Micro Finance Institutions Operations & Impact - Guest Post by Bhakther Solomon

About the Author: Bhakther Solomon , the CEO of Development Promotion Group (DPG), Chennai, is an economist by training who worked within the NGO sector for more than 35 years.

He initially worked in senior management capacity for several NGOs, including ActionAid India before founding DPG in 1986 which works in Tamil Nadu, Andhra Pradesh and Karnataka. These projects, both urban and rural in nature, range from watershed development to sanitation to housing to education.

Since 2000, DPG had begun an active role in the provision of micro credit facilities, facilitating federations and SHG-Bank linkages.  RA

In recent years, both urban and rural areas have seen the entry of many Micro Finance Institutions (MFIs) and MNC sponsored Micro Finance Companies. Their declared goal is to provide Micro Finance to the poor, at least cost, at their door steps. One can now see nearly a dozen Micro Finance institutions in almost all villages in our working areas. On the positive side, this has reduced the role of money lenders and the interest rates have come down. 

The other side of the picture is that these institutions have now slowly pegged up their interest rate. In the early period i.e. about a decade ago, MFIs did provide credit at around 12% equivalent to the bank interest rate. But now their rates are much higher than the Bank loan rates. It goes up to even 36%.

MFIs: New Lenders:

If one takes into account all the hidden charges, the interest rate varies from 18% to 36% and in a few cases, well above 36%. Again, due to availability of plenty of credit outlets, many are forced to take credit for all purposes. It is also surprising to note that few families have become clients in more than two or three institutions. A Bangladesh model is slowly getting in operation, wherein one gets a loan from a MFI to repay another MFI loan. Strange but true. 

In few cases, I won’t be surprised if such a trend creeps into our villages also. Even if the credit is used for productive purpose, whatever the poor get as “additional income” is now mostly appropriated by the “new lenders”. Unfortunately, the simple explanation given by MFIs for high interest rate is that the cost of funds plus operation costs are much higher that the normal bank rate! Unfortunately, the labour theory of Karl Marx is not even being talked about by his so-called followers!

Dictomy: 

It is a pity that NGOs which come into being to help the poor to acquire their legitimate rights to be established from the Government, Banks and other development  organizations have now floated their own for-profit micro-finance  institutions to “serve” the same poor. 

The alternative model of growth initiated by MFIs has become very costly compared to normal development credit from banks and other Government sources. The MFIs that are supposed to mobilize the people to get Bank loans under Differential Rate of Interest (DRI) Scheme and other portfolios have now become merchants of their own credit portfolios. Unfortunately, these merchants are more visible everywhere than the financial inclusion policy and practices of banks!

Privatization:

There is a danger of the Government slowly withdrawing from its anti-poverty programmes and allowing “Privatization of anti-poverty programmes”. There is also the danger of Graham’s Law of money operating, in rural areas. The danger of these new Micro Finance entrants driving out old Community Based Organisations’ (CBOs) small Micro Finance Initiatives. 

Will this bubble explode at one point in time resulting in greater injury to the poor? How long will this go on? Will there be a regulatory body-self regulatory or Government controlled one – to ensure that the marginalized are not explicated further? What matters in Development is not the cost of operation but the causes that lead the families to poverty! 

MFI Securitization: Clamp down avert a Sub-Prime Crisis developing in the India Economy

 

Two years ago the global financial markets witnessed an upheaval that caused more mayhem than the world has ever seen in its entire economic history. It was primarily attributed to the sub-prime loans.

So what’s a sub-prime loan? 

Let’s begin first with what’s considered “prime”. It refers to individuals who have good credit ratings and to whom the banks lend directly. Sub-prime is just the opposite of this and as such mortgage loans (or housing loans or junk loans) is very risky as they are given to people with unstable incomes or low creditworthiness. However, where the risk is high, profits are equally high, tempting alot of lenders to get into this business in trying to make the quick buck.

Individuals with low creditworthiness are usually turned down by banks for home loans. Enter a business entity with high credit rating and is willing to take risks to give loans to the latter. So they borrow from the bank and disburse the amount to a number of low creditworthy individuals for an interest rate, higher than he borrowed from the bank. The interest is set high to offset a few defaults. Additionally, the interest is set on floating rates viz. as bank interests go up, so do these loans, which in turn escalate the Equated Monthly Instalment (EMI) system.

In their greed for profits, rather than wait for recovery flows to sustain new lending, these institutions securitized these loans i.e. converting these loans into financial securities that pay a rate of interest that in turn is sold to large institutional investors. The interest is met through the EMIs paid by the sub-prime borrower. The money got from securitization is used either to dispense more loans or close the original loan taken by the institution from the bank.

For institutions buying these securities, this was irresistible in an environment where housing prices soared on the back of huge demand for real estate and bigger and better homes. The bubble burst when the US economy slowed down and the sub-prime loans fell as a house of cards as it prompted foreclosure and defaults of these loans. A deluge of such defaults inundated these institutions and banks, wiped out their net worth. Their mortgage-backed securities were almost worthless as real estate prices crashed.

As defaults kept on piling, the institutions that took loans from banks weren’t able to service their loans. So they went to seek out new lenders and these too stopped as the latter realized that the collateral backing this credit would soon lose value in the falling real estate market. Institutional investors in securitised paper from the sub-prime home loan market in the US saw their investments turning into losses. In order to maintain solvency, more money had to be invested in the US. This amount had to come from somewhere. So they began large scale selling off their investments outside the US that led to stock market and currency collapses, including in India. But even this step fail to stop the rot as over 100 banks and financial institutions, even reputed ones such as Lehman Brothers and Well Fargo went bankrupt in the US and other parts of the world.

 A similar development contributed by MFIs was developing in India. The State of the Sector Report (2010) describes this:

“MFIs ramped up their loan portfolio in India from US$ 252 million to US$ 3.8 billion between 2005 and 2010. The funding for this expansion came from several sources apart from equity funding. Bulk loans from banks are the most important source of funds. In recent years, quasi-equity, mezzanine funding, non-convertible debentures, debt assignments and sale of securitized debt have all emerged as other means of raising resources.” 

 

According to IFMR Capital, a Chennai based NBFC expects more than Rs. 1000 crore worth of securitization transactions to take place in the Indian micro finance sector for the financial year 2010-2011. Dr YV Reddy, ex Governor of The Reserve Bank of India who steered the country out of global mayhem caused by the sub-prime crisis and recently earned the wrath of MFIs for calling them moneylenders was first to sound the alarm bells. According to the Economic Times:

“Ultimately, it’s something like subprime lending...The same incentives are operating here... it was securitisation and derivatives that operated in the US. Here it is the priority sector lending by banks."

The IMFR blog proudly flaunts a new instrument: “IFMR Capital Mosec I, the multi-originator Special Purpose Vehicle, has issued two tranches of securities:  a 77 percent senior-rated tranche with an expected maturity of 6 months, and a 23 percent subordinated strip with an expected maturity of 11 months. CRISIL assigned the highest short term rating of   P1+ (so) to the senior tranche, which was subscribed to a Bank. The closing of this transaction has resulted in the emergence of a new pricing benchmark in the less than 6-month maturity asset class.” 

See above photo of the signing of this supposedly landmark agreement. Introducing poison into our economic system as warned by YV Reddy?? Don’t miss the smiles of these MF promoters.

My friend Ramesh Arunachalam, a MFI practioneer and consultant in his recent post “Growth of Securitisation, Equity Investments and Priority Sector Lending in Indian Micro-Finance: Was Dr Y V Reddy Right After All?” provides an excellent analysis of this enveloping crisis spread by MFIs. For those who are interested in reading this analysis backed up by useful statistics, painfully complied read here.

The similarities between the US and India was that MFIs in pursuit of rapid growth multiple lent to the same borrower and often who did have the repayment capacity to service these loan burdens. There are however two marked differences between the MF securitization in India and those of the US housing sub-prime crisis. Firstly, in India, MF securitization is still in their infantile stage, and as a percentage of total securitization is mostly insignificant materially. Secondly, despite multiple lending to low credit worthy individuals, repayment rates are 99%  which we now know is due to coercive collection practices, and as such borrower defaults are not significant to have any material impact. High repayment rates are partly conditioned by the biggie MFIs eying IPO launches where these high rates condition valuation of their stocks post listing. In contrast in the US, once an institution securitises a loan, it does not remain on the books of the institution. Hence that institution does not take the risk of the loan going bad. The risk is passed onto the investors who buy the financial securities issued for securitising the home loans. 

The real concern in India is once MFIs like SKS get their shares listed at high valuations; will they still concentrate on repayments or fall into the trap of their US counterparts, not bothered of their loans going bad as their securities recoup their advances? While IPO was the first level scam by MFIs, there are many analysts in the country, led by YV Reddy who feel the second level was the evolving micro-loan securitization racket.

The ground situation has changed in India as a number of investment bankers like JP Morgan, Karvy and latest Citigroup have downgraded SKS and other micro-finance institutions. For the full report of Citigroup’s downgrade read here. Fitch has specifically downgraded MF securities, including SKS. 

This is the way The State of The Sector (2010) report provides a summary overview of the material contribution of securities 

"Micro-loan securitization provides banks a profitable way to increase their investment in the microfinance sector through rated and tradable securities." 

No longer is this option available as banks have stopped buying these securities, in fact no one does any more. This is blow for the MFI are already facing defaults in Andhra Pradesh; forced to curb lending in other parts of the country and are facing a cash crunch as banks are not releasing even sanctioned credit pipelines. But then only the biggies in the MF space avail the benefits of securitizations and not the rank and file of smaller MFIs. 

If this trend of securitization was left unchecked, MFIs in the quest to amass wealth quickly would not have stopped just inducing borrower suicides but would have no hesitation to destabilise the entire Indian economy just as the sub-prime housing loans did to the US economy. Accordingly, for the Indian public, this crisis in Andhra Pradesh however should be a welcome one as it prevents MF securitization developing as a full blown scam. This however calls into question what RBI was doing all this while? But at least in this juncture, they need to act and act decisively to cut the problem in its nascent bud.

Breaking: Andhra Assembly Passes Micro Finance Bill without Amendments. SKS to get fresh hammering

Ignoring reconsideration demands from the microfinance institutions network—MFIN, the Andhra Pradesh state assembly passed the micro-finance bill without amendment.

The body demanded weekly collections, whereas the government made monthly collection mandatory. Secondly, MFIN wanted any public place to be collection centre, while the government wanted Panchayat office to be the sole collection centre. Thirdly, MFIN wanted single and centralised registration, where the government wanted all branches in districts to be registered.

The bill, on being passed in the legislative council, would replace the ordinance issued by the government Oct 15 following a spate of suicides by many small borrowers.

The government turned down the demand by opposition parties to refer the bill to select committee to make it a comprehensive legislation. Women Development and Self-Help Groups Minister Sunitha Lakshma Reddy said this could result in the lapse of the ordinance. She said the legislation would come to the rescue of over 10 million poor women in the rural areas, who were being subjected to harassment by MFIs to recover the loans. She said the government issued the ordinance after 75 borrowers committed suicide during last few weeks due to harassment by MFIs.

According to the provisions of the legislation, MFIs can't deploy any agent for recovery of loans or resort to any coercive action. Any person, who contravenes the provisions, will be punishable with an imprisonment for a period of six months or with a fine which may extend up to Rs.10,000 or both. 

The SKS stock gained around Rs 100 from last Friday’s close, on heavy long accumulations to close Rs 747.45 at the National Stock Exchange today. The stock is expected to open tomorrow with a huge gap and this week should see PE and VC investors like Soros and Treeline ensnared in the SKS share, who bought the share around Rs 639. This leaves only Catamaran, VC of Narayana Murthy, ex founder of Infosys, still with nominal profits, having bought SKS share at Rs 300.  This target also can be taken out within a month or two.

Let's salute the Andhra assembly for this progressive step.

Castrate the for-profit MFIs to Recast the Sector!

The die has been cast with the introduction of the Andhra Pradesh Micro-Finance Regulatory Bill in the State Assembly yesterday. The Bill to replace the ordinance passed by the government in October 15th is scheduled to be discussed this coming Tuesday and passed as an Act by Wednesday, tightening the noose around MFIs.  Before its introduction, the Micro Finance Institutions Network (MFIN), demanded radical amendments to the Bill. [MFIN is an association of 50 for-profit micro lenders among its members, which account for more than 85% of the microfinance market in India.] According to the Indian Express:

“MFIN president, Vijay Mahajan said:  If those modifications are not made, there would be major repercussions not only for access to finance but also for the banking system.”

The bill, copies of which were circulated Friday, proposed no amendments to the ordinance, as demanded by microfinance institutions (MFIs) who say if their concerns if not addressed, may force them to shut operations in the state. Mahajan told MoneyControl.com: “If beyond a point the model is rendered unviable due to an act of law or something beyond the court of law, then basically one would have to reconsider the whole thing."

The Economic Times further quoted Mahajan to give an insight to this crisis as the industry like the public to see it: “According to Vijay Mahajan, president, MFIN, their business activity came to a grinding halt and collection rate dropped to 20% from 95% after the state government passed the ordinance. `This can have far reaching implications on the entire credit system as MFIs borrow money from banks to lend it to their customers, said Mahajan. He pointed out that during the last 45 days 12 lakh loans worth Rs 1,200 crore could not be disbursed due to the hostile conditions. We are unable to collect Rs 7,400 crore from our borrowers. If it continues it will affect the entire Rs 24,000 crore given to MFIs by banks. Besides, it is also demoralizing our 2 lakh staff, he said.”

It is apparent that the stock of MFI credibility and influence, both within the country and internationally, seems to have fallen to such low ebb that their demands for change in the bill have literally fallen on deaf ears. India’s Reserve Bank further indirectly accused Mahajan of resorting to gross exaggeration when RBI Deputy Governor Subir Gokarn said the sector was only under some amount of stress, but there was no threat to their survival.

That the industry is living in a state of denial is illustrated by Mahajan in another interview to CNBC-TV18 suggesting that the MF industry was depending on the outcome of their writ petition in the High Court to bail them out. He further conceded that rather than the ordinance it was politicians who encouraged people to default on overdues which proved the main obstacle for normalcy of operations:

“Our writ petition at the high court which was against the ordinance remains absolutely alive, and that's equally valid for the bill if it gets passed into an act because it is the same language. So that’s the first recourse. Right now what is stopping us is not the ordinance. It is the statements of various political leaders such as Mr Chandrababu Naidu saying that loan of MFIs should not be repaid. We think this is highly irresponsible because it foments credit indiscipline.”

If the MFIs are looking at the High Court for ultimate relief, then it is analogous to a drowning man clutching at straws. In India, litigation may stretch several years and time is exactly not what this heavily leveraged industry has on its side. Further, even if the judiciary upholds the industry’s contention, all it needs for the government to give a policy shock is to give a directive to public sector banks to avoid credit to MFIs by treating the whole sector as one asset class. Besides, a judicial win for MFIs does not wish away the grim reality that politicians of different shades would not be willing to play ball, in letting normalcy to prevail.

As for repercussions on the banking sector in the event of the MF sector collapsing, this is totally blown out of proportion by the MF industry, used as a scare tactic in the hope of getting leniency from the system. Banks have a collective exposure of about Rs 24,000 crore to MFIs.  In Andhra Pradesh the total outstanding loans amount of MFIs is Rs 8,000 crore, of which, Rs 5,000 crore is funded by banks. Yet for public sector banks, their total MFI exposure as a percentage of their total lending in the country is just a small fraction of 1%. Accordingly, repercussions if any in the event of a MF sector collapse would be no more than a ripple in an ocean. 

The powerful All-India Bank Employees' Association (AIBEA) could be another obstacle in the way of MFIs. "RBI should not accept it ... Banks should not give loans to MFIs under priority sector category," said AIBEA general secretary, C.H. Venkatachalam. "PSBs should (instead) go for large-scale micro lending through more number of rural branches."

Besides, the issue of financial inclusion is reflected in a national goal to provide banking services to 100 per cent of citizens living in villages with a population of more than 2,000 by March, 2012. The progress on this goal may not be much to talk about at present. But, in the next two years, we should see the UPA government giving more impetus to realization of this national goal which in turn reduces MFIs strategic importance in promotion of financial inclusion.

So all things considered, portends are that the MFI industry may have no options but be forced to enact their threat to close shop in Andhra Pradesh.  In 2006, during the Krishna crisis wherein MFIs faced a similar situation, they wriggled out of confrontation with the government by promising to adopt a Code of Conduct, which we now know that they had practically no intention of adhering to. This time round too, they are promising to turn a new leaf by the series of steps they claim to have undertaken including interest rate reduction; uploading credit data of borrowers in two RBI licensed credit bureaus; conciliatory meetings with government, commissioned a study on suicide and sensitivity trainings of their staff against coercive collection practices.

The MFI industry for some time now has been blaming rogue members within its own fraternity as being responsible for the present crisis. In his latest statement, Mahajan has once again resurrected this bogey but he is not telling just who these rogues are.

So why cast a shroud over the identity of these rogue MFIs we can ask?

In our archive post, we found that it is most likely that the Akulas (SKS) and Mahajans (BASIX) are resorting to this tactic in order to deflect blame from their own organizations to those smaller in size within the industry. We then asked, what kind of MFIs attracts higher plausibility to go rogue? Logically it points to MFIs with mind boggling, mushrooming growth and profitability. So just who are they likely to be? We found it was most likely the six biggest MFIs in the country who control 94% of the market share that meet these criteria.  Among these six are SKS of Vikram Akula and Basix of Mahajan. Rogue MFIs accordingly could then well be a euphemism for these six MF biggies in the country.

The blog Candid Unheard Voice of Indian Microfinance gives additional data of such burgeoning growth facilitated by large scale equity infusion:

"- 6 MFIs added US $ 2.18 billion during 24 months (April 2007 to March 2009).

- Equivalent to Per Month Addition of Portfolio of US $ 90.81 Million (or Rs 4177 Million for all 6 MFIs.

- Equivalent to each MFI adding a portfolio of US 15.135 Million (or Rs 696.25 Million) every month, this is certainly a lot of money.

Contrast this with their growth during the period April 2005 to March 2007 when they added just over US $ 1/2 a billion (0.504 billion US $ to be exact) and this is about 18.79% of the total portfolio added during the period April 2005 – March 2009.

- Adding 1/2 billion US $ over 24 months is equivalent to these MFIs adding portfolio worth US $ 21 million (or Rs 966.15 Million) every month for 24 months. That is about 1/4th of the monthly portfolio addition done by the same MFIs during April 2007 – 2009”

The table and figure are rather self-explanatory…Equity investments from April 2007 onwards until July 2010 (A whopping US $ 646.97 Million) are almost 20 times the size of equity investments prior to April 2007 (which are a miniscule US $ 32.51 Million). In many ways, April 2007 appears to be a watershed…with regard to equity investments.

In fact, the burgeoning equity investment in Indian micro-finance has prompted experts like Mr N Srinivasan (Author of The State of The Sector Report) to suggest that perhaps ‘micro-finance was the preferred sub-sector of choice in the financial sector for investment bankers.

During the period April 2007 – March 2009, the top 14 Indian MFIs (with 6 AP Headquartered MFIs) added almost 75% of their total portfolio of 2009. In numerical terms, this is approximately US $ 2.799 Billion, which is huge by any standards.

During the same period, the Big 6 AP Headquartered MFIs also increased their gross loan portfolio by almost US $ 2.077 Billion during this period {in other words AP headquartered MFIs accounted for almost 74.19% of the total portfolio (US $ 2.799 Billion) increase during April 2007 – March 2009}.

The period, April 2009 – March 2010, which succeeds the fastest growth period (of April 2007 – March 2009) as of now shows the highest equity investment in Indian micro-finance (US $ 390.72 Million)?”

Significantly the explosion in equity infusion came during a period where globally the financial sector was experiencing the sub-prime crisis, with many banks and companies going bust or needed to be bailed out by their governments to prevent insolvency.  Presumably, many Private Equity (PE) and Venture Capitalist (VC) investors had either burnt their fingers in this crisis, sitting with huge losses and/or found avenues within the financial sector for investing highly contracted. The unregulated MF industry in India thus became their natural destination where they looked to recoup their losses or as an alternate investment avenue within the financial sector. For MFIs this increased PE/VC interest came as manna from heaven as after the Krishna crisis (2006), commercial banks in the country were slightly reluctant to lend to them.

If it takes two to tango, the offspring was the AP crisis! Once PE and VC investors burst into the scene, the MFI promoters found themselves no more in complete control of their companies. The Akulas and Mahajans became more and more the front of their companies. It was these investor stakeholders with no social equity commitment that literally slave drove these MFIs to achieve stupendous growth targets through charging usurious interest rates, multiple lending to already overburdened customers instead of seeking new ones and coercive recovery practices.

The fact is that while the normal portfolio investments of PEs and VCs gave them hardly 20% return, it was the micro-finance sector in India that gave them mind boggling returns between 50-500%. So no wonder  the sector became the "preferred sub-sector of choice in the financial sector for investment bankers” as accurately observed by N Srinivasan (Author of The State of The Sector Report). This situation perhaps prompted Xavier Reille of CGAP in his paper Are MFIs in India overvalued?, to comment:

“Overvaluation might be driven by excess capital flows.  A significant share of equity investment in India comes from investors whose objective is to realize profits by floating or otherwise exiting their investments in a relatively short time frame. In many cases in the past this type of capital has produced overvaluation of equity prices in the short term and disappointment in the long term. After all, India is the only microfinance market that has attracted large private equity funds.”

So when the Akulas (SKS) and Mahajans (BASIX) blame rogue MFIs for the AP crisis, to use the old adage, they are probably the wolves in sheep clothing. It is these six for-profit MFI biggies that look most plausible to be the rogues than the rest of the industry. Put another way, it is most likely for the misdeeds of these six biggies that the entire MF industry now faces a sectoral backlash that threatens their very existence.

In terms of lobbying, MF sector apparently found only support from Montek Singh Ahluwalia, Deputy Chairman of Planning Commission. According to a WSJ-Livemint report, Montek wrote to the Prime Minister Manmohan Singh and sought intervention of the Reserve Bank of India (RBI) to save the microfinance sector in Andhra Pradesh from falling apart. Commenting on the microfinance ordinance Ahluwalia said, “If implemented as it stands, it will lead to the collapse of the MFI sector”.

But Montek’s clout within the government and the ruling Congress Party is extremely low and latter is more likely to listen to the likes of YV Reddy, ex-RBI Governor. Y V Reddy likened MFIs to moneylenders, stating that most MFIs are either registered or unregistered NBFCs, he said they are following a flawed business model by lending to consumption-related spends. YV Reddy called for the total recast of the industry.

Meanwhile, in his latest book Fault Lines: How Hidden Fractures Still Threaten the World Economy, Raghuram Rajan, former chief economist of the International Monetary Fund and an economic adviser to India’s Prime Minister, said, “Although microcredit has a promise on a small scale, history suggests that when scaled up, and especially when used as an instrument of government policy, it will likely create significant problems.” So Raghuram Rajan, another influential economic adviser to the government takes a more neutral stance.

The fact that the ruling Congress high command permitted their state unit to introduce the Andhra Pradesh Micro-Finance Bill is an indication which way the wind is blowing. It does suggest that the Central Government is in the mood of “recasting” the micro-finance industry, suggesting the YV Reddy line has prevailed.  The RBI had in fact finalised in a July-August report, which recommended withdrawal of priority sector status to microfinance institutions (MFIs) for public sector bank loans. But before the regulator could act on the report, the sector was mired in crisis. Meanwhile RBI appears also concerned about PE funds investing in Microfinance Companies.

“RBI officials told CNBC-TV18 in an interview that they are yet to take a view on how to treat private equity investments in Microfinance Institutions. For decades microfinance in India was always seen as a not for profit function with a social purpose  but this has changed drastically in the last few years with many foreign based private equity funds pouring money into this sector. The central bank has said it views microfinance as a key part of its drive for financial inclusion, and clarified that while it was not contemplating a cap on interest rates charged by microfinance institutions (MFIs), there was a need to regulate the rates.”

Recast is simply a euphemism for the restructure of the industry. Winds of change that are blowing suggest that future policy environment would castrate the growth of the for-profit MFIs, particular the six biggies by depriving them of priority lending status; clamp down on PE investments in the sector and control of interest rates indirectly by  leveraging the power of discretion in sanctioning credit to the sector. At the same time, government policy would focus to reduce MFI strategic significance in promotion of financial inclusion by expanding bank coverage, giving a fillip to SHG-Bank linkages by NGO or government initiatives and encouraging public sector banks to directly enter micro-finance activities.

Can SKS Microfinance buck the industry’s momentum to doom?

November 16th 2010.  Ever since the crisis broke out in Andhra Pradesh, MFIs have used every trick in the PR book to whip up sympathy, but instead found that their support base continuously dwindling even faster.  It is one thing for Vijay Mahajan, President of MFI association M-Fin to attempt to play the sympathy card and another for founder-Chairman of SKS Microfinance, Vikram Akula to do so. SKS being the only listed MFI Company in the sector the key difference between the two. So when Akula naively disclosed that collections have come in lower than normal post the Andhra Pradesh government ordinance, the effect was a virtual invitation to bears to hammer the stock. And the bears responded with glee.

November 17th 2010.   SKS share touched a historic low of Rs 601 in the National Stock Exchange (NSE) - a fall of 60% from its all time high of Rs 1,490  - trading stopped by triggering the 20% downward circuit breaker!

November 18th 2010.    Feeling the pinch, Akula and his CFO, Dilli Raj walks into CNBC-TV 18 Newsroom to give an interview in an attempt to stem the tide. The interview succeeded in arresting the decline of the stock, giving it a small bounce.

December   3rd 2010.    The stock closes at Rs 711.30, though it made a recent high of Rs 750 intra-day. In the last week, volumes thinned considerably except on Friday, which saw bulls trying to breakout out of range but the huge selling pressure brought back the share to Rs 711.

The question is whether SKS can hold on to its strong support between Rs 705-711 or would this range instead turn into a strong resistance level for that stock? To answer this we need to revisit Akula’s claims on November 18th to ascertain their veracity on the basis of new information now available to the market. Extracts of their verbatim CNBC interview is provided as given in MoneyControl.com

CLAIM 1:  EXPOSURE IN ANDHRA AND IMPACT ON REPAYMENT

Akula: Let me start by emphasizing that while the ordinance has had an effect on some microfinance institutions, we are here, today, representing SKS Micro-finance and not the sector. In our case, we haven’t seen a significant impact as of yet... If you look at the attendance at our meeting, last week for example where we do have the data, the attendance at the meeting of our borrowers is 97%.It is true because of the ordinance, we weren’t able to conduct financial transactions but the fact that borrowers were coming to our meetings at the rate of 97% shows that there continues to be from the borrower level, customer confidence. 

Raj: To start with, our exposure to Andhra Pradesh it is a mere 20% of total portfolio mix. In hard number that is Rs 1,400 crore compared to an assets under management (AUM) of more than Rs 5,600 crore. In terms of your question on what is overdue, the ordinance came into effect from October 15, with a monthly periodicity so collection it started November 15 onwards. It is just three days, which is too early to talk about what is overdue....There could be some minor impact on FY11 earnings guidance that we have given but we have just three days data, so it is near impossible to define the impact in a week’s time.

At the beginning of the crisis, Akula put SKS exposure in Andhra as high as 38%. By Nov 18th, his CFO now says it is a measly 20% in an attempt to play down Andhra’s criticality in affecting the bottom line performance of SKS Micro-finance. Akula further totally retracts his statement made a few days earlier that his collections are affected in Andhra. His CFO further skirted the question by resorting to technicalities claiming since the periodicity of collections from weekly to monthly basis has been changed, it is too early to comment on overdues.

WSJ-Livemint.com   4th Dec

“The ordinance has led to massive defaults by borrowers in AP, forcing the industry to stop issuing fresh advances, Mahajan said, adding that the industry is now worried the trend will spread to other states. Mahajan said over 90 per cent of borrowers in the South Indian state have not been paying their EMIs for over a month now... Already, 90-95% of the Rs.8,000 crore outstanding MFI loans in Andhra Pradesh are overdue.

In the villages, news spread fast and since we have stopped fresh lending, people have come to believe that we are in crisis and so why to pay up?," Mahajan said, adding that this has aggravated industry's troubles.” 

So just three weeks after the Akula-Raj CNBC-TV18 interview, according to M-Fin Chair, MFIs are experiencing in Andhra a default rate of over 90%.

Christian Science Monitor Nov 17

"But the current crisis is roiling the entire industry,” says Matthew Titus, executive director of Sa-Dhan, a Delhi-based association that groups over 260 nonprofit, self-help, and commercial lenders. “It’s not only the bad boys that will get hit. Everyone will get hit. People can’t differentiate between who are the good boys and who are the bad boys”.

Both MFI associations (M-Fin and S-a-Dhan) assessments of negative impact radically differ from those Akula tries to paint. Akula claims SKS is immune to any significant impact flowing from the ordinance, while MFI trade associations’ assessment clearly think on the contrary - that its impact will be cross the board, sparing none!

CLAIM 2: MATERIAL IMPACT IN NON-ANDHRA STATES

 

Akula: If you look at the non-AP portfolio, which is close to three quarters of our overall portfolio, there we continue to have 99% repayment rates. So there are absolutely no issues in 18 states where we work.   

Wall Street Journal: 19 Nov 

“While Mr. Akula’s booster dose of confidence may provide temporary relief for investors, concerns still linger, as J.P. Morgan’s Seshadri Sen said in a recent report. We believe that the Andhra Pradesh book would be impacted significantly and credit behavior in other states would also be materially impacted.”

WSJ-Livemint.com   4 Dec

Mahajan: It is only a matter of time before the news spreads to other parts of the country. Already, we have seen some things happening in Madhya Pradesh, where a municipal councillor after losing an election urged borrowers not to pay back MFIs. Chandrababu Naidu is doing it on a much larger scale in Andhra Pradesh, he said, calling Naidu’s campaign “irresponsible”.

Three weeks from the CNBC interview, there are strong indications that MF repayment rates are starting to decline as credit behaviour in non-Andhra states starts to change.

CLAIM 3: LIQUIDITY  

Akula:  No banks have withdrawn from them. “ICICI Bank, Axis, SBI, PNB Have supported us. We do not need any liquidity support from anyone” 

Raj: As of date we are in complete compliance with a self-imposed financial discipline. We hold sufficient liquidity, we thank eight banks who have leased Rs 367 crore to us in the last 15 days and we are sitting on a sanction pipeline of Rs 2,500 crore and we disbursed Rs 1,050 crore 

Times of India  4 Dec 

“Microfinance lending activities across the country will be "dead, absolutely" by January 1 unless banks release fresh credit to the cash-strapped sector, an umbrella body representing MFIs said today.

If the current severe credit crunch continues till the end of December, "There will be no microfinance in 2011... Come first January, we are dead, absolutely... it will be finished," the President of the M-Fin Network, Vijay Mahajan, told reporters here today on the sidelines of the annual Bancon 2010 banking conference.” 

WSJ-Livemint.com   4 Dec  

"Some institutions that have sanctioned lines of credit are not disbursing money. But we have to explore all options,” said S.V. Raja Vaidyanathan, chairman and managing director of Chennai-based Asirvad Microfinance Pvt. Ltd.

Our (MFIs) total outstanding with banks is Rs 24,000 crore and we pay them about Rs 1,000 crore monthly. A substantial part of this is from AP and as of now, we are diverting the money from the rest of the country to repay their debt," Mahajan said.

Business Standard    26 Nov  

“Investors are shying away from securitised loans of micro-finance institutions (MFIs), as the ordinance issued by the Andhra Pradesh government has slowed recoveries, creating uncertainty around the underlying portfolio. 

Securitisation is the process through which MFIs pool the receivables from loans given to their customers and sell these to third parties like banks, insurance companies and mutual funds. Unlike the traditional loan portfolio sale or assignment, in this process the MFI portfolio is rated and converted into standardised securities, which can be traded more easily. Securitised loan products of MFIs were emerging as a good investment option, as they offered returns of 9-12 per cent per annum. The size of this market was pegged at a little over Rs 1,000 crore.” 

The downgrade significantly constrains MFIs ability to raise external funding. Further access to fresh loans from banks and financial institutions has dropped materially, which is probably due to attempts by banks to reduce their exposure to the sector. MFIs are now being double squeezed in terms of liquidity. On one hand, sanctioned credit lines have been effectively radically cut. On the other hand there are no takers for their securitization products. The net effect affects MFIs ability to service debt and limits their fresh disbursements, which can have a cascading effect on their growth and asset quality in the near term.

CLAIM 4: PROFITABILITY  

Akula: Given our scale and our efficiencies in terms of economies of scale, even at 24% there is a margin one continues to have that will allow for continued profitability. Maybe not the same profitability we once had but certainly a healthy profitability going forward. The specific numbers we are not in a position to comment on as of yet because we need to wait and see how monthly versus weekly evolves.

Sify.com 23 Nov 

“Ratings agency Crisil has put 12 microfinance institutions (MFIs) – including the country’s largest, SKS Microfinance, and Spandana Sphoorty Financial – having bulk of exposure in Andhra Pradesh on a rating watch with negative implications... The implementation of the Andhra Pradesh (Andhra) ordinance has triggered a chain of events that can permanently damage the business models of MFIs by impairing their growth, asset quality, profitability and capital-raising ability," the rating major said on Monday.

Last week, Fitch India had said the securitised paper floated by Indian MFIs was unlikely to receive the highest long– or short–term ratings as a consequence of the unique risks they faced. The limited historical asset performance and evolving regulatory and legal framework would also prevent highest rating for MFI securitised paper, according Fitch India.”

Together with MFIs forced to reduce their interest rates, the downgrade by rating agencies like CRISIL and Fitch would imply that their own cost of borrowings would now be higher, lowering margins even further. 

The Hindu-Businessline   24 Nov

“Microfinance institutions (MFIs) in West Bengal witnessed almost 50 per cent drop in monthly disbursements over the last two months on account of a liquidity crunch in the system. The cash crunch is primarily because of banks' hesitation to lend to MFIs after the recent Ordinance promulgated by the Andhra Pradesh Government making recovery from borrowers difficult for these institutions.

Disbursements have dropped from about Rs 100 crore a month till about two months ago to just about Rs 50 crore at present, according to Mr Shubhankar Sengupta, Managing Director – Arohan Financial Services and Member – Microfinance Institutions Network (MFIN). Commercial banks that account for almost 80 per cent of our source of funds have now gone slow on lending after the Andhra Pradesh Ordinance. These banks have a big exposure to the MFIs in that State and as repayment, there has taken a hit they have adopted a wait-and-watch policy and are unresponsive to MFIs in other parts of the country as well, he said.”

West Bengal is the second biggest market for SKS Micro-finance and the M-Fin claims that bank disbursement for the entire industry there is reported to have dropped above 50%. We further learn from Mahajan that though MFIs are able to recover advances in non-AP states, they have disbanded altogether or drastically cut down loan advances in these states to tide over liquidity problems. Accordingly we may infer MFI loan disbursements have overall contracted drastically in the country which in turn should have high material impact of the performance of the sector MFI which start reflecting itself in their third quarter results and we can have an insight to their full impact from the fourth quarter results. 

CLAIM 5:  TRANSITORY OR TEMPORARY PHASE 

Raj: This is a transitory, temporary issue and we don’t see any material impact of that on our net worth or our FY12 earnings.

Raj’s statement is typical of one being in denial. The current problem may be transitory or temporary but the question is how short or long drawn out will be such a phase? The MF Bill was supposed to be introduced in Parliament this month but it has been withdrawn to be re-drafted to reflect the experience of Andhra. At the very earliest, the bill can be expected now to be introduced during the Budget session in March and bill could take as much as end of next year to be passed. As and until the Act is passed, this crisis will not go away.

The current buzz within government circles is to let things drift and permit a few MFIs to go bust to drive MFIs to a level of desperation that they would accept even an Act that put them under tight leash in order to prevent repetition of AP behaviour. But the MFIs are already in such a heightened state of desperation that they are willing to even accept public sector banks mulling the prospect of getting their shares at par in exchange of defaults as seen in these media reports: 

Indian Express  5 Dec 

“Public sector lenders have come out with a proposal to salvage troubled microfinance industries (MFIs) —conversion of loans into equity in the company in case of any default. State-run Corporation Bank is the first bank which has come with the idea to safeguard its risk through this route.

Other lenders like State Bank of India, Bank of India, Indian Overseas Bank, Punjab National Bank and SIDBI — which have maximum exposure in the sector — are also said to be toying with this idea, said a banking source. “The microfinance industry is a very lucrative sector and we consider it very good from the investor perspective. From now on, we will be putting a clause in our loan contracts through which we will get an equity stake in the MFI in case of a default,” Corporation Bank chairman and managing director Ramnath Pradeep said.

No lending has yet been done under the equity-in-case-of-default clause. This applies to the newer ones which we will be giving,” Pradeep said. “The equity-for-loan clause mentions that the stake will have to be given to the bank at par or at the face value of every share, which can result in a windfall to a bank,” Pradeep said, adding “MFI shares are still strong. The share's market value can be Rs 700 but I will get it for Rs 10 as the face value.”

WSJ-Livemint.com   4 Dec 

Mahajan: Already, 90-95% of the Rs.8,000 crore outstanding MFI loans in Andhra Pradesh are overdue. Right now companies are just collecting from other states and disbursing it in Andhra (Pradesh), but this cannot continue for long because some of the other states have not seen disbursals in the last two-three-four weeks and the borrowers there are wondering as to why companies are only collecting dues and not giving out loans,” he said.

Mahajan added that if this continues the same way for a few more days, then defaults will start in other parts of the country too, because a lack of disbursements will push borrowers towards defaults.

MFIN’s Mahajan said equity is only one of the few things MFIs have to give as collateral “because our only assets are the credit we have given, and we own very few fixed assets”. 

So if non-Andhra states are still giving healthy repayment rates to MFIs, then Mahajan does not expect this to continue as “a lack of disbursements will push borrowers towards defaults”. The longer this crisis lingers on, the higher the chances of MF industry going bust as the crisis expands country wide in impact. 

The MFI sector is besides looking to the neo-liberals within the government and bureaucracy to ensure that the MF Act in its final form will be compassionate to their interests. This expectation too is devoid of reality. The government is of course under considerable pressure from the World Bank to integrate MF within their existing development schemes such as NREGA. While the government is open to this suggestion, they want to ensure MF to be gentler to the interests of the poor as compared to the barbaric streak the latter displayed in Andhra. While the central government pressure succeeded in getting MFIs to reduce their interest rates to 24%, they would be more at ease if this is around 18% while state governments will like to see them in single digits. Besides, the Andhra crisis have whipped up so much controversy that opposition parties will aggressively oppose any Bill that leaves MF to pursue a business as usual operation. 

So even if the neo-liberals have their way, it is highly unlikely that such a bill will attract adequate political consensus to pass it as an Act. Accordingly, within the expected future policy environment, it is highly unlikely that the MF sector will be as lucrative and high growth as it was in the past. This means that the MF as a sector need to drastically re-rated in valuations as compared to current valuations. The indications to this effect are reflected in the following media report:

Bloomberg.com 02 Dec 

“Private equity companies may struggle to recoup almost $565 million in investments in India’s microfinance industry since 2006 after a regulatory backlash led at least two firms to delay initial public offerings.

Temasek Holdings Pte, billionaire George Soros and Sequoia Capital are among investors who’ve put money into the world’s largest market for micro-loans as lending and profits swelled. The boom culminated with the IPO of Sequoia-backed SKS Microfinance Ltd., which raised 16.3 billion rupees ($357 million) in August.

I don’t think private equity investors will recover their money at the rates they thought they would,” said Sanjay Sinha, managing director of Gurgaon, India-based Micro-Credit Ratings International Ltd. “The market is not as wonderful or as large as the investors made it out to be, and they paid far too high prices for their stakes.

Valuations for Indian microfinance companies, which focus on providing loans in areas largely shut out from traditional banking services, are three times the global median, based on private equity investments, the Consultative Group to Assist the Poor, a Washington-based policy and research canter that aims to help increase financial access, said in a report in March.”

CLAIM 6:  SCALE 

Raj: What are going to supplement that profitability are scalability and productivity gains. Our operating cost has come down from 12.7% to 10.4%. If you look at it, at the end of the day it’s separating men from the boys. The company with the strongest balance sheet, best management, best practices, adequate capital on the balance sheet and liquidity and also customer centricity is actually going to gain out of it.

The claim of SKS of having best governance practices in public eyes is plain bluster after the company sacked their CEO, Gurumani arbitrarily. So is the claim of customer centricity with charges of alleged suicides due to their coercive recovery practices. Besides customer centricity is best provided by smaller MFs than a nationally scaled one.

This leaves the strongest balance sheet, capital reserves and liquidity as seemingly sound arguments that validate SKS claims that these are what separate men (them) with boys (others). Now scalability is a two way sword. As long as there is growth, then all these SKS claims maybe probably true. But what if a MF of a size like SKS actually experience rapid negative growth? It is obvious that it can just as easily slip into bankruptcy in lightening speed. Particularly so as Mahajan points out that the only assets MFIs have are current (loans they disburse) with very little capital assets.

One of the major reasons why operational costs to delivery of credit are high is due to the high overheads of MFIs like SKS. The sacked CEO of SKS Microfinance, Suresh Gurumani, received an annual salary of Rs1.5 crore and gross remuneration of Rs2.45 crore in 2009-10 in addition to perks and benefits much more than this amount. In contrast the chairman of SBI, India’s largest bank receives just Rs 26.5 lakhs, the RBI Governor, a paltry  Rs 15 lakhs while his deputies - a relatively pittance amount of Rs 13 lakhs. This gives a glimpse of why all claims of operational cost cutting by SKS are just bunk. It is because it is all bunk; scalability in an environment of rapid negative growth rate can easily turn a curse. This would give SKS an equal probability of getting bankrupt as compared to any small sized MFI.

The vulnerability of MF as a sector is not only because of its highly skewed geographic concentration in Andhra Pradesh but also its high dependence on the government funds for its operational lending activities via public sector banks. This dependence is estimated at over 80% of all their lending and in the case of SKS, slightly lower. As a reaction to the crisis MFI’s first looked to infusion of Private Equity (PE) funds, even in exchange of equity. By first week of December, PEs though offering initial interest, expressed their unwillingness:

Bloomberg.com 2 Dec 

“No logical person would invest in microfinance right now, because there is no microfinance right now,” said Vineet Rai, founder of Mumbai-based investment company Aavishkaar Venture Management Services Pvt. “If all the big guys are facing the risk of not being around, you have to be very courageous or mad to invest. Aavishkaar’s funds invested $18 million in seven Indian micro-lenders including Spandana Sphoorty Financial Ltd.”

With PEs willing in spirit but not in mind to invest further, MFIs survival revolves entirely around government’s mercy. Unfortunately for them, none has been forthcoming todate!

So we ask again. Logically, can SKS Microfinance buck the industry’s momentum to doom? You decide and re-rate SKS stock accordingly.