Aavas in Sanskrit means home. And an apt name for a home financier too. Aavas Financiers was founded by a team, one of them was Sushil Agarwal who was also the CEO. This is a small tribute to Aavas and Sushil Agarwal.

So what is so great about Aavas and Sushil Agarwal? I’ll try to present the story in 4 reasons.

Reason #1: Solving a hard problem.

In one of Paul Graham’s essays he says:

Suppose you are a little, nimble guy being chased by a big, fat, bully. You open a door and find yourself in a staircase. Do you go up or down? I say up. The bully can probably run downstairs as fast as you can. Going upstairs his bulk will be more of a disadvantage. Running upstairs is hard for you but even harder for him.

What this meant in practice was that we deliberately sought hard problems. If there were two features we could add to our software, both equally valuable in proportion to their difficulty, we’d always take the harder one. Not just because it was more valuable, but because it was harder. We delighted in forcing bigger, slower competitors to follow us over difficult ground.

– Paul Graham, founder of Y Combinator

Aavas is both a borrower and a lender. It borrows from Banks and other institutions and lends to small borrowers.

When Aavas was founded it had a BBB+ rating. Which meant that when Aavas went to Banks to borrow, they had to pay a big interest. Contrast that with the big daddy of Housing finance- HDFC who could get loans at really cheap rates and so it could lend onwards to borrowers at rates far lower than Aavas. So how was Aavas to even compete with the big boy?

So Aavas had to do what Paul Graham asks you to do when chased by a bully – run upstairs. Therefore it had to find hard problems that were difficult to solve. Therefore while HDFC would lend 60 or 80 Lakhs to prime white collared customers, Aavas would lend to the self employed and those without credit like tailors, small restaurant owners, small shopkeepers a measly sum of Rs 10 Lakhs to construct their own house. This was a segment of customers that banks and large institutions found difficult to serve and therefore neglected them. So Aavas would borrow at 13% and lend at 18%. (The spread of 5% was needed for Aavas to invest in technology, manpower, branches etc.)

If HDFC tried to do what Aavas did, it would be doomed. To get to 80 Lakhs, HDFC would have to assess many different borrowers and find 8 trustworthy borrowers and lend them 10 Lakhs each. HDFC would rather say “No thank you. I’ll stick to prime white collared borrowers“.

The way Aavas did was to first assess the borrower and the property and then lend based on cashflows of the small business and to lend based on qualitative parameters. This is far harder than lending based on IT Returns, Bank statements etc. that HDFC did.

And Aavas not only lent money, they also got their money back from the borrowers. In 12 years of operations and having disbursed nearly 22,000 Crs till date, they have written off only Rs 25 Crs! Let that sink in.

Aavas’ underwriting is so good that their NPAs were far lower than HDFC’s. So not only did Aavas lend money to the so called riskier customer class, they lost far less money that HDFC which lent to the prime customers. Let that also sink in.

So Aavas converted their biggest weakness (small size and high cost of borrowing) to their biggest strength by running upstairs. HDFC would never dream of leaving it’s cushy segment and come after it.

Reason # 2: Win-Win

Remember, I said that when Aavas started life their credit ratings were low. Over time, they managed their risks (see below) very well and always had surplus money. Banks that lent to Aavas loved to lend to Aavas because Aavas was a reliable and responsible borrower who always paid back on time with interest. And so over time, it’s credit ratings improved. And with better credit ratings, their cost of borrowing reduced.

When Aavas’ cost of borrowings reduced, they went and reduced the rates of interest for it’s own borrowers. Imagine you borrowed money from Aavas and after a few years, Aavas came to you and said “please pay us lesser going forward”. (In fact, think of your own life, how many businesses have told you “please pay us lesser“.)

Charlie Munger loves Costco for the same reason that as Costco became bigger and more efficient, it kept lowering it’s prices. With each passing year, Costco seems to tell it’s customers “please pay us lesser“.

Sushil Agarwal wanted to give his employees the same life that he desired. So all systems mandatorily shut down at 7 PM which forced everyone to work efficiently and avoid late nights. Work was evenly paced and no month end, quarter end or year end pressures.

Looking at Aavas, you may think it is an NGO with no profit motive. But would you believe that Aavas has been a profitable venture from the get go and they kept doubling their size and profits every 3 to 4 years?!

So you see everyone associated with Aavas wins – the lenders (Banks), the customers, the employees and the shareholders. One stakeholder isn’t benefitting at the expense of another. When every stakeholder wins, it creates a flywheel effect.

To understand this- take IPL as an example. The players want to play in IPL because they get paid a lot; the sponsors want IPL because it gives them eyeballs; the team owners want IPL because it earns them money; BCCI wants IPL because it earns a lot. When all stakeholders win, it is likely to happen and get bigger over time.

Contrast win-win with win-lose. In most businesses you will see customers benefitting at the expense of suppliers; shareholders benefitting at the expense of employees. You know a fine institution when you see how they treat their vendors. D-Mart pays it’s suppliers every 10 days whereas Shoppers Stop pays it’s vendors after a year!

Reason # 3: Built to last

Charlie Munger is a big fan of inversion. When he plays a game, he wants to know in all the ways you can lose and then his strategy would be to avoid those pitfalls. So instead of focusing on winning, he would focus on avoiding losing.

When Sushil Agarwal was conceptualizing Aavas, he studied every Bank and NBFC and made a list of all their mistakes so Aavas could avoid it. Here are a few that Aavas has said no to:

No commercial papers. Commercial papers are short term loans that are cheap. Many in the industry like GE Capital in the USA and Piramal and DHFL in India have fallen for it. They borrowed cheap short term money and lent it at higher interest rates for long duration. So when the time to repay the Commercial Paper comes, you just borrow from other Commercial Papers to pay the first. Kind of like a Ponzi scheme. You borrow from Peter and pay Paul. Then you borrow from Pramila to pay Peter and so on. It works beautifully until it doesn’t. What if you were counting on Pramila but she doesn’t lend to you and then how are you going to repay Peter? If you don’t repay Peter, you will become a defaulter and your credit ratings would be downgraded to junk status. So this is one way that you can lose the game and therefore Aavas never borrows using CPs.

No negative ALM. ALM stands for Asset Liability Mismatch. Think of Assets as cash inflows and Liabilities as cash outflows. Since Aavas is both a borrower (from banks) and lender (to borrowers) it needs to make sure that cash in and cash out are matched. In fact they don’t play close to the line at all. They have more cash in than cash out at every period of time. So they will never run the risk of defaulting.

No fast growth. Lending is a business full of risks. You can exacerbate it by lending fast. I was watching an interview of Ajay Piramal and he said his biggest mistake was going too fast in lending. In lending it’s easy to lend, difficult to recover. It’s also a business where good news comes front and bad news comes later. Therefore you need to approach it cautiously.

Even Motilal Oswal, the great investors made rookie mistakes. They have a subsidiary that provides home loans. At this subsidiary they didn’t setup a proper collections arm. And the guys underwriting the loans reported to the sales guys. Imagine this- the sales guy has targets and is he more likely to say Yes or No to business? Of course, Yes! And if the guy whose job is to underwrite, reports to this sales guy with animal spirits- is he likely to displease his boss by saying No? Of course not! So Motilal Oswal not only gave loans when they shouldn’t have, they also didn’t have a good collections team to get the money back. Result: they ran up NPAs of 10%! Yes- Motilal Oswal, the gurus of investment made these rookie mistakes! (Source: ET)

So you see, when Sushil Agarwal and the founding team designed Aavas, it was designed to last. No short cuts, no playing close to the line, no short term focus. It was all built with the long term in mind. It was built with risk management in mind.

Reason # 4: Consistent

I did a fun exercise. I counted the number of times Sushil Agarwal used the word “consistent” in every earnings call. It would amount to about half a dozen times in each call. And you could see it in how Aavas would do business. Aavas would open branches with consistency. Aavas would grow with consistency…never too fast, never too slow.

Also, every quarter, the results would come on a Thursday afternoon and the earnings call would happen on a Friday. If they had a call on a Monday and the earnings call would happen on a Tuesday, no one would care. But looks like Aavas cared for consistency. And this would happen consistently, quarter after quarter.

So I remarked to a friend that in Q4 of FY 23, that it is strange that the results are coming on a Wednesday and the call is happening on a Thursday. And just like that – Sushil Agarwal resigned from the house he had built. It was like Steve Jobs leaving Apple. But I doubt if he will ever come back like Jobs did.

It was quite sad to see that Mr. Consistent would no longer be a part of Aavas.

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So there … I have tried to present my reasons for why Aavas is a great business and why Sushil Agarwal was a great CEO. So while the house may last, for me a bit of the charm is lost.

Thank you Sushil Agarwal for building this fine home called Aavas. You have been an inspiration and I have learnt a lot from you and Aavas.

– Cheers

PS: To make a story interesting, you need an anti-hero too. And HDFC served that purpose. 🙂 HDFC is a fine business too. I have learnt a lot about Affordable Housing Finance from it’s former subsidiary Gruh Finance. I have paid tributes to Mr. Sudhin Choksey in a previous blog here.