SKS Microfinance (SKSM IN) Favourable operating environment

Transcription

1 INSTITUTIONAL EQUITY RESEARCH SKS Microfinance (SKSM IN) Favourable operating environment INDIA NBFC s Initiating Coverage 13 November 2014 Market share to rise in the fast growing microfinance industry The microfinance industry will grow at a CAGR of 20% over the next 4 5 years to touch Rs 1.83tn from its current size of Rs 763bn. NBFC MFIs market share should rise to 60% from the current 40% over the same period. Since SKS Micro Finance is the largest NBFC MFI, it tends to grow at an accelerated pace we see 35% compounded annual growth rate over the next 4 5 years, translating into a higher market share of 4% from its current 2.25%. Several factors allay regulatory and political risk RBI acts as the sole regulator for this segment and issues directives on operational parameters. Around 90% of the industry players, including SKS, are under RBI s supervision this allays concerns about a nodal regulatory authority being present and provides confidence to stake holders. Establishment of credit bureaus address concerns of credit discipline and will ensure better asset quality management. Microfinance is a sensitive subject and will always be subjected to political risk SKS is managing this in the most effective way by widening the geographical spread of its portfolio. Fast revenue growth and cross selling to drive earnings Its loan portfolio will see a robust 41% CAGR over FY14 17 given the favourable operating environment and its topline growth will mirror this growth because margins are regulated. However, cross selling of various products and services will aid return ratios. Scalable model + technology to provide operating leverage SKS intends to implement its growth objectives without adding too many new branches or incurring additional capital expenditure. Fresh additions will be mostly in the form of loan officer (will add 1,500 such loan officers annually). It continues to focus on optimising its cost structure by enhancing the productivity of its employees, introducing technology for expedient reporting, and re engineering its internal processes. The costto AUM ratio should decline further to 7% by FY17 from the current 9%. Risk management tools: business model, geography, monitoring Under its JLG model, peer pressure acts as a biggest deterrent against group members defaulting. Additionally, the establishment of credit bureaus has enabled SKS to check the credit history of micro credit borrowers. The wider geographical spread of its portfolios will also keep political risk low. Political risk and natural disaster pose a biggest risk to the sector We have not factored an Andhra Pradesh like crisis (Annexure: 3 Andhra Pradesh Crisis) into our estimates, considering various developments such as a strong regulator, selfimposed credit discipline, efficient credit monitoring, and geographically diversified loan portfolio. Empowering state legislation to override the RBI directive to NBFC MFIs may impact business prospects. Valuation and Recommendation SKS Micro finance is expected to deliver strong earnings at a CAGR of 42% over FY14 17e with superior return on asset of ~5% and return on equity of +20%. At current market price of Rs360 the stock trades at 3.4x FY16 ABVPS of Rs107.5 & 2.8x FY17 ABVPS of Rs132. We initiate coverage with a BUY rating with a price target of Rs503 per share. BUY CMP RS 360 TARGET RS 503 (+40%) COMPANY DATA O/S SHARES (MN) : 126 MARKET CAP (RSBN) : 46 MARKET CAP (USDBN) : WK HI/LO (RS) : 373 / 141 LIQUIDITY 3M (USDMN) : 11.9 PAR VALUE (RS) : 10 SHARE HOLDING PATTERN, % PROMOTERS : 9.3 FII / NRI : 57.5 FI / MF : 15.3 NON PROMOTER CORP. HOLDINGS : 4.2 PUBLIC & OTHERS : 13.8 PRICE PERFORMANCE, % 1MTH 3MTH 1YR ABS REL TO BSE PRICE VS. SENSEX Apr 11 Apr 12 Apr 13 Apr 14 SKS Finance BSE Sensex Source: Phillip Capital India Research KEY FINANCIALS FY14 FY15E FY16E Pre prov ROE (%) Pre prov ROA (%) Net Profit (Rs mn) % growth EPS (Rs) Adj BVPS (Rs) ROE (%) P/E (x) Adj. P/BV (x) Source: PhillipCapital India Research Est. Manish Agarwalla ( ) magarwalla@phillipcapital.in Page 1 PHILLIPCAPITAL INDIA RESEARCH

2 Investment Thesis Our investment thesis for SKS Microfinance is based on stable regulatory scenario; favorable industry outlook and improvement in credit underwriting and monitoring standards. Top line growth of SKS to mirror loan portfolio growth, which we expect to grow at a CAGR of 41% CAGR over FY Because of regulated margin in micro finance business, net interest income growth will reflect the growth in asset under management (AUM). However, initiatives like cross sell, cost optimization and contained credit cost will translate into a robust 55% compounded annual growth rate in profit before tax. Profit after tax is expected to witness 42% compounded annual growth rate (as the company will have to pay MAT from FY16 onwards). We expect SKS to maintain return on asset of +5% and return on equity of +20% on a sustainable basis. At current market price of Rs365 the stock trades at 3.4x FY16 ABVPS of Rs107.5 & 2.8x FY17 ABVPS of Rs132. A favourable operating environment, strong business and earnings, and a superior return ratio warrants a premium valuation. We believe that high operating cost and regulated margin will restrict new entrants. Due to the unsecured nature of the business, only a diversified portfolio only can sustain any credit risk. As SKS is an established player with a well diversified presence, sizeable loan portfolio, and is the largest NBFC MFI (Bandhan, the largest MFI, received a banking license), it stands in a sweet spot to ride the microfinance growth cycle. We initiate coverage with a BUY rating with a price target of Rs503 per share. SKS MICROFINANCE INITIATING COVERAGE Valuation Methodology DCF Excess Return Valuation High growth Stable growth stage Phase Return on Equity = 22.00% 20.00% Retention Ratio = % 50.00% Expected growth rate = 22.00% 10.00% Cost of equity = 13.40% 13.00% sss Year Terminal Year Net Income (Rs bn) Equity Cost (Rs bn) Excess Equity Return (Rs bn) Terminal Value of Excess Return (Rs bn) Cumulated Cost of Equity Present Value (Rs bn) Sss Beginning BV of Equity (Rs bn) Cost of Equity (%) Equity Cost (Rs bn) sss Return on Equity (%) Net Income (Rs bn) Dividend Payout Ratio (%) Retained Earnings (Rs bn) sss Equity Invested (Rs bn)= 8.5 PV of Equity Excess Return (Rs bn) = 54.9 Value of Equity (Rs bn)= 63.4 Number of shares ( In bn) = 0.1 Value Per Share = 503 Source: Company, PhillipCapital India Research PHILLIPCAPITAL INDIA RESEARCH 2 P age

3 Market share to rise in the fast growing microfinance industry The microfinance industry will grow at a CAGR of 20% over the next 4 5 years to touch Rs 1,828bn from the current Rs 763bn. NBFC MFIs will gain market share to touch 60% from current 40%. SKS Micro Finance, being the largest NBFC MFI, tends to grow at an accelerated pace we see 35% compounded annual growth rate over next 4 5 years, translating into an enhanced market share of 4% from the current 2.25%. Microfinance in India started evolving in the early 1980s when informal self help groups (SHG) were formed for providing access to financial services to people who were deprived of credit facilities. Currently, National Bank for Agriculture and Rural Development (NABARD) and Small Industries Development Bank of India (SIDBI) are devoting their financial resources and time towards the development of microfinance. The Indian microfinance sector should grow at a CAGR of 20% over 4 5 years to touch a size of about Rs 1.8trn from the current market size of Rs 0.8trn. It has enormous growth potential as 41% of Indian households still do not have access to formal banking services. These institutions are organised under three models: Self Help Group (SHG), Grameen model/joint liability groups, and individual banking groups as in cooperatives. As of March 2014, both SHG bank linkages (bank provided micro finance credit through self help group) and MFIs collectively have outstanding loans of Rs 763 billion. SKS MICROFINANCE INITIATING COVERAGE Market share: Based on gross loan portfolio Based on disbursement Bandhan 24% 22% SKS Spandana Janalakshmi 23% 26% Share 3% 4% 4% 5% 6% 7% 11% 8% 7% Ujjivan Equitas Satin Asmitha Muthoot (Panchratna) Others 4% 3% 4% 4% 4% 5% 6% 7% 14% Source: Company, PhillipCapital India Research, Sa dhan As per the 2011 census, the total number of households under formal banking services in India is 145mn (59%) of which rural are 91mn (54% of total rural households) and 53mn are urban (68% of total urban households). The untapped 78mn rural households provide a big opportunity for microfinance lenders. Assuming all rural households are potential customers (one customer per household), the client base for the microfinance segment can increase from the current 110mn households to 190mn households. Considering a credit outstanding of only Rs 9,700 per customer (current loan per customer at Rs 6,900 + factoring an annual inflation of 7%), the microfinance market can reach a size of Rs 1.8trn from the current level of Rs 0.8trn in next 4 5 years. PHILLIPCAPITAL INDIA RESEARCH 3 P age

4 SKS MICROFINANCE INITIATING COVERAGE Microfinance industry 200 Client outreach, mn SHG NBFC MFIs Total CAGR 6% CAGR 21% CAGR 11% 0 FY09 FY10 FY11 FY12 FY13 FY14 FY19e Source: Company, PhillipCapital India Research Estimates, Sa dhan Microfinance industry Gross loan portfolio, Rs bn 2000 SHG NBFC MFIs Total CAGR 19% CAGR 10% CAGR 29% FY09 FY10 FY11 FY12 FY13 FY14 FY19e Source: Company, PhillipCapital India Research Estimates, Sa dhan The NBFC MFI sector in India has gone through two phases in its lifecycle so far. Phase 1 was high growth ( ) and phase 2 was the Andhra Pradesh crisis (Annexure: 3 Andhra Pradesh Crisis) and consolidation ( ). The sector has gained momentum in its 3rd phase (current) and is expected to see accelerated growth. This phase is characterised by a more stable regulatory environment, steady availability of funds, improving profitability with comfortable asset quality, and capital adequacy and relatively lesser impact of concentration risk. Hence, we expect that NBFC MFIs will gain 60% market share in the next 4 5 years (from the current 40%) to due to favourable operating environment and superior model (Annexure: 2 SHG Model vs. joint liability model). Since SKS is the largest NBFC MFI, it should see accelerated growth, thus gaining market share in a fast growing industry. We expect SKS market share to increase from 2.25% (% of overall microfinance loan outstanding including that of SHG) to 4% in the next 4 5 years. PHILLIPCAPITAL INDIA RESEARCH 4 P age

5 SKS MICROFINANCE INITIATING COVERAGE SKS Microfinance client outreach and loan portfolio SKS Microfinance market share Client outreach, mn Loan outstanding, Rs bn 78 7% 6% 6% 7% 70 5% 4% CAGR 15% CAGR 35% 12 4% 3% 2% 1% 4% 1.4% 2.5% 2.3% 0 FY09 FY10 FY11 FY12 FY13 FY14 FY19e 0% FY09 FY10 FY11 FY12 FY13 FY14 FY19e Source: Company, PhillipCapital India Research Estimates PHILLIPCAPITAL INDIA RESEARCH 5 P age

6 SKS MICROFINANCE INITIATING COVERAGE Several factors allay regulatory and political risk RBI now acts as a sole regulator and issues directives on operational parameters. Around 90% of industry players, including SKS, are under RBI s supervision this allays concerns about the existence of a nodal regulatory authority and provides confidence to various stake holders. Establishment of credit bureaus addresses the concern surrounding credit discipline and ensures better asset quality management. Microfinance (being a sensitive subject) will always be subjected to political risk. A wider geographical spread of portfolio is the most effective way to manage this. RBI acts as a sole regulator for microfinance lenders and it issued a separate set of directives for MFIs categorising the segment as non banking finance company microfinance institute (NBFC MFIs). NBFC MFIs are tightly regulated by the RBI with Micro Finance Institutions Network (MFIN) acting as the SRO (self regulatory organisation). SKS satisfies the conditions mentioned under the RBI s directive including qualifying asset criteria, asset classification and provisioning, pricing of credit, and capital requirement etc. therefore, it was also re classified as a NBFC MFI. The advent of the central regulator has allayed various stakeholders (banks, equity investors, borrowers) concerns, which has resulted in restoration of bank funding to the segment and flow of capital from various equity investors. The Government of India had presented the Microfinance Institutions (Development and Regulation) Bill, 2012 (MFI Bill 2012) before the Parliament of India in May The MFI Bill 2012 provided for the development and regulation of microfinance institutions and envisaged empowering the RBI to issue directions to MFIs in connection with prudential norms, corporate governance norms, and operations. The bill was introduced in the Lok Sabha in May, 2012 and was later referred to the standing committee (headed by former finance minister Mr. Yashwant Sinha) for perusal. However, the standing committee did not approve the draft legislation and returned the MFI Bill 2012 stating that the current Bill was unacceptable in the present form; the Standing Committee suggested that Centre must have wider consultations with the State Governments and stakeholders and arrive at a consensus on vital issues. The standing committee also recommended the setting up of a unified and independent regulator Micro Finance Development and Regulatory Council (MFDRC) for the entire micro finance sector. Under new government, revised Micro Finance Bill will be introduced in the parliament. Key highlights of RBI s directive for NBFC MFIs Parameters Regulation Capital requirement Qualifying asset criteria Capital adequacy ratio consisting of tier 1 and tier 2. Capital which shall not be less than 15% of its aggregate risk weighted assets. The total of tier 2 capital at any point of time shall not exceed 100% of tier 1 capital. Income of borrowers P.A. Rural <= Rs 60,000; Urban <= Rs 120,000. Ticket size Rs 35,000 (1st cycle) & Rs 50,000 (subsequent). Total indebtedness of borrower to be less than Rs 50,000. Tenure >=24months if loan size in more than Rs 15,000. Collateral free loan with repayment model of weekly, fortnightly, or monthly collection. No penalty for delayed payment. PSL Norms for NBFC MFI Qualifying assets to constitute not less than 85% of its total assets (excluding cash and bank balances). At least 70% of loans for income generation activities. The cap on margins as defined by Malegam Committee may not exceed 10% for large MFIs (loans portfolios exceeding Rs 1bn) and 12% for the others. The funding for loans fulfilling the above mentioned criteria qualifies for indirect PHILLIPCAPITAL INDIA RESEARCH 6 P age

7 SKS MICROFINANCE INITIATING COVERAGE Asset classification Provision norms agriculture exposure under PSL. Loan processing fee <=1% Standard asset (0 90 days); substandard asset ( days); loss asset (>180days) Standard asset (1% of overall portfolio); substandard asset (50% of instalment overdue); loss asset (100% of instalment overdue). Note: The aggregate loan provision will be maintained at higher of 1% of overall portfolio or sum of provisioning for substandard and loss assets Source: Company, RBI, PhillipCapital India Research The need to avoid multiple lending to prevent over indebtedness has been keenly felt by MFIs after the Andhra Pradesh microfinance situation and especially after RBI s subsequent legislation prohibiting multiple lending. MFIs are also required to become a member of at least one credit bureau through which they will share client data periodically and generate client reports before making decisions on loan disbursements. The number of MFIs that have joined credit bureaus has been increasing, and there is a significant initiative to check the credit history of micro credit borrowers and understand their credit behaviour, repayment patterns, existence of multiple borrowings, and risk of over indebtedness. Currently, almost all MFIs are reporting to credit bureaus, which have over 100mn client records, and generate more than 1mn reports every month for MFIs before they approve loans to borrowers. SKS, being one of the pioneer members, adopted the practice of credit check with credit bureaus such as Equifax or Highmark for each disbursement. Microfinance is a sensitive subject and will always be subjected to political risk. Wider geographical spread of portfolio is the most effective way to manage this. SKS has a well diversified portfolio, spread over 16 states. Learning from the Andhra Pradesh crisis, SKS has diversified its portfolio it has no more than 15% exposure to any particular state. At the time of the Andhra Pradesh crisis, its exposure to the erstwhile state was 30%. Geographical distribution of loan portfolio Orissa karnataka Source: Company, PhillipCapital India Research west Bengal Bihar Maharashtra Uttar pradesh Madhya pradesh kerela Rajashthan Jharkhand Punjab Haryana Chattisgarh Uttranchal SKS loan disbursement policy Metric Cap on disbursement state <15% District <3% Branch <1 NPA No disbursement to a branch with NPA > 1 % Collection efficiency No disbursement to a branch with on time collection efficiency of < 95% Source: Company, PhillipCapital India Research PHILLIPCAPITAL INDIA RESEARCH 7 P age

8 SKS MICROFINANCE INITIATING COVERAGE Fast revenue growth and cross selling to drive earnings SKS loan portfolio will see robust 41% CAGR, given the favourable operating environment. Topline growth will mirror loan portfolio growth due to regulated margin. Improved financial parameters and well capitalised balance sheet enabled a rating upgrade, resulting in easy availability of funds at competitive costs. Cross selling of various products and services will aid the return ratio. Robust growth in the loan portfolio: SKS provides small value loans and certain other basic financial services to its members (Annexure: 1 SKS operating model). Its members are predominantly located in rural areas in India, and loans extended to them are mainly for use in small businesses or for other income generating activities and not for personal consumption. SKS: Portfolio distribution based on activities livestock Tailoring & cloth weaving 16% Grocery store and other retail outlet 3% 4% 5% 25% Masonry, painting, plumbing, electrician, ca rpenter and related Trading of vegitable & fruits Trading of agri commodity vehicle repair 6% 11% Eateries 6% 8% 8% 9% Agriculture Garment & Footwear retailing Other income generating activities Source: Company, PhillipCapital India Research SKS revenue growth is directly linked to its loan portfolio growth, given a cap on margin (cost plus 10%). Being one of the largest microfinance institutions, the company should benefit from the favourable operating environment. Its disbursements should see robust CAGR of 35% and loan portfolio should see a CAGR of 41% over FY14 17, driven by new client additions. Trend in loan portfolio and net interest income Disbursement, Rsbn Gross loan Portfolio, Rsbn Net Interest Income, Rsbn 140 Grwth % (rhs) 80% 60 Grwth % (rhs) 150% 9.0 Grwth % (rhs) 100% % 40% 20% 0% 20% 40% 60% % 50% 0% 50% % 60% 40% 20% 0% 20% 40% 60% 80% 0 80% 0 100% % FY10 FY11 FY12 FY13 FY14 FY15e FY16e FY17e FY10 FY11 FY12 FY13 FY14 FY15e FY16e FY17e FY10 FY11 FY12 FY13 FY14 FY15e FY16e FY17e Source: Company, PhillipCapital India Research Estimates PHILLIPCAPITAL INDIA RESEARCH 8 P age

9 SKS MICROFINANCE INITIATING COVERAGE SKS new client additions are expected to be around 4mn, taking the total client base to 9.8mn in the next three years, driven by factors such as new branch/centre and increased client base in existing centres. The branch and centre network should increase to 1,435 (1,255 at the end of FY14) and 289,913 (228,188 at the end of FY14), respectively, by FY17. SKS client base touched 7.3mn in FY11, i.e., before the Andhra Pradesh crisis. Nonavailability of funds (banks limited credit lines after the AP crisis) reduced SKS ability to service its clients and its client base declined to 5mn by FY13. Availability of funds from the banking system and strong demand for its securitised paper will provide the necessary resources to reach out to more clients, which were not serviced so far. Efficient use of technology will enable SKS to add more clients to existing centres thus improving the operational efficiencies. Client outreach (nos) FY10 FY11 FY12 FY13 FY14 FY15e FY16e FY17e Branches 2,029 2,379 1,461 1,261 1,255 1,285 1,335 1,435 Centres 226, , , , , , , ,913 No. of Members (mn) Source: Company, PhillipCapital India Research Estimates Exploring multiple funding avenues: Primary sources of funding for NBFC MFIs are bank loans and securitisation. After the crisis, scheduled commercial banks limited their funding to the MFI sector due to the latter s high delinquency. Even securitisation deals declined, given the fragile state of the industry. Gradually, the market stabilised, there was clarity on the regulatory front, fair pricing practices were adopted, and credit bureaus were established. All this allowed NBFC MFIs to recapitalise their balance sheets, which helped their performance, in turn resulting in better availability of funds and a rating upgrade. The cost of bank borrowings declined with diminishing credit risk. Borrowing costs, which were at base rate +400bps immediately after the Andhra Pradesh crisis, declined to base rate +250bps. Securitisation regained its ground with improved business fundamentals (because securitisation deals are usually done in Q4, its share in overall funding appears very high at the end of fiscal we expect year end securitised funding source to remain high, upwards of 45%). Funding Source FY09 FY10 FY11 FY12 FY13 FY14 Bank 48% 44% 64% 44% 58% 45% Financial institution 17% 16% 12% 8% 7% 6% NBFC 0% 2% 2% 1% 0% 2% Securitisation 35% 38% 23% 47% 35% 48% Source: Company, PhillipCapital India Research SKS is exploring various funding options such as commercial paper market, external commercial borrowing, and non convertible debentures to reduce its funding costs. It recently issued Rs 300mn worth of commercial paper. The decline in funding cost will be passed on to the borrower due to regulated margins. However, we believe that the decline in the lending rate will be seen as a manifestation of fair pricing practice and enables SKS to ward off any negative public perception against MFIs. Cross selling of various products and services to enhance RoA: SKS leverages its network to distribute financial and non financial products of other institutions to its members (customers) at a cost that is lower than competition. Its network also allows such distributors to access a segment of the market to which many do not otherwise have access. While the focus continues on its core business of providing micro credit services, it continues to diversify into other businesses involving feebased services and secured lending (such as gold loans). Its objective in these other PHILLIPCAPITAL INDIA RESEARCH 9 P age

10 businesses is to focus on lending that will allow it to maintain repayment rates, increase member loyalty, and also provide economic benefits to its members and their families. Such other products and services offering fee income will allow it to increase its overall RoA. Financial products and services other than micro credit include: providing loans to its members for the purchase of mobile handsets in association with Nokia India Sales Private Limited, secured loans to its members against gold as collateral, and loans to its members to facilitate the purchase of solar lamps in association with D.Light Energy Private Limited. Another product in the pilot phase is loans for sewing machines. SKS earns a commission from the manufacturers for facilitating the sale of these products. Apart from gold loans, all these loans are unsecured and for products that enhances member productivity in its economic activities. Credit breakup SKS MICROFINANCE INITIATING COVERAGE Solar lamp 1% Micro credit 95% Non micro credit 5% Gold 4% Mobile 0% Source: Company, PhillipCapital India Research Tax liability to remain low in medium term: SKS had carried forward deferred tax assets (DTA) worth Rs 5.58bn by the end of FY14. As the DTA gets utilised against future profit, the tax rate in normal circumstances will be NIL (until the entire DTA provision is utilised). While the company will be subjected to minimum alternate tax, for FY15, the effective tax should be nil as SKS will continue to write off its Andhra Pradesh loan portfolio (completely provided) in order to avoid MAT. As per our estimate, SKS tax incidence will be nil for FY15 and at 20% in FY Rs mn FY15e FY16e FY17e Deferred tax asset (DTA) MAT credit Outstanding Provision on AP portfolio PBT Tax liability (in normal case) DTA utilised Write off Effective tax (MAT) Effective tax rate 0% 17% 20% Source: Company, PhillipCapital India Research Estimates PHILLIPCAPITAL INDIA RESEARCH 10 P age

11 SKS MICROFINANCE INITIATING COVERAGE DuPont Analysis FY10 FY11 FY12 FY13 FY14 FY15e FY16e FY17e Interest on loan Income on securitisation Loan processing fee Income from operations financial expenses Net interest income Other income Total income Operating expenses Operating profit provision and contingencies Profit before tax Tax Profit after tax leverage Return on equity Source: Company, PhillipCapital India Research Estimates PHILLIPCAPITAL INDIA RESEARCH 11 P age

12 SKS MICROFINANCE INITIATING COVERAGE Scalable model + technology to provide operating leverage SKS intends to implement its growth objectives without adding a significant number of new branches or incurring additional capital expenditure. Fresh addition of headcount will be in Sangam managers (loan officers), with an annual run rate of 1,500 loan officer. SKS will continue to focus on optimising its cost structure, which includes enhancing employee productivity, introducing technology for expedient reporting, and re engineering the internal processes. The cost to AUM ratio should decline further from 9% to 7% by FY17. SKS provides collateral free credit to most of its members in their own neighbourhoods, and its Sangam Managers (loan officers) assist with the processes of credit verification. While this helps its borrowers save on travel costs, it results in high operating expenses, particularly personnel and administrative costs. Personnel costs were 67% of its operating expenses in FY14. It has embarked on cost optimisation initiatives by improving its ratio of borrowers per Sangam Manager, while realising the benefits of economies of scale. The borrowers per Sangam Manager ratio was 411 as of 31 st March 2012, and has improved to 944 by SKS merged its branches, both in undivided Andhra Pradesh and other states. It intends to implement its growth objectives without adding a significant number of new branches or incurring additional capital expenditure. There was a net reduction of approximately 200 branches in FY13 and six branches in FY14. Its total headcount was reduced from 16,194 as of 31 st March 2012 to 8,932 as of 31 st March Though the capital expenditure may not be at a rapid pace compared with balance sheet growth, SKS does not want to hold back in an environment which is favourable for growth. Considering the huge potential for client addition and expansion of centres underway, the fresh addition of headcount would be Sangam managers (loan officers) with an annual run rate of 1,500 loan officers. Other factors that the company continues to focus on is optimising cost structure including enhancing employee productivity, introducing technology for expedient reporting, and re engineering internal processes. SKS has completed all branch connectivity with daily MIS flow to the head office. This has enabled better treasury and cash management, reduced the need of maintaining high cash balances at branches, and reduced operating cost (cost of managing cash is high). The results of cost optimisation are seen in a 42% fall in operating expenses between FY12 and FY14. The cost to asset under management ratio declined over the last few years and should keep falling. SKS other technology initiatives are refactoring of its in house lending system for effective monitoring and control, enabling loan officers with hand held devices to improve productivity, and mobile banking in order to make disbursements cashless. These initiatives will lead to an improvement in the client per loan officer ratio as well as a fall in the cash balance in its balance sheet. Improving operating efficiency Cost to AUM ratio 16% 14% 12% 10% Client per loan officer Cash as percent to total asset (rhs) 45% 40% 35% 30% 8% 6% 4% 2% 0% FY09 FY10 FY11 FY12 FY13 FY14 FY15e FY16e FY17e FY11 FY12 FY13 FY14 FY15e FY16e FY17e 25% 20% 15% 10% 5% 0% Source: Company, PhillipCapital India Research Estimates PHILLIPCAPITAL INDIA RESEARCH 12 P age

13 Risk management tools: business model, geography, monitoring Under the joint liability group model, peer pressure acts as a biggest deterrent to group members defaulting. The establishment of credit bureaus enables the lender to check credit history of micro credit borrowers. Wider geographical spread of portfolio is the most effective way to manage political risk. SKS has an advantage over banks because of its strong Joint Liability Group (JLG) model. It has been rigorous in its approach towards customer education and monitoring of its customer behaviour, which makes it stand out from banks. Under its joint liability group lending model, SKS lends solely to women borrowers (similar to the Grameen Bank model) in this model, women guarantee each other s loans. There are three reasons why SKS lends only to women: 1) women tend to use resources more productively than men; 2) they are more likely to invest most of their income back into the household; 3) they are more likely to avoid risky ventures and instead use loans to undertake small, manageable activities. Since all the members in the group are liable to repay any loans under the JLG model, peer pressure acts as a biggest deterrent for the group members to default. The collection efficiency has been very encouraging under the JLG model. The establishment of credit bureaus enables the lender to check the credit history of micro credit borrowers and understand their credit behaviour, repayment patterns, existence of multiple borrowings, and risk of over indebtedness. Microfinance is a sensitive subject and will always be subjected to political risk. A wider (geographic) portfolio spread is the most effective way to manage this. SKS has a welldiversified portfolio spread over 16 states. Learning from the Andhra Pradesh crisis, SKS does not have more than 15% exposure to any particular state. Similarly, it has put in a disbursement cap per district and per branch. It also follows a stringent NPArecognition policy >60 days overdue vs. the >90 days prescribed by the regulator. Having completely provided for its Andhra Pradesh exposure, any improvement in the operating environment could be value accretive for SKS. It has obtained interim relief from the Supreme Court to restart lending and collection activities in the state. The apex court has relaxed some of the criteria laid down in the Andhra Pradesh Microfinance Act, While this is positive, and SKS has re started operations, it has done so in a limited way. The company has preferred to wait for the parliament s sanction of the MFI Bill, 2012, so as to avoid any possible confrontation with the state government. Trend in asset quality SKS MICROFINANCE INITIATING COVERAGE 60% 50% 40% 30% 20% 10% 0% 0.3% 0.2% 1.0% 0.3% 0.2% 2.3% GNPA, % NNPA, % Credit cost, % loan portfolio 37.2% 33.7% 52.1% 17.7% 20.1% 2.4% 1.3% 7.2% 0.4% 10.9% 0.1% 0.9% 4.8% 0.9% 0.2% 1.6% 0.8% 1.0% 1.2% 0.7% 1.0% Collection efficiency (%) FY09 FY10 FY11 FY12 FY13 FY14 FY15e FY16e FY17e FY11 FY12 FY13 FY14 Source: Company, PhillipCapital India Research Estimates PHILLIPCAPITAL INDIA RESEARCH 13 P age

14 SKS MICROFINANCE INITIATING COVERAGE Key Risk Political risk and natural disaster pose a biggest risk to the sector We have not factored Andhra Pradesh like crisis in our estimates considering various developments like strong regulator; self imposed credit disciple; efficient credit monitoring and geographically diversified loan portfolio. Empowering state legislation to override the RBI directive to NBFC MFI may impact the business prospects. Non availability of fund may impact business growth Banks are primary funding source for SKS Microfinance. Around 86% of on book funding requirement is sourced from banks. Any disruption in flow of funds to impact the business growth and our assumption of robust 41% CAGR in loan book over FY14 17e. Most of the banks have restored funding to SKS given its improved financials and strong capital base. High attrition rate Employee strength of the SKS Microfinance was 8,932 as on March 31, The manpower distribution shows that the field staff in branch offices is 7,731 (86.6%) and Head Office & Regional Office staff is 1,201 (13.4%). Voluntary attrition rate during FY14 was 26.1%. Study done by MFII (Micro finance Institute of India) suggest high attrition for the industry ranges between 6% 53%. The high attrition is in the field officer segment, which may impact business growth and reduce productivity. PHILLIPCAPITAL INDIA RESEARCH 14 P age

15 COMPANY NAME INITIATING COVERAGE Annexure: 1 SKS Business model The company is primarily engaged in providing microfinance to low income individuals in India. SKS Microfinance s core business is providing small value loans and certain other basic financial services to its members (customers), who are predominantly located in rural areas in India. These members use SKS loans mainly for small businesses or for other income generating activities; they are not usually used for personal consumption. These individuals often have no access (or very limited access) to loans from institutional sources of financing. In its core business, SKS uses a village cantered, group lending model to provide unsecured loans to its members. This model relies on a form of social collateral and ensures credit discipline through peer support within the group. SKS believes this model makes members prudent in conducting their financial affairs and prompt in repaying their loans. If an individual borrower fails to make timely repayments, other members in the group will not be able to borrow from SKS in the future. In such a situation, the group usually uses peer pressure to encourage the delinquent borrower to make timely repayments or will often make a repayment on behalf of a defaulting borrower, effectively providing an informal joint guarantee on the borrower s loan. Under its joint liability group lending model, SKS lends solely to women borrowers (similar to the Grameen Bank model) in this model, women guarantee each other s loans. There are three reasons why SKS lends only to women: 1) Women tend to use resources more productively than men; 2) They are more likely to invest most of their income back into the household; 3) They are more likely to avoid risky ventures and instead use loans to undertake small, manageable activities. SKS s approach is to provide financial services at the doorstep of members in villages and urban colonies. This allows its customers convenience and savings in terms of cost and time associated with travelling to mainstream banks. It also enables SKS staff to promptly and fully collect repayments. SKS loans are designed for convenience with small weekly repayments corresponding to cash flows. Small first loans inculcate credit discipline and collective responsibility. SKS uses a five member Joint Liability Group (JLG) lending methodology based on the Grameen Bank model, where each member of the group serves as the ultimate guarantor for each of its members. Further, multiple groups (4 to 10) of members in a single village are combined together as a Sangam (centre). The Sangam is responsible for the repayment of all groups, creating a dual joint liability system, where the Sangam pays in case any of the group defaults on payment. The centre meets every week, where the Sangam Manager (Loan Officer) collects loan application forms, disburses loans, and collects loan instalments. PHILLIPCAPITAL INDIA RESEARCH 15 P age

16 COMPANY NAME INITIATING COVERAGE The way MFI s operate in India Selection of villages Before starting operations, staff conducts village surveys to evaluate local conditions like population, poverty level, road accessibility, political stability, and means of livelihood. Group Formation Women form self selected five member groups to serve as guarantors for each other. Experience has shown that a five member group is small enough to effectively enforce group peer pressure and, if necessary, large enough to cover repayments in case a member needs assistance. Compulsory Group Training CGT is a four day process consisting of hour long sessions designed to educate clients on SKS processes and procedures and to also build a culture of credit discipline. Using innovative visual and participatory teaching methods, SKS staff introduces clients to its financial products and delivery methods. CGT also teaches clients the importance of collective responsibility, how to elect group leaders, how to affix signatures, and a pledge that serves as a verbal contract between SKS and its members. During this training period, SKS staff collects quantitative data on each client to ensure qualification requirements are met, as well as to record base line information for future analysis. On the fourth day, clients take a Group Recognition Test conducted by a different staff member than the one who trained them. If they pass, they are officially accepted as SKS members. Centre Meetings During Centre Formation, groups are combined to form a centre of 3 to 10 groups or 15 to 50 members. Weekly Centre meetings serve as a time to conduct financial transactions. Meetings are held early in the morning, so as to not interfere with clients daily activities. A leader and deputy leader are selected to facilitate meetings and ensure compliance with SKS procedures. In addition to financial transactions, members use the weekly meetings to discuss new loan applications and community issues. Centre meetings are conducted with rigid discipline in order to sustain the environment of credit discipline created in CGT. Key features of JLG Model Five members groups are the basic units 5 8 such groups constitute a branch (Centre) Centres meet once a week Disbursements and collections are made in centre meetings Groups and Centres appraise the loans and undertake joint liability All Centre meetings are attended by the staff of MFI Flat rate of interest calculation Started by Grameen Bank of Bangladesh Highly standardised processes Many adopters all over the world PHILLIPCAPITAL INDIA RESEARCH 16 P age

17 COMPANY NAME INITIATING COVERAGE Annexure: 2 SKS s JLG model versus the bank s SHG linkage model Self Help Group Model Initiated in India in the 1980s Clients may be men or women A group of individuals Is an independent entity Is usually promoted by Self Help Promoting Institutions (SHPIs) or MFIs Have their own bank accounts and books of accounts SHGs collect savings and give loans to their members Can borrow on their own account SHGs can execute documents Are recognised by government Also take up social issues SHG has its root in social development Banks provide loans only after 6 months of group formation JLG Model A group comprising 5 members 4 10 such groups constituting members forming a centre Usually promoted by an MFI Mainly promoted for loans, not internal transactions No bank accounts No books of accounts are maintained by JLGs Have to depend on MFI for all their loan requirement Are not recognised by the government Cannot execute documents JLG has its roots in microfinance Loans provided immediately by the MFIs after the group is formed Why is the JLG model more successful than banks SHG model? Even though SHG (self help group) linkage programme made impressive progress in the last two decades, the last few years have seen stagnation in their credit growth. The main reasons were: 1) in SHG, group formation is perceived as a means to avail of government subsidies and entitlements, which also led to an increase in the number of multiple memberships, and 2) the financing banks were also ill prepared for the sudden spurt in SHG loans and their monitoring and supervision of such loans became less regular (and even totally absent at times!). Fresh loans to SHGs have been near stagnant for last few years, though it showed a marginal rise in However, a region wise analysis shows a disturbing feature Southern and Central regions show an increase of nearly 20% and 10% in the number of SHGs that extended fresh loans; the Northern region, too, saw a marginal increase of 1.74%. All other regions points to negative growth in the numbers. Backward states such as Bihar, Chhattisgarh and Jharkhand reported a decline of over 20% while North Eastern States recorded a high 50% decline. PHILLIPCAPITAL INDIA RESEARCH 17 P age

18 COMPANY NAME INITIATING COVERAGE SHG lending by banks is highly concentrated in Southern India Source: Company, PhillipCapital India Research Mounting NPAs in SHG lending From an envious record of almost 100% recovery, the NPAs of SHG loans by banks have reached an alarming high of over 7% of loans outstanding against them. More painful is the fact that loans to SHGs in the most resource poor regions in the country reported NPAs of over 10%. GNPAs in SHG stood at 7.08% in this figure was just 2.9% in This explains why banks have been wary of lending in the SHG segment. Southern region with an NPA of 5.11% was the lowest while Central region with an alarming 17.3% was the highest. Of grave concern are the high NPAs in major states like Madhya Pradesh (21.16%), Uttar Pradesh (18.22%), Odisha (18.27%), Tamil Nadu (10.81%) and Kerala (12.38%) Alarmed by the steady increase in the NPAs of loans to SHGs, NABARD undertook studies in two important states Uttar Pradesh and Odisha to understand the underlying reasons for the spurt. The studies highlighted the following reasons: Focus on group formation for availing subsidy from the government, not selfhelp or group dynamics. Some groups were not functioning at all no regular meetings, no records of transactions, not trained / exposed to SHG functioning, no regular internal savings or lending and members not even aware of the default of loans. Self Help Promoting Institutions (SHPI s) do not provide the escort services necessary to nurture the SHGs, rather more target oriented and confined to linking the groups with banks for disbursement of loan and subsidy. Banks have largely left the issue of monitoring / supervising the group functioning to the SHPIs, and there were no regular post disbursement followups. Widespread prevalence of middlemen / agents for SHG bank linkage, even for depositing the savings amount this led to pilferages. No proper credit appraisal or rating of SHGs was done before extending the loans No proper training to the bank staff or to SHPIs/SHG members before groups were linked to banks. Wilful default and external environment was not conducive to regular loan repayment. PHILLIPCAPITAL INDIA RESEARCH 18 P age

19 COMPANY NAME INITIATING COVERAGE Annexure 3: Andhra Pradesh Microfinance Crisis Andhra Pradesh has the highest concentration of microfinance operations with million SHG members and 6.24 million MFI clients. The total microfinance loans in Andhra Pradesh including both SHGs and MFIs stood at Rs 157,692mn with average loan outstanding per poor household at Rs 62,527, which is the highest among all the states in India. This data implies that the state is highly penetrated by microfinance (both MFIs and SHGs) giving rise to multiple borrowing. The average household debt in Andhra Pradesh was Rs 65,000 vs. national average of Rs 7,700. This high penetration of both SHGs and MFIs also led to stiffer competition for client outreach between the state and private financial providers resulting in wider conflict of interest. To arrest the growth of MFIs and to stem the alleged abusive practices adopted by the MFIs, the state government promulgated an ordinance on October 16, In December 2010, the Ordinance was enacted into The Andhra Pradesh Microfinance Institutions (Regulation of Money lending) Act, The ordinance was a result of a series of suicides attributed to the alleged abusive practices of MFIs such as charging high interest rates, adopting coercive collection practices, and lending aggressively beyond the repayment capacity of the borrowers rather than helping the poor get out of poverty. According to one report more than 77 rural people have been driven to suicides unable to bear the coercion unleashed by their recovery agents. One of the key steps the ordinance has proposed is setting up of fast track courts in every district for MFI related issues. As of January, 2011, the MFI repayment rates fell from 99% right before the issuance of the ordinance to less than 20%. The stringent regulations set by the state government (such as monthly repayments, all MFI branches to be registered with the government, no door to door collection of repayments etc.) coupled with active encouragement by the local politicians, led to the fall in repayment levels. Some MFIs such as Star Micro Fin Society, a small NGO MFI, faced 0% repayment rate in urban operation areas and 2% in rural areas vs. 100% before the MFI Ordinance. This, along with other reasons, led to what is commonly termed as the AP crisis. The crisis undermined the growth and indeed the very existence of commercialised microfinance institutions. The crisis had an impact not only in the state of AP but also throughout India with many MFIs facing issues raising funds, expanding operations, etc. Multiple Borrowing A key finding of the CMF study on Access to Finance in Andhra Pradesh was that multiple borrowing is extremely common among rural poor, with an estimated 84% of households having two or more loans from any source. The findings also implied that many cases of multiple borrowing appear to be driven by an inability to obtain sufficient credit from a single source as suggested by data collected on timing and purposes of loans. The study further brought out that households had taken more than one loan within two successive months in the past year 36% of 428 households (153 households) reported taking more than one loan within two successive months mostly from informal sources in the past year. PHILLIPCAPITAL INDIA RESEARCH 19 P age

20 COMPANY NAME INITIATING COVERAGE Distribution of total loans 60% Distribution of Total Loans 50% 40% 30% 20% 10% 0% 2 Loans 3 Loans 4 Loans 5 Loans 6 Loans Source: Company, PhillipCapital India Research Sources of Credit CMF s study highlighted that respondents did not borrow from banks because they did not have enough savings to open bank accounts; they perceived opening bank accounts was expensive and a majority of them had no idea about the process. Major Source Percentage of Households with Loan Outstanding Any Bank 34% 33% SHGs 55% 57% MFIs 9% 6% Informal 67% 64% Source: Company, PhillipCapital India Research According to micro save, in more than 80% of the focus group sessions, respondents listed SHGs, moneylenders, and MFIs as the most popular options in order to meet their credit requirements. Most respondents did not prefer banking services despite the presence of banking network in the study areas. Respondents cited inordinate delays, cumbersome procedures, and complex documentation requirements of banks as the major reasons for not preferring banks as a source of credit. After the AP MFI crisis After the Andhra Pradesh Microfinance crisis, certain large MFIs with their headquarters and substantial portion of their businesses located within the state were more significantly and adversely affected. In the year from August 2012, several of the big commercially oriented NBFC MFIs had recovered their confidence as the banks began to supply funds again to MFIs. Investors regained their interest in MFIs, primarily those located outside Andhra Pradesh, resulting in a rise in the number of investments in MFIs. The guidelines issued by the RBI also brought about a more orderly manner of operation for MFIs, which improved the credibility of the MFI sector as an industry with greater transparency and less risk. The situation for the NGO MFI sector also referred to as the non profit or community based microfinance sector appears to be different. Many sector leaders believe that in the current scenario, these MFIs, majority of which are small and local in terms of their operational focus, will not fare as well. As the focus is almost completely concentrated on the regulated NBFC sector, NGO MFIs are generally struggling to recover. PHILLIPCAPITAL INDIA RESEARCH 20 P age