Indian Microfinance Sector and the companies in the sector

[richdreamz]

A brief note on Indian Micro Finance Sector:

The Indian micro finance sector has come a long way post the then united AP crisis involving SKS Micro finance. I strongly believe the time has come to invest into this sector as equity partners and be a part of its high growth phase. However, it is important to understand the risks that surround a micro finance company before investing money.

Firstly, let me start off with Risks:

1. Being vey low ticket loans, from INR 10000 to 100000 to 250000, majority being around 25000 INR, the companies serve the really needy people of very low income group. So, political risks exist, where to garner votes, Government may impose restrictions on collections. I personally believe this risk may become low as we progress as an economy.
2. Surprisingly, the net NPAs of most of the micro finance companies is “Zero”. Yes it is. This may be due to the way the loans are given, the business models (group lending, strict KYC norms, tiered lending etc)
3. Though net NPA levels are low, I think it is prudent to build in some NPAs into our models as any natural calamity would displace population and their ability to repay. So, geographic risk exists, but this risk can be mitigated by spreading the loan book across geography.
4. Too high a growth for the next 3-4 years. Yes, most of the MFIs are looking to grow anywhere between 40% to 70% CAGR until 2019. Such high growth will bring in its own associated risks.
5. To be able to grow at such rates, capital infusion at regular intervals is necessary and so companies should be able to secure equity partners else growth is a problem
6. This may lead to equity dilution in order to maintain CAR and though book value might increase if NPAs increase alarmingly the RoE may not scale back to pre-dilution levels.
7. South markets are mostly saturated while North is relatively under penetrated.
8. I’m sure there could be some more risks but I think the above are important risks.

Post the AP crisis, RBI played an active role in formulating regulations, credit bureaus are formed providing customer credit scores to the MFIs who subscribe to these agencies for a fee (X INR per query).

MFIs help the needy lead a respectable life and stand on their own feet, which could be one of the reasons why the NPAs are so low. People generally would not cheat companies those who helped in times of need.

Largest 4 Players in the sector:

SKS Microfinance: South and West: Rural focussed: Listed.
Janalakshmi Microfinance: Pan India: Urban focussed: Unlisted.
Ujjivan microfinance: Pan India: Urban & Semi Urban: Unlisted.
Satin Creditcare network: North India: Rural only. Listed.

There are about 13 NBFC-MFI players pan India which have some scale, of which the largest one Bandhan got Universal Bank license and so is not an NBFC-MFI anymore. So, out of the remaining 12, the above 4 are the largest in terms of AUM in that order. Loans are mostly given for ‘income generation’ activities and not for consumption! It is important to have an eye on this metric if possible as any loan given for consumption would have higher delinquency. A typical loan seeker would be someone with a small automobile parts store, a vegetable vendor, a tailor, someone who wants to expand his small business.

Other Key points:

1. ONLY 2 out of 12 players are listed on Indian stock exchanges and so there will be a scarcity premium attributed for anyone who wants to invest in this sector. Over the next few years, I think the other MFIs would get listed on exchanges and the older players might start to get good valuations.
2. The ultimate destination for these MFIs could be to become a Universal Bank on the lines of Bandhan, Yes bank, Kotak etc. but by then these players would have attained scale.
3. While becoming a bank may reduce political risks as they come under RBI ambit completely and not under local political whims, becoming bank itself will bring in the statutory requirements, initial set up capex etc.
4. Getting a loan from MFI though a time consuming initially, is much better than securing loans from loan sharks who charge atrociously high interest and are not under RBI’s ambit.
5. Huge opportunity as more people move away from loan sharks and move towards MFIs. Better economic activity, GDP growth should provide the required tailwind as well.
6. Microfinance is not a new concept limited to India or to developing countries, it is equally applicable to developed nations where even now there is a set of people unserved by mainstream banks. Recently read about a paypal employee quitting company to set up an MFI in USA and becoming hugely successful.
7. The NIMs are high and the maximum interest spread is capped at 10% by RBI. So, the NIMs are very high compared to NBFCs and banks and so should command better risk adjusted valuations.
8. Due to low ticket size, the client bases are huge, the largest MFI has a client base of more than 2 million.
9. Banks, NCDs, ECBs, other financial institutions are the major source of debt funding while banks still make up the largest source by far.
10. Some MFIs like Satin have other fee based income sources like providing insurance on loans taken, LAP etc. but still do not form significant portion of profits yet but provide nice cushion for PAT growth.
11. Also, the size of loan increases as the customer pays off the previous low value loan. To start with the loan sanctioned would be 15000 INR and if this is re-paid successfully, the loan size would increase to let’s say 30000 INR. This is a very good business model.
12. One customer can avail loan from 2 MFIs only. So circular loans is not possible - revolving loans - take loan from one and pay other continuously. Here the credit bureaus play an important role. So, the data of these bureaus must be updated as we progress.
13. Loan is also provided to customers who have government provided ID cards like ration cards etc. The loan tenure is typically 1 to 2 years and repayment is either daily, weekly, bi-weekly, monthly as per mutual agreement.

Satin Creditcare Network

While each MFI has it’s own strengths and weaknesses, let me concentrate on Satin Creditcare Network as this intrigued my interest based on the below points and so I went digging deeper into the company to evaluate if it is investment grade or not:

The above points made me bullish on the sector as a whole and was looking to invest. However, as pointed out earlier, we have limited choice. It is either SKS or Satin Creditcare Network. SKS is anyway widely covered by analyst community. Satin got listed recently in both BSE and NSE and so is undiscovered.

1. Satin is the largest player in North India which is under-penetrated compared to South and so huge opportunity size.
2. 25 years of history starting with loans to people to buy generator sets and has steadily grown over the years with best risk management systems in place and prudent lending practices.
3. During initial states, the promoter himself personally vetted each application before providing loans. He is a first generation entrepreneur, Harvinder Pal Singh with growth oriented focus and highly qualified (CA and Wharton management course). The promoter is hands on and very experienced in the industry and well respected for his views.
4. Managed to keep promoter’s stake at 35% even others like Ujjivan (promoter stake of 1% only) have diluted own stake. High promoter stake means he has continuously put his own money as well along with other equity partners. High promoter stake inspires trust though it may come down with further equity placements.
5. Has very good fundamental and strong PE investors backing the company - Danish micro finance partners, a Danish Government company, SBI FMO (not our State bank), ShoreCap, NMI Fund etc.
6. High operational efficiency - 6.2% (Opex/AUM%). RoE of 19% in FY 15, RoA of around 1.6. The metrics should improve as the company gets bigger.
7. CARE rating of BBB+, raised rating for consecutive years. As the company grows, the ratings should improve. I believe due to its current rating the cost of funds are higher than Ujjivan and Janalakshmi. By Fy17, the ratings would likely catch up with peers providing the cost of funds reduction.
8. Diversified loan book across 11 states around. Net NPA of “Zero” for past 2 years.
   Looking to grow its AUM from current 2150 crore to 13300 crore by FY19. This was what intrigued me into reading about MFIs and the company in particular and as per my research, this growth is indeed possible!
9. Average ticket size of 22000 INR and should grow aiding AUM growth. Top player in UP and MP. Total of 22500 villages covered with 1.2 million customers.
   The moat for the company in my opinion is it is looking to go deeper into rural areas and cover the population while other MFIs are looking to grow covering urban populace. Though Satin might have higher OPEX, it would have better spreads and lower NPAs as the real rural people are better payers of their EMIs due to peer pressure and strong local/community bondage. Satin has a better understanding as well due to its 25 years of experience in this field.
10. The management is confident of AUM growth. 6 times in 3 years approximately.
11. The distribution channels, company collection officers, collection process, already invested in scalable IT systems ready for future growth, the management expertise, strong PE investors would help company scale up.
12. Majority of Satin customers are women. Mostly women tend to work to augment family’s income and to provide good education to her kids.
13. Majority of Satin’s loans are for agri related, animal husbandry, trade and services and majority of its customers are women who tend to be loyal in paying back.
14. Relatively inexpensive valuations when compared to SKS, the only listed player. My own metric is based on Market Cap/AUM. While it is about 1 times for SKS, it is about 0.5 for Satin. 15. I believe Satin deserves better valuation when compared to SKS owing to its better growth prospects, better managed portfolio, risks, play in North market which has less competition, rural play, prospect of improving its credit rating fro BBB+ to A over a period of time and thus reducing its cost of funds.
15. Almost 85% is with promoter (35%) and PE players (~50%). So, the floating stock is really less. This should help in scarcity premium and richer valuations.

The above notes point to some of the the unique prepositions that Satin offers under MFI companies for investors.

This note has been taken completely from the documents available online (attached) and I have put in my perspective based on my own subjective understanding of the documents. The attached documents would give much better in depth information.

NOTE: This thread is intended for discussions related to micro finance. I have included notes related to Satin also as this is how I made my personal notes and is in sync with thought process. Let’s continue Satin related discussion in its dedicated thread, linked here.

Satin Creditcare Network Ltd - Reaching out!

SATIN CREDITCARE NETWORK LTD : http://www.satincreditcare.com/index.php Satin Creditcare Network Limited (SCNL) was formed in 1990 as a Non-Banking Finance Company (NBFC) with the simple concept of providing individual loans to urban shopkeepers for tiny businesses by Mr. Harvinder Pal Singh. Since then the company has expanded and evolved into one of the leading microfinance institutions in India with its current geography in North as well as Central India. SCNL provides loans to both urban …

This is to start off with, let’s collaborate further and discuss the micro finance sector per se.

Disclosure: I hold the shares in Satin Creditcare and is about 10% of my portfolio. This is not a buy/sell recommendation. Do your own due diligence.

Must read on the Indian Microfinance sector by Religare. Must appreciate the work done by them.

India Microfinance - Sector Report 19Aug15.pdf (3.0 MB)

Satin Investor Presentation:

Satin_Creditcare_Investor_Presentation.pdf (1.2 MB)

IMFR document on Satin Unique preposition (Old document)

case-study-satin-creditcare-network-limited-unique-in-its-field-2006.pdf (320.8 KB)

[chiragjain1976]

@richdreamz

Very nice write up and explanation on the sector.

how about shriram cityunion finance.
Somewhat it is also in the some sort of micro finance and Mr Piramal has bought stake in it.

[RajeevJ]

@richdreamz

Comprehensive n insightful coverage of the sector. Well done!!

[Anant]

Microfinance risks have manifested themselves in different ways. In my opinion the major sector risks are different from what has been listed above. I will list down a few:

a) Political risk: Microfinance comes under the purview of state governments. Since most of the rural MFI loans are given to economically backward strata of the society and also since they form a major chunk of voting population any impact on them can lead to heavy clamping down by the state govt. The AP microfinance crisis clearly shows how badly state government regulations can impact the industry in a state.
b) Geographic risk: Any geographic calamity can have severe impact on an MFI. Example of this are available when the recent floods in Pakistan Punjab wiped out the MFI industry assets.
c) Multiple loans: This has been the biggest challenge operationally to the Microfinance industry. It has manifested itself time and again. The credit bureaus only cover MFIs (as per RBI regulation only two MFIs can lend to a person) but they do not cover loans from SHGs(Self help groups), HFCs(Housing Finance Companies), NBFCs and of course the local pawn broker. SHG loan books are almost the same size as MFIs. The recent RBI guideline of increasing the ticket size from Rs 30,000 to Rs. 60,000 greatly increases this risk significantly. Also MFIs lending from non operational revenue generating activities (consumer activities) are highly prone to this.
d) Religious: In certain communities interest on a loan is considered against the basic tenets. This risk manifested in the Mysore region where MFI loans were given to silk weavers.
e) Disease: Since a large amount of MFI loans are for animal husbandry purposes any disease outbreak could lead to wiping out of huge assets (think about mad cow disease, bird flu).

Along with these the standard risks of financial institutes are all present. In most of the cases these risks have combined together and resulted into huge losses to MFIs. The NPA of below .1% is a mirage since whenever any of these risks strike the NPAs have risen very sharply and have destroyed the entire MFI capital base.

Coming to the listed players which again I have gone into details:

Satin: Very high leverage. Preferential shares as part of tier 1 capital reduces interest coverage significantly. Not sure about management ethics. +ve ROAs are heading North every quarter. High exposure to animal husbandry.
Arman: Great management, conservative, focused on their work. Geographic and political risks.
SKS: Decent mgmt., lowest borrowing cost (lowest lending cost), wide geographic presence.

DIsclosure: Exited Satin recently. Looking to enter SKS.

[ankitgupta]

Hi,

Recently a friend was discussing about MFI sector and two reports from Religare and Ambit which have come out highlighting some concerns about the sector. I thought since I have been tracking Arman Financial Services Limited for over a year now and had done some work on the sector, I would give my views:

• Non productive asset being build by borrowers: I think there is a clear differentiation between ‘personal loans’ and ‘MFI loans’. MFI loans are not for consumption purposes like buying some non productive asset. Most of these loans are lent for purposes like buying inventory by small grocery shop owner, purchasing cattle, goats, tailoring equipment etc (Arman doesn’t lend to farmers for purchasing seeds, fertilisers etc). These are very much linked to income generation purpose.

• High interest rates being charged by the MFIs: I think we need to understand the loans being charged by money lenders and then compare it with the lending rates of MFIs. Money lenders charge as high as 4 - 5% per month (translating into 48 - 60% per annum rate of interest) whereas these guys charge around 18 - 25% per annum (its somewhere around the same rate as the interest being charged for vehicle loans). Also, post the implementation of Malegaon Committee recommendations, the interest rates have been capped at 10% over the cost of funds of MFIs (12% for smaller MFIs having loan book of less than Rs.100 crore). These would lead to passing on the lower interest rate benefit to the customers in declining interest rate scenario. Also, please note that the people who are being given loans have no access to capital and these small loans help them in increasing their incomes.

• Post Andhra crisis, lot of positive changes in the way MFIs work: The scenario of the MFI sector has changed completely post the Andhra crisis. Let’s just talk about how the situation was in the Andhra Pradesh. There was reckless lending, siphoning off of loans by building a nexus between MFI employees and borrowers (SKS’ ARs of FY11 and FY12 are pretty interesting), borrowers taking loans from 3 - 4 MFIs, taking MFI loans to pay installments of other MFIs etc. I think all these Andhra based MFIs got carried away by the growth and access to cheap capital. However, post the crisis, there have been lot of steps taken by the RBI - the foremost being implementation of recommendations of Malegaon Committee. One should read the report (I have attached it)Malegaon Committee Report.pdf (254.3 KB). Some of the key changes include:

• Capping the interest rates being charged by MFIs

• Capping processing charges

• Not allowing a borrower to take loans from more than two MFIs

• Forming Credit Information Bureaus for borrowers

• Restricting coercive method of recovery

• 50% of the aggregate loan installments which are overdue for more than 90 days and less than 180 days and 100% of the aggregate loan installments which are overdue for 180 days or more

• Recognition as ‘priority sector lending’ for banks

• Exemption from Money-Lending Acts

• Question marks about the sustainability of robust Asset Quality: One point we need to understand here is the role of Joint Liability Group (JLG) model where the borrowers are organized in group of eight to ten women living in an area of around 500 – 600 meters, each jointly liable for other members. In case if one out of 10 members defaults, the remaining nine members have to compensate the MFI on the behalf of one defaulting member. There is a big role played here by social pressure of peers. In addition, there are pressure on the members to repay as the defaulting members will find it very difficult to borrow once again. Also, the lower strata of people who avail these loans have a better track record in terms of repayment. I think Andhra Pradesh crisis did not spread much to other states in terms of delinquencies. Arman had negligible NPAs during FY10 - FY13 period. However, the overall sector faced lot of challenges in terms of funding from banks. In hindsight, the crisis led to better regulation of the sector and curbing of poor practices followed by most MFIs. The point of increased penetration of MFIs leading to lowering of credit standards by MFIs depends entirely on the practices followed by individual MFIs. For eg, as per some industry insiders just before the allotment of small bank licences by RBI, some of the MFIs who had applied for the same had become pretty aggressive. There is so much under penetration in the sector that MFIs have lot of areas of growth. As per Arman management, if there are three to four MFIs operating in an ares, the competition is manageable. However, political risk continues to remain the biggest risk for the sector. Pending passage of MFI Bill is also a concern.

• Impact on MFIs from the ones who have got small finance banks: The impact on the MFIs is expected to be not much in the near to medium term as most of these licence holders will be busy in reducing their foreign shareholding, arranging for funding as well as complying with other RBI regulations for banks. Also, one will have to monitor the increase in cost of setting up a new branch as well as operating costs. The cost of setting up a new branch for MFIs is not much (as per Arman its around Rs.2 lakh) as the rentals are low in rural and tier III areas as well as not much furniture and computers are required. In the long term the lower cost. The cost of funding for these license holders will decline as they will now have access to low cost CASA bank deposits. However, how much is the impact on the other MFIs is difficult to tell now as ‘access to capital is more important than cost of capital’.

A very good way to track the development in the sector is to go through these MFIN reports which are published every quarter - http://mfinindia.org/wp-content/uploads/2016/03/Micrometer-Issue-16_Q3-FY-15-16_19th-Feb-2016_for-dissemination-among-members.pdf

[richdreamz]

Looks like it is negative press for Microfinance industry these days. They are doing a good job of highlighting the concerns and not to sway away by the growth rates alone. Perspectives from both side of a coin.

Putting the Ambit report and an article by IIT Professors on MFI industry as this is relevant to the thread here.

Why microfinance is fading out, dated March 19, 2016:

Why microfinance is fading out

Ambit Report:

Ambit- Microfinance errclub Will the dream run continue.pdf (421.5 KB)

[Anant]

In my discussion with an MFI veteran he said there are multiple unlisted MFIs which are involved in unscrupulous practices. He said that the entire sector is more or less ungoverned and unregulated. Also a lot of grants from foreign countries go into the sector (Satin has received multiple grants). In my opininon we need to look into the sector in a different way mainly due to the following:

a) Regulatory framework: Despite the current changes in the sector which are for good, the regulatory framework remains very weak. Credit information bureaus are just the starting point as they do not carry information about SHG’s and NBFC lending.

b) Asset quality: Asset quality, ROA and RoE are all point in time measurements of a financial institutions. None of these indicate business sustainability in the longer run. A highly leveraged financial institute can hide behind great ROE at the cost of high risk. Think of all Investment banks pre 2008 crisis.

c) Impact of few black sheep: A few black sheep can destroy the great work done by the others. This increases political and other risks significantly.

Despite multiple regulatory requirements the banking sector in India is in doldrums. In my opinion the balance sheet of a financial institution is only as clean as its promoters. I think what is important is to discount the promoter and media talk and try understanding their loan processes, their lending culture, try meeting some of their on field employees and also some of their customers.

No holdings in MFIs looking to understand the sector more.

[mvr99]

I have closely worked with an MFI company in the past (though its been a while), so sharing some thoughts based on that experience. Most of the points have been covered above and are absolutely on the mark, but there are some conclusions drawn which may not be right. In random order :

1. Demand - there is ample demand, particularly in the rural regions. However the law of diminishing returns applies - as we go deeper and deeper, the cost of loan servicing keep increasing (as distance between villages starts to increase, one loan officer can only cover so much area in a day, which is required for daily collections; or one branch can cover fewer villages).

2. RBI guidelines limit the number of MFI loans per person to two, and the maximum amount of loan to 50,000. So individual loan (or ticket) size cannot go beyond 50k.

3. One of the key limitations to growth, particularly for smaller MFIs is access to debt capital (assuming they have got enough equity in the first place). Banks typically prefer to lend to larger MFIs (larger = safer in their opinion), plus rating agencies dont increase their ratings unless the MFI crosses particular AUM thresholds - so its sort of a chicken and egg problem for smaller MFIs. Ultimately results in higher borrowing costs for MFIs.

4. While Bandhan has got a bank license, the MFI entity is separate. From their site, “Bandhan Bank Limited was incorporated as a wholly-owned subsidiary of Bandhan Financial Holdings Limited. Bandhan Financial Holdings is owned by Bandhan Financial Services Limited (BFSL), the largest micro finance organization in India”. So largest MFI in India is still Bandhan - not sure if they have plans for an IPO though.

5. While MFI NIMs are very high compared to other NBFCs or banks, the operating costs are also very high - this is because for every payment of an MFI loan, a loan officer has to visit the house of the customer. This is a ‘high touch’ model as opposed to say banks, where once the loan is disbursed the bank wont contact you unless you miss a payment.

6. I would think after RBI stepping in, the political risk (of state/local politicians stepping in) is significantly reduced, to the extent that it is not a factor any more than RBI changing lending norms is a risk for banks. Typical MFI customers like the MFI because it keeps them away from the local loan sharks. And the group lending concept means that everyone usually knows why someone has defaulted, so the chance that they would try to assign the blame on the MFI and drive them away using local politicians is miniscule. What happened in Andhra, where at times 9 MFIs had lent to the same person, was a one off, and most (if not all) of the causes of that crisis have been addressed by RBI’s guidelines.

7. Some important operational metrics to monitor along with the usual financial ones (if you can get the data) - AUM/Income per loan officer, AUM/Income per branch, customers per loan officer, first time customers as % of total customer base. These can help one understand if the MFI is growing correctly and profitably or not, before the financial metrics kick in.

[ankitgupta]

Thanks Ramesh for sharing your insights having worked in the industry. It really helps.

[Anant]

This is superb info Ramesh. One more question on the lines of law of diminishing returns:

a) In a village that is covered how does MFIs expand further? Does every next loan by MFIs in a village a loan to less credit worthy individual?

[mvr99]

@Anant, not sure what you mean exactly when you say ‘covered’, but I presume you mean coming close to 100% penetration (like in some locations in South states). Once the majority of demand in a particular location is fulfilled, with the RBI limit of 2 MFIs per borrower, it becomes a marketshare game technically, but doesnt really pan out that way. There is not much poaching of customers that can happen, unless a group is particularly unhappy with its MFI - in my experience this rarely happens. Usually once the loan term is over, the group upgrades, say from a 10K per head loan to a 15K per head loan, or to whatever amount the MFI is willing to give. This is one way for the MFI to grow with the same number of customers. But this also has a limit of 50K ticket size as I mentioned earlier. But I doubt if any MFI is near those limits. Average ticket size as per MFIN last report is ~18K.

Secondly, the MFI model is such that the individual’s credit worthiness is not really the point, it is the group which matters, and the MFI processes which ensure that the group is credit worthy. The group has a strong inherent selection mechanism because one wrong selection and the rest of the group will have to pay. How is a group formed in the first place? The loan officer (LO) of the MFI scouts around in her alloted area (typically the LO is also from around the same geogrpahy) for people who need a loan. She manages to find 2-3 people who need the money. But since a group needs 8-10 people, she explains the group lending model and asks the 2-3 people to help find more people to complete the group. So already the selection bias is in play, and the new people coming in are those who are credit worthy as per the first 2-3. Typically all these people are from the same neighbourhood (prudent MFIs have norms to avoid collusion e.g. members of same family/close relatives cannot be part of same group). The group then undergoes training and then testing to make sure they understand the group lending concept, and only after that does the loan disbursal happen. This is how typically a prudent MFI would work - so you can see that the processes can ensure that every next loan is not less credit worthy.

However if the MFI management is not prudent they can skip these checks and go aggressively for growth, forming groups randomly, not having any group norms, not explaining the group lending concept clealy and so on… easy to guess what the end result will be.

[mvr99]

Btw, two more MFIs, Ujjivan and Equitas had filed their DRHPs some time back - can access at below links :

http://www.investmentbank.kotak.com/downloads/ujjivan-financial-services-limited-DRHP.pdf

http://www.edelweissfin.com/Portals/0/Documents/Investment_banking/Project_Fair_-_Draft_Red_Herring_Prospectus-October_16,_2015-Filing_Vers…pdf

[ankitgupta]

Hi Ramesh,

As you have worked in the sector, it would be really helpful to get few insights from you regarding the sector:

• As per MFIN reports for quarter ended December 31, 2015, 33.20% loans are used fro agricultural activity (17.10% for agriculture and 16% for allied activities - I am assuming that would be cattle/goat rearing etc), 42% for non-agricultural activity (32.90% for trade and services and 9.10% for manufacturing purpose) and remaining 24.80% for household finance. Do you think MFIs do check the end purpose of the loans being taken by the borrowers and give loans based on the assessment?
• Does social pressure play a very important role in the repayments?
• Do you think interest rates play a very important role in switching to other MFIs or new small banks for e.g. SKS has sub 20% interest rates while all other MFIs charge at least 25% interest rate?

[mvr99]

• There is a broad principle that loan should be given for income generating activity, but this is very difficult to always ensure from what I know. This parameter is one of the less important ones. If the LO has reasonable assurance that the repayment capacity is there, she will go ahead. Yes, the MFIs try to have a broad mix of usage to ensure lower risk but I doubt if that always pans out e.g. in case of a severe drought in a rural area, not only the 33% in agri but also the 33% for trade and 25% household finance would be at risk since the rural economy as a whole would collapse.

• The structure of the group is such that social pressure comes into play if required only. Each group is different and probably the MFI also would not know if social pressure came into play… so I would definitely not claim to know how much it is a factor. But it is a wrong perception that typical MFI customers would stop repaying if there was no social pressure. On average they are just like you and me, would not take a loan unless really needed, and would do everything possible to repay the loan as soon as possible - this would be true for 95% of the population is my guess (or my hope!). Social pressure is needed for the rest 5%.

• Certainly such a large difference in interest rates would be an advantage to SKS. However we are not into the market share game yet and there is enough demand for many MFIs to grow. SKS also has limited amount of money to disburse. Switching in between typically does not happen on a large scale because the onboarding process is usually lengthy - you have to attend multiple group meetings etc. - and for most of these folks time is literally money e.g. someone running a retail shop would need to close it down for few hours and lose income to attend the meetings. Once the loan is repaid, customer usually wants a higher amount loan - again if you want to go with a new MFI you need to go through their onboarding process, but this would mean there is a gap in between, say a month or so, during which you have no access to capital, whereas if you just continue with the existing MFI it is a smooth process. Plus there is a risk the new MFI may reject your application for whatever reason. Plus, a new MFI wont give you a higher amount as loan since they dont know you, whereas your old MFI would. Lastly, consider this - for a 10K loan to be repaid in 52 weekly instalments, what is the difference between 26% and 20% in terms of weekly payments? 6 Rs (218 vs 212 Rs per week). So all in all, I would say it is a factor but not that important at this stage of the market.

Discl - not invested in any MFI. My experience with MFI industry is limited to my work experience with one small company spread in 3 states, so please take my comments with a pinch of salt.

[v4value]

Thanks for your super helpful and patient answers Ramesh. I had a quick qn on the willful default scenario. Do the borrowers put long term pain ahead of shrt term gain? I mean if a local politicon says its ok to default why wont the whole village default and enjoy the debt waive off (though longer term they would be impacted by higher debt cost)…thanks

And the group lending concept means that everyone usually knows why someone has defaulted, so the chance that they would try to assign the blame on the MFI and drive them away using local politicians is miniscule. What happened in Andhra, where at times 9 MFIs had lent to the same person, was a one off, and most (if not all) of the causes of that crisis have been addressed by RBI’s guidelines.

[mvr99]

I certainly think they focus on the long term. Remember that they are coming to MFIs from local money lenders who are at much higher cost, and they havent forgotten that. Also, like I said 95% people are honest, hardworking and wanting to pay off the debts they owe - question is can the 5% whip up such a frenzy to get the 95% behind them and get politicians into play. They can if the social conditions exist e.g. poor economy, MFIs start using coercive methods (which happened in Andhra) but not under normal business conditions which exist these days. Event risks (earthquake, flood, drought, riots, poor monsoon…) are of course always there and can influence behaviour, but this is a risk every business faces.

Also the fact that no such (major) incidents have happened since the RBI norms came into effect should give us some comfort on this.

[v4value]

Thanks Ramesh. Your inputs are super helpful.

[crazymama]

Since there is no Equitas topic, felt it best belonged here.

CONFERENCE CALL - from Capital Markets

Equitas Holdings

To continue focus on strong growth

Equitas Holdings conducted concall on 09 May 2016 to discuss financial performance for the quarter ended March. PN Vasudevan, MD of the company addressed the call:

Highlights:

· The company has 3 subsidiaries - Equitas Microfinance providing group loans to the customers having no formal documents of income, Equitas Finance offering loan for used commercial vehicles and micro and small enterprises (MSE), Equitas Housing Finance providing loans in the affordable housing segment

· The company has recently launched another subsidiary Equitas Technologies Private Limited which would provides technical platform connecting entities interested in transporting their loads and truck owners. The company would soon start its operations.

· The loan tickets size stands at Rs 3.5 lakh for used vehicle loan segment, Rs 1.7 lakh for MSE loan segments and Rs 12000 to 20000 for microfinance.

· The lending rate stands at 22.5% microfinance, 18% to 22% for used commercial vehicles as well as for MSE loans.

· As per the RBI regulation, 90 days over due bas NPA recognition norms applies to the microfinance companies, while the company is classifying its microfinance loan based on 30 days overdue basis. Housing finance company has been recognising NPAs on 90 days overdue basis basis.

· However, the company has shifted to 150 days overdue basis NPA recognition norms in the commercial vehicles and MSE loans segment in June 2015. The company expects to shift to 120 days NPA recognition norms by March 2017. However, the company will have to recognise NPAs on 90 days overdue basis, immediately on conversion to the bank.

· The company has the network of 549 branches at end March 2016. The company has added about 40 branches in FY2015.

· The company expects to consistently improve opex to asset ratio from 10.9% in FY2013 to 7.1% in FY2016. It expects to reduce opex to assets ratio to 3% to 3.5% in the near term.

· The customer base of the company stood at 27.44 lakh. The loan officers count stood at 1008, while collection officer count was at 1500 at end March 2016

· The stock of repossessed vehicles has come down to 220 vehicles at end March 2016 from 360 vehicles at end March 2015.

Performance

· The PAT of the company increased 28% to Rs 46.8 crore in Q4FY2016 and 57% to Rs 167.1 crore in FY2016.

· The provisions of the company increased to Rs 59.1 crore in FY2016 from Rs 50.4 crore in FY2015, mainly lead by increase in standard asset provisions to Rs 17.65 crore in FY2016 from Rs 10.3 crore in FY2015.

· The company has improved RoE to 13.3% in FY2016 from 11.15% in FY2015, driven by increased leverage and improved efficiency. The company expect to continue to improve RoE, while raising leverage.

· The company has continued to maintain NIMs at 9.5 to 9.7%

· The ending rate for microfinance has been reduced in FY2016 to 22% from 23.5%, driven by decline in the cost of funds to 11.3% in FY2016 from 12.07% in FY2015.

· The employee cost of the company increased in FY2016 mainly on account of Rs 9 crore of provisions for employee benefits due to change in Bonus Act, while the senior level recruitment to take care of Small finance Bank also contributed to the rise in operating expenses.

· The loan book of the company increased 11% QoQ and 53% yoy to Rs 6125 crore and March 2016 over March 2015. The company proposes to continue focus on strong loans growth.

· Microfinance loan Book stood at Rs 3283 crore (up 53%), used vehicles at Rs 1510 crore (up 28%), MSE at Rs 1087 crore (up 113%) and Housing Finance at Rs 246 crore (up 37%).

· GNPA ratio of the company stood at 1.3 4% at end March 2016 up from 1.08% at end March 2015.

Small Finance Bank

· The company has applied for final Small Finance Bank (SFB) licence with the Reserve Bank of India.

· The merger of 3 subsidiaries is pending with the Madras High Court order which is expected in short time.

· The banking operations are expected to be launched by the end of 2016

· The SFB would focus on four major areas – first, it would focus on growing existing loan products, while may also add couple of new loan products such as loan against gold which will be mainly a banking loan product than a NBFC loan product.

· Secondly, the SFB would focus on building strong retail liabilities.

· Thirdly, the SFB would be offering third party products such as insurance, pension etc

· Fourthly, the SFB would strongly utilise technology to improve efficiency and customer experience which would in turn help to improve risk control and reduce cost.

· The SFB would be 100% subsidiary of the holding company. As the SFB has to be listed within 3 years, the company may consider the option of reverse merger.

· As per the company on conversion to the SFB, about 400 branches will be converted to the liability branches and rest will be the asset branches.

[pikrohit]

One question about valuations of microfinance companies-
In past many people have been saying that HFCs should be values on PE as a metric. What should MF sector be different?

[v4value]

Hi Rohit. HFC’s are good candidates to be valued at PE because of stability of earnings vs Banks. This is because of low dependence on non interest income but more importantly stability in credit cost. One could argue that MFI have very similar charecteristics. Credit costs are a boolean event owing to group lending. Either it will (A) stay low and stable (even more than HFC owing to MFI charecteristics vs individual lenbding) or B) if it blows up (like previous Andhra episode) it can bankrupt. There is enough data globally across cycles in various countries to show this thesis.

So because of (A) I would value them on PE. Because of (B) I would give them lower PE for similar ROE and growth.