles and Tractors are often purchased on credit, through Banks or other Financial
Institutions. With a vast network of Dealers, Mahindra was creating a large captive
business of extending credit to customers willing to invest in these vehicles. Also, it was
not uncommon to find customers who otherwise seemed trustworthy of credit, but did
not fit into the Bank (or other commercial partners) requirements - this affected sales as
such customers would often buy a product which came with credit support. Seeing this
opportunity, to both build a financial services business, as well as improve sales by
finding creditworthy customers missed by the banking system of India then, Mahindra
set up the Financial Services business under the leadership of Mr. Ramesh Iyer in 1995,
who started with 2 people and a desk in Mumbai. Mahindra went around building this
opportunity up using the "transferability" of its rural knowledge to set up a large
ecosystem of finance throughout the country.

Mahindra Finance did several unusual things for a finance company, from the beginning
- gaining from disorder and creating a truly antifragile business in the process. They
focused sharply on the bottom of the pyramid - the rural and semi-urban people who
had credit needs to acquire assets that can make them more productive, who were
often excluded by the Indian banking system then. They relied on the judgment of their
frontline executives on who should be lent, and how much, rather than having elaborate
credit scoring mechanisms and judging centrally. They pioneered the Earn & Pay
model which focused on providing loans for income generation, not consumption. Items
such as tractors, farming or haulage appliances, vehicles used for transportation etc.
were supported. Financial products such as asset financing, fixed deposits, mutual
funds, SME Financing, Rural Housing Finance, Life Insurance and non-life insurance
broking services, were often customised to suit the peculiar requirements of rural
customers. For example, a home loan may be offered for a small amount, to just build a
compound wall to begin with.

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Once that is repaid, a further loan will be extended to build a foundation. Once that is
repaid, a further loan will be extended to create a roof, and so on. Mahindra Finance
differentiated by focusing on building a relationship of trust with the customers, by
reposing complete faith on their customers ability to repay loans on time. These unique
approaches enabled Mahindra Finance to grow into a INR. 40,000 crore enterprise,
employing 16,000 people serving 4 million customers spread across 241,000 villages in
India. Going public in 2006, Mahindra Finance also set up subsidiaries for insurance
and Housing Finance - Mahindra Insurance Brokers Limited, and Mahindra Rural
Housing Finance Limited - to tap into adjacent opportunities through transferability.

LIVE BUSINESS CHALLENGE: ACING THE LEASING BUSINESS

Mahindra Finances core customer is the rural Indian, who is often a farmer. But the
profile of the rural Indian is evolving rapidly. The future farmer is likely to be a 25-year
old, as against a few years ago when he was often a 50-year old. The age of the farmer,
the vehicle buyer, the loan taker is changing. Also, the decision making pattern is
changing - from a family decision, it is now individual decision, and the fear of failure is
at the lowest level ever witnessed before in this segment. Earlier the biggest criterion on
this segment was I should not fail, and therefore I will decide if I should borrow at all
Today, it is I dont care if I fail - since the age profile has changed and alternatives
have come, competition is increasing and there is feeling that If I dont, someone else
will Even the earning potential has changed - they are no more dependent on just one
stream of cash flow, and going forward it is going to be even more. They now borrow to
have their dream fulfilled, rather than borrow because they have no other alternative to
live. The beliefs, attitudes and behavior towards finance is changing. The regulatory
framework around the business is also changing, and so is the delivery mechanism.
The customer is still the same, but the data available around the customer is much
richer today. So, making an informed credit decision is not based on how many years
Mahindra Finance has been in an area, but how well the data is understood. There is a
shift in paradigm in rural finance now. This data driven decision making is a huge
opportunity for the business to leverage and can be leveraged to usher in new insights
around customers and the products that best serve their needs.

The past year was one of the toughest year for Mahindra Finance, from a business
standpoint. The first quarter of the year (April16-June16) was drought prone in major

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states and that affected the off take of vehicles as well as financial products. Then came
a great monsoon, and October16 was one of the best months ever for Mahindra
Finance, recording 25%+ growth. Start November16 and Demonetization impacted the
business in a very big way from November16 right through January`17, as most of
Mahindra Finances operations is based on collection of cash, and people ran out of
cash to pay back. People also ran out of cash to make the initial down payment for their
vehicles. So, on both sides the business got hit - in sales and collections. Again,
February saw a good monsoon and a bumper harvest, propelling Mahindra Finance to
record a profit of over INR. 200 crores - covering for the loss of the previous months as
well. Overall, the year had just 2 good months in 12, but yet Mahindra Finance clocked
INR. 500 Crores in profits! The agility of the business centered on its anti-fragile
business model enabled it to leverage an opportunity that it presented itself and gained
from.

But is this volatility and apparent resilience good or bad? Should Mahindra Finance look
for ways to de-risk, and ensure secured growth in the future? With strong government
intervention through Aadhar, digital approach, a younger population ready to take risks,
what strategic changes should Mahindra Finance bring in? How can Mahindra Finance
create optionality to benefit from the positive aspects of uncertainty (caused by black
swan events and disruptions such as such as the emergence of many NBFC financing
options together with advent of companies in the payments banking ecosystem, and
demonetization) without too much harm from the negative aspects? One such possibility
seems to be in the Leasing business, which would create an optionality for Mahindra
Finance.

If we look at the Indian Market, one of the peculiarities is Leasing. India is one country
where leasing has never taken off, but it looks like GST is set to change that. But a
popular financial product is Hire Purchase, which is slightly different from Leasing, used
in the purchase of Housing and Consumer Durable Products by Middle Income Group
customers. NBFCs usually accept deposits from the public offering higher interest rates,
and would also earn from collecting higher interest rates from the buyers of durable
goods on hire purchase. This allowed the NBFCs to claim depreciation benefits and the
consequent tax benefits. In 1998, changes in accounting requirements and regulatory
restrictions were imposed, that linked the extent of deposits accepted by NBFCs to their
credit rating. Since then, the acceptance of deposits by these companies has declined,

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causing a corresponding reduction in hire purchase activities in India. To protect sales

through hire purchase arrangements, leading automobile companies - including
Mahindra Finance - set up their own hire purchase finance companies. Contrary to Hire
Purchase, Leasing is popular with Industrial customers. Information Technology
Equipment, Vehicles and Construction Equipment are 3 major sectors for Leasing,
accounting for 40% of Indias total leasing volume. Aircrafts, Containers, Railway
Wagons, Office Equipment, Temporary Power, Renewable Power and Medical
Equipment are other sectors which are expected to gain momentum in Leasing. Leasing
includes maintenance, asset-light, re-sale or residual value protection. Therefore the
EMI (of the product part alone) in case of leasing would be lower than what the
customer would have paid in case of a loan, because the estimated residual value is
deducted upfront from the price of the asset, assuming both the lender and borrower
agree on the maintenance and residual values.
The main difference between the erstwhile Hire purchase schemes and Leasing in
the treatment of depreciation benefit for tax computation. In lease, the lender derives
the depreciation benefit for income tax, whereas in Hire Purchase, the borrower gets the
depreciation benefit. Historically, the growth potential of Leasing in India has been
constrained by the tax environment, which made life more difficult for lenders. For
instance, the Tax benefit was not available to the lender but it was available only to the
borrower (as in hire purchase).

The introduction of Goods & Services Tax (GST) effective 1st July 2017 could prove to
be a disruptive effect in the Indian Leasing Industry. Before GST, leasing services would
invite a combination of service tax (levied on services) and VAT (levied on the product
part), as it is seen as a bundled contract where goods and services are both provided
simultaneously. It was worked out that out of the total lease amount, 10% shall be the
service charge component by the lessor, on which service tax was applicable - VAT was
applicable on the balance 90% of the value. With GST, there is no distinction between
goods and services for levy of tax. Goods and Services as defined by the respective
sections do not include money - therefore the interest component shall not be
chargeable to GST. Also, the input tax will be available only where the input is used to
further the business. This makes Leasing in Business to Business situations more
attractive, a means to gain GST credits.

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The Mahindra Group comprises the Automotive & Farm Divisions, and even the Realty
Business are OEMs that supply the product - the asset; Mahindra Authorized Service
Centers & First Choice Service Centers which can optimize the maintenance cost of the
asset; Mahindra First Choice Wheels which can maximize the residual value of the
asset and Mahindra Finance, which can finance the asset.

Could an entry into the Leasing business be a game changer, a growth engine,
and a portfolio optimizer (as it de-risks from over dependence or rural and agri
based revenues) for Mahindra Finance? Should Mahindra Finance enter the
Leasing business at all, or stay away from it? Why is Leasing working
everywhere, and what is the exact condition of Leasing in India? Would Leasing
work in India, or not? How can Leasing be made more attractive? What would the
different stakeholders - the OEMs, Financial Companies and other partners need
for Leasing to work? What are the categories of purchases and segments of
customers for which Leasing would work? What are the success factors for acing
the future in the Leasing business? Are they a fit for Mahindra Finances
aspirations and goals? How should Mahindra Finance address that, assuming
they look with fresh eyes, without limitation of product involved or customer
segment? What can Mahindra learn by benchmarking with leaders in leasing such
as LeasePlan, Orix and TeamLease? What can Mahindra Finance learn from
global markets? Can Leasing give the ability for Mahindra Finance to grow their
balance sheet significantly bigger, while helping the whole group achieve their
strategic intent? Would it create a new market in both urban and rural, thereby de-
risking and re-positioning the company? Synergy, Innovation, Creating a New
Market, Derisking the current strategy, and building a new business out of it all -
can Mahindra Finance achieve all this through leasing?

Considering these factors, examine the appropriateness of Mahindra Finance to

enter the Leasing business and if you think they have to enter, evolve a
comprehensive business strategy and plan for Mahindra Finance to become a
significant player in the nascent Leasing Industry in India.

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