SMERA Weekly Report: Sector Analysis (Microfinance Industry)

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1 SMERA Weekly Report: Sector Analysis (Microfinance Industry) The Andhra Pradesh crisis of 2010 changed the landscape of the MFI industry for good. The subsequent Malegaon Committee brought about sweeping changes in the industry, ending non-adherence to regulations and unabated exploitation of the underprivileged. The crisis which saw Portfolio at Risk (PAR) breach even the 20 percentage point mark for some players resulted in the conceptualisation of NBFC MFI. These entities regulated by the RBI complement the scheduled commercial banks with primary sector lending and small ticket size loans SMERA analyses the MFI industry and provides its observations. This report includes our views based on our rating experience of MFIs over the years. It also incorporates our opinion on what to expect from the transition of MFIs to SFBs. The MFI industry is going through a major structural change and these are indeed interesting times to witness the evolution of not only India s financial sector but also borrowing patterns of micro level consumers who were previously ignored by the organised sector. December 3, 2015

2 SMERA Sector Perspective SMERA strongly believes that the Microfinance industry is the best financial architecture to reach the unbanked, underserved and lowest strata of the population while contributing significantly towards the financial inclusion agenda of the government. The significance of the MFI industry can be further emphasised - around eight MFIs received RBI s nod to set up small finance banks and one started functioning as a universal bank. With improvement in the funding environment, strong regulatory framework and government initiatives (on rural banking and financial inclusion), the microfinance industry has received a major boost. With the introduction of the Rs.20,000 crore mandate of MUDRA in the market, SMERA expects improvements in the capital raising efforts of MFIs. SMERA MFI Ratings Universe Parameter Variable (Average) Rate of Interest Charged 20.07% Yield on Portfolio 23.88% PAR 3.01%* Operational Self Sufficiency Ratio % CAR 29.31% Net Loan Portfolio (Rs.) 15,33,92,000 Profit/Loss (Rs.) 25,95,000 Operational Expense Ratio 25.21% Source: SMERA Research; *Including AP Portfolio; #Sample Size: 66 Small MFIs SMERA Ratings Observations - MFIs SMERA has analysed over 100 MFIs (including, NBFCs, NGOs/Trusts, Section 25 Companies) and as per our observation the following parameters are to be factored in while rating an MFI: Portfolio at Risk (PAR): Sa-dhan estimates that PAR among Indian MFIs is less than 1% for 80% of all players. While MFI portfolios are unsecured, the risk of bad debts is low as compared to scheduled commercial banks with strict KYC norms (Fig: 1). SMERA has observed that the rated institutions recorded PAR at less than 0.65% (excluding AP Portfolios) on an average, which is lower even than the industry average. Unsecured Loan: The issue of unsecured loan is a universal phenomenon in the MFI space and Credit Rating Agencies (CRAs) must incorporate this thinking in their rating mechanism. The unsecured loan and risky borrower profile parameters are still major impediments in assessing the viability of a portfolio. Geographical Diversification: SMERA observes that small MFIs (Trusts/Societies/Section 25 Companies) have limited portfolio diversification (geographically) due to funding constraints. The constitution of MFIs has been cited as the reason for reluctance of banks in providing loans to smaller players. Large MFIs (NBFCs) on the contrary, have been successful in overcoming the shortcomings and have benefited from diversification. Bandhan and SKS -

3 large players in the MFI space were able to handle defaults (the Andhra Pradesh crisis), better due to intra-regional diversification of their operations. Effective MIS: SMERA strongly believes that using customised MIS Systems is important to manage operations efficiently. SMERA has observed that small MFIs do not have customised MIS systems mainly due to non-availability of required skill sets and also from the cost perspective. In such a situation, accessing real time information is not possible and manual aggregation brings down efficiency. MIS softwares such as MIFOS, IKLANT, Quantum Sampurna and MFMIMS to name a few can help MFIs in a big way. Management Experience: Individuals at the helm of affairs at microfinance institutions must have deep understanding of the industry. SMERA believes management experience is a positive variable and that effective management can lead to informed decision making. Risk Management: MFIs should ideally have robust risk management practices in place. According to SMERA, small MFIs are not keen on incorporating such systems and operate on gut level- without real time operational overview. SMERA Risk Management Matrix Geographic/Portfolio Diversification Credit Policies MIS/Portfolio Management Over-indebtedness Flexibility/Customization NBFC Vs Other Constitutions SMERA observes that financial institutions and banks choose to provide capital to large NBFCs (with a portfolio size of Rs.500 crore). This has led to an extremely skewed MFI universe leading to over 88% (Fig: 2&3) of the market being controlled by them. As a result, smaller players such as Trusts, NGOs and Section 25 Companies find it difficult to raise capital in an extremely competitive market and their constitution becomes an obstacle in portfolio expansion. SMERA has observed that financial institutions are sceptical in providing loans to non-nbfcs because of their non-regulated structures. SMERA believes that financiers must broaden their scope of loan portfolios to include smaller and non-nbfc MFIs as well. For, non-nbfcs are responsible for a good amount of social impact created in the MFI space. The MFI sector is expected to benefit if the constitution of industry players does not become a barrier for funding. Also, the PAR for both NBFC and non-nbfc players is similar. Therefore, SMERA does not believe that non-regulated structures of the latter, is inherently risky as compared to the former. Financial institutions may lay emphasis on adherence to risk management processes and tools in order to further expand the scope of the industry.

4 (Fig: 1) Estimated NPA (SCB) Vs PAR (MFI) NPA PAR Source: SMERA Research; Including AP Crises Timeframe SMERA MFI Centric Suggestions for Stakeholders Customised understanding of the peculiar nature of MFIs Separate/specified Rating Tools for the MFI sector Collective approach involving lenders, MFI players and government agencies along with independent experts Constitution-wise Breakup and Regional Spread of Gross Loan Portfolio for 2015 (Fig: 2) FY 2011 FY 2012 FY 2013 FY 2014 FY 2015 Gross Loan Portfolio(Rs in Crores)

5 Society & Trust Co-operatives Section -25 NBFC MFIs (Fig: 3) 5% 7% 11% 38% 15% 24% South East Central West North Northeast (Fig: 4) Source: Sa-dhan SMERA View on Transformation of MFIs to Small Finance Banks (SFBs) As mandated by the RBI, the primary function of SFBs is to complement commercial banks in primary sector lending. With 75% credit to be reserved for the sector and 50% of the portfolio to be below

6 Rs.25 lakh, SFBs will play an extremely important role in financing the unfinanced. Therefore, around eight out of 10 SFB licenses went to MFIs because of their experience in grass root level financing. As per IFC estimates, the debt requirement of Indian MSMEs is around $520 billion and in the short term, only 38% of the same can be met by the formal financial sector. The most threatened are the micro enterprises that comprise almost 80% of this debt gap. The MFI SFBs will eventually become the primary financiers of this space. Therefore, the transformation of the micro finance institutions into small banking institutions will be an evolution of sorts that will unleash innovative financial products to the underprivileged. Once the small finance licences comes through, MFIs will be in a position to offer working capital financing and a diversified product range apart from access to electronic channels. The experience gained by the successful MFIs will help them reach critical mass within a specified timeframe and help further incubate India s vibrant but unorganised entrepreneurial culture. SMERA believes that the highest value created by the MFI SFBs will be towards the lower end of the supply chain- a lacuna that is in the direst need for financial assistance. We observe that SFB transformation will help these MFIs by providing them with a comprehensive regulatory framework and freedom to access capital. After becoming SFBs, the microfinance institutions will be able to overcome political and regulatory uncertainties and access public deposits. Hence, MFIs must clearly address these issues with RBI before venturing into full time banking operations. Also, SMERA observes that successful MFIs will face challenges especially when it comes to building a deposit base. Creating visibility amidst intense competition, dealing with greater regulatory oversight, trimming foreign shareholding to meet RBI regulations and dealing with high ticket loans are additional concerns. New MFI SFBs will have to give a thought to brand repositioning with transformation from credit only to deposit mobilizing institutions. The infusion of human talent, change in the borrowers profile and venturing into diversified products will be game changers. It remains to be seen how this transformation brings about a sea change in the financial industry in the near future. If the model is successful, SFBs will become the dedicated micro financiers of the masses offering a gamut of financial services not previously accessed through unorganised means.

7 Annexure 1 Rating Rationale of Annapurna Mahila Multi State Co-operative Credit Society Limited SMERA has assigned a rating of MF2 to Annapurna Mahila Multi State Co-operative Credit Society Limited (hereafter referred as Annapurna). The rating indicates that in SMERA s current opinion, the rated MFI s ability with regards to credit strength is high. The rating assigned to Annapurna reflects the following strengths: Annapurna is promoted by Dr. Medha Purao Samant, who possesses extensive experience in the banking and social development sectors and is supported by a team of senior management with experience in financial services, the development sector and microfinance. The gross loan portfolio of Annapurna increased moderately from Rs.221,263 (in thousands) in FY to Rs.373,378 (in thousands) in FY Annapurna s asset quality is at adequate levels with almost 99% on-time repayment rate during the period under study. Further, its portfolio at risk (PAR) of over 30 days has declined from 1.65% in FY to 0.29% in FY Annapurna uses Quantum Sampurna Software and MFMIMS to maintain its MIS, adequate to maintain accuracy. This enables the organisation to track collections and disbursement on a daily basis. Further, all information is expected to be soon transferred to MFMIMS in order to develop an integrated software for its insurance program, impact measurement program and voluntary savings program. However the rating is constrained by the following weaknesses: Annapurna s portfolio currently is concentrated in Pune and Mumbai with network of 18 branches resulting in geographical concentration risk. Absence of regular internal audit and loan utilisation check for loans upto Rs.50,000 About the Company Annapurna Mahila Mandal, Mumbai was established in 1975 by Padmashree Prematai Purao to provide financial support to women. Annapurna Pariwar provides services in the microcredit, micro saving, micro insurance fields. It also offers support services such as day care centers for slum children, educational sponsorships for children of single mothers, hostel for working single women among others. In July 2012, Annapurna Pariwar joined hands with LIC to offer pension services through the NPS-Lite Swavalamban Scheme.

8 Annexure 2 Rating Rationale of Apex Abishek Finance Limited SMERA has assigned a rating of MF3 to Apex Abishek Finance Limited (hereafter referred as Apex). The rating indicates that in SMERA s opinion, the rated MFI s ability with regards to credit strength is Above Average. The rating assigned to Apex reflects the following strengths: Apex has board members with experience in financial services, social services and microfinance. Mr. Muthukumar M., the promoter, has around 25 years experience with TIIC (Tamil Nadu Industrial Investment Corporation), vast experience in project financing and NPA management. The loan portfolio of Apex increased during the period under study from Rs.38,625 (in thousands) as on March 31, 2012 to Rs.48,074 (in thousands) as on March 31, 2013 to Rs.88,051 (in thousands) as on March 31, It stands at Rs.168,193 (in thousands) as on December 31, The on-time repayment rate improved from 91.99% in FY to 94.25% in FY and stands at 98.11% in FY2015 (December 31, 2014). Apex has installed Iklant, a cloud-based technology developed by Ionixx Technologies that can be connected to all branches and enables the management to extract reports on real time basis. However, the rating is constrained by the following weaknesses: Apex earned revenue of around Rs.12,047 (in thousands) for FY2013 and Rs.12,124 (in thousands) for FY Being a relatively new player in the microfinance industry, Apex is expected to face intense competition from other market players The portfolio of Apex remains concentrated in three districts of Namakkal, Gobichettipalayam and Coimbatore in Tamil Nadu. As on December 31, 2014 the total portfolio outstanding is Rs.168,192 (in thousands). Rs.105,865 (in thousands) is outstanding from the above mentioned districts of Tamil Nadu and constitutes around 62.94% of the total portfolio. About the Company Apex was incorporated in 1996 under the Companies Act, 1956 and commenced operations in microfinance from 2010.

9 Annexure 3 Rating Rationale of SV Creditline Private Limited SMERA has assigned a rating of Code of Conduct Assessment (COCA) 2 to SV Creditline Private Limited (hereafter referred as SVCL). The rating indicates that SVCL exhibits high level of adherence with all parameters and consequently complies well with the code of conduct laid out. The rating assigned to SVCL reflects the following strengths: The management comprises individuals with experience in banking as well as extensive experience in the MFI industry. Around 2/3rd were independent members The management approved policies are compliant with RBI guidelines The credit policies are well established, documented and communicated Strong loan appraisal and monitoring systems are in place. The company has adopted high standards of governance and integrity The MIS tracks delinquent loans, the IT system is secure with well defined access rights The company ensures that all information regarding the loan is given to the client There s compulsory check on over indebtedness of every borrower Efficient systems and strong internal audit team are in place to check misappropriation and compliance However, the rating is constrained by the following weaknesses: Proper training on products is not imparted. Field Officers are not well versed with the latest developments in the industry. About the Company SV Creditline Private Limited (SVCL) was originally incorporated in August 1996 as M/s Mantrana Finlease Private Limited and was renamed SVCL in September SMERA Economics Team Operations Contact Media Contact Karan Mehrishi Lead Economist Economic Research Team SMERA Ratings karan.mehrishi@smera.in Arindam Som Associate Economic Research team SMERA Ratings associate@smera.in Basant Panda Rating Analyst (MFI Sector) SME & MFI Ratings SMERA Ratings basant.panda@smera.in Bedabrata Bagchi Manager Marketing SMERA Ratings bedabrata.bagchi@smera.in

10 SMERA Ratings Limited is a joint initiative of SIDBI, Dun & Bradstreet Information Services India Private Limited (D&B) and leading public and private sector banks in India. SMERA, so far, has assigned 37,000 ratings. SMERA is a full service credit rating agency registered with SEBI for rating of debt instruments, and NSIC for rating of MSMEs. SMERA has also received accreditation from Reserve Bank of India for rating of bank facilities.