Tuesday, May 31, 2011

RBI bats for big MFI autonomy

Till early this month, there was an expectation among the various stakeholders that the Reserve Bank of India (RBI) would strike a balance on the contradictory responses to various recommendations put forth by its sub-committee — the Malegam panel — on a policy for microfinance institutions (MFIs).

But the RBI's announcement of a MFI policy on May 3, broadly on the basis of the Malegam panel's views, throws up more questions than answers on the health of the microfinance model.

An analysis of the key points of the RBI's policy suggests that the apex bank may be batting more for the big MFIs, leaving aside the smaller players and, more importantly, the poor.

To begin with, the fixing of the interest margin and interest rate cap at 12 per cent and 26 per cent respectively would still leave more profit margins for the bigger MFIs in a sector linked with financial inclusion and economic empowerment of the poor.

According to industry estimates, the average cost of funds for MFIs varies between 12 per cent and 14 per cent, while operational expenses for the big MFIs are 6-7 per cent. So, there is actually no strong case for the RBI to fix the interest rate cap at a liberal 26 per cent, against the 24 per cent cap suggested by the Malegam Panel.

Further, the RBI also seems to have turned a blind eye to the fact that, over a period of time, the incremental cost of operations would be less for major MFIs, which have a presence in a large number of States. They can also take advantage of core microfinance operations for other businesses such as sale of insurance, mobile handsets, and so on.

For instance, SKS Microfinance, which has announced plans to enter into lending against gold ornaments to tide over the microfinance crisis in Andhra Pradesh, will obviously use the same field force used for distributing micro loans, with little incremental cost but with augmented income.

The business models could still be viable for big MFIs, even if the interest is capped at around 20 per cent. The RBI could well have gone for a two-tiered model for deciding the caps on interest margins and interest rates, taking into account the variations in the cost of operations across major and smaller NBFC-MFIs.

If the RBI really wants to protect the entire microfinance sector, it should also take into account the situation of medium and small MFIs.


It also appears that the banking regulator is rather silent on some of the serious issues that came to light in Andhra Pradesh over the last year.

The root-cause of the MFI crisis in that State was the over-indebtedness of the poor, driven by multiple lending. However, as against the stringent norms in the AP MFI Act on multiple lending, it has been said in the policy that an indebtedness of up to Rs 50,000 could be allowed and a single member could take loans from two MFIs.

This is worrisome, as the annual income of poor (going by the data of the AP Government) is below Rs 36,000 per annum.
If one could get loans up to Rs 50,000, the maximum indebtedness, there can be multiple loans of different combination for any MFI client. This means that the poor could be constantly in a debt trap from which they cannot escape because their indebtedness exceeds their annual income.

Under these circumstances, it may come as no surprise if a similar situation to the MFI crisis in Andhra Pradesh crops up in some other States, following the saturation of their markets.


The need to ensure a proper implementing agency has also been ignored in the policy. The question still remains: While on-paper regulation is done by the RBI, who is responsible for on-field regulation of MFI activities?

A gamut of operations — from ensuring transparency in interest rates, maintenance of interest caps, harassment-free collection and disbursal of loans, to name a few — have to be monitored very carefully.

By ignoring a reasonable contention of the Andhra Pradesh Government, that the lack of an enforcement mechanism is a serious problem, the MFI policy went along with the Malegam panel's suggestion that MFIs should be self- regulatory organisations.

Even for lending under the priority sector category, banks may have no choice other than to go by the interest margin/ interest rate submitted by the MFIs!


Given the seriousness of the issue, the RBI should have also made a reference to the AP MFI Act in its policy. The outward impression in the industry is that, along with other recommendations, the RBI had also accepted the Malegam view that there would be no need for the AP MFI Act if all of the panel's recommendations were accepted. But the fact remains that the RBI is part of the Government. It cannot be silent on an existing Act that totally contradicts the much-awaited policy on micro-finance institutions.

As the Andhra Pradesh Government is adamant about continuing with its Act, it remains to be seen how things will unfold.

SKS Micro-finance: The Venture Capitalist Spin


There was an interesting article that appeared in the media entitled "Sequoia's Roller Coaster Ride with SKS: The Gains & The Losses"
The article claims that the notional loss of Sequoia in SKS Micro-finance was a whopping Rs 1,199 crore or $268 million. The article however confirms that the total investment by Sequoia was only $ 48.5 million in two tranches. Obvious that something does not add up - a $268 million notional loss on an investment of $ 48.5 million! 

The reality is that Sequoia had invested through two funds SCI II Llc and SCIGI I with average cost of purchase pegged at Rs 61.18 and Rs 137.53 per share, respectively. SCI II was a part of the group of shareholders who together offered to sell a part of their holding in the public issue that was priced at Rs 985 per share. 

This part sale of their stake enables them to recoup not only their total investment of $ 48.5 million but also booked a small tidy profit. Their current cost per share is zero and the historic low of SKS script at Rs 255 and it current price - Rs 342. So where's the notional loss?
The article clarifies - "Notional loss is computed  assuming it had sold the shares at the peak of the market as compared to current value."
Oh really??
Here's the spin which the Venture Capitalist industry resorts to for attempting to generating public and government sympathy for bailout of the sector. RA

Sequoia's Roller Coaster Ride with SKS: The Gains & the Losses  

Sequoia Capital India was the first venture capital firm to spot microfinance as a sector that a VC can invest in India. In 2007, Sequoia participated in a $11.5 million round in SKS when the other PE firms were yet to spot the company. In 2008, it participated in another round of investment of $37 million. But the big PE firms joined the party only in late 2008 when SKS raised $75 million from a group of PE firms like Sandstone Capital at a much higher valuation.

In July last year, the company went in for a dream IPO to raise Rs 1654 crore, which was subscribed about 14 times. The company's shares, which got listed at Rs 985, rose to Rs 1490 on September 28, 2010. So small wonder, it was a multi-bagger, trophy investment for Sequoia. 

Cut to the present. The shares hit Rs 262, the 52-week low of the stock, although it bounced back to Rs 297.85 at the close on Bombay Stock Exchange. Over the last few months, it has been a terrible time for the microfinance sector in general and for SKS Microfinance specially. Sequoia, which owns about 14 per cent stake in the company, has been considered a promoter at the IPO, and has a three year lock-in. So the private equity fund has been suffering all the brunt on the stock as it has no freedom to exit at will. Where does that take Sequoia's holdings in SKS?


To be fair, Sequoia made sure it didn’t lose all of the gains it made as it part exited during the public issue of the SKS. It sold part of its shares held by one of the two funds through which it invested over three years ago with mouth-watering returns of over 16x.

Sequoia had invested through two funds SCI II Llc and SCIGI I with average cost of purchase pegged at Rs 61.18 and Rs 137.53 per share, respectively. SCI II was a part of the group of shareholders who together offered to sell a part of their holding in the public issue that was priced at Rs 985 per share.

The value of remaining shares representing 13.9 per cent stake held by these two entities rose significantly when the share price of SKS Microfinance hit its all time high of Rs 1,490 last September, just weeks after its debut on the stock exchanges.

The value of shares held under SCI II Llc rose to Rs 760 crore (~ $170 million) as against cost of acquisition of Rs 31.5 crore (~$7 million) or 24 times in less than four years. The portfolio value of SCIGI I rose to Rs 738 crore(~$165 million) from investment of Rs 68 crore(~ $15.2 million) or almost 11 times. But the shares have a mandatory lock-in that restricts Sequoia from encashing any more of it soon enough.


While the company managed to steer through various issues at the time of the IPO and pretty much had a similar performance post listing as its Mexican peer Banco Compartamos, the firm was hit by a spate of bad news including adverse regulatory changes in its most important local market in India, the state of Andhra Pradesh.

This was visible in the latest quarter result of SKS Microfinance. It posted a loss of Rs 69.7 crore in the fourth quarter ended March 31, 2011 compared to a net profit of Rs 62.9 crore during the same period previous year, as the company went through poor repayment rates and also faced a new policy regime in Andhra Pradesh. The company's revenue also fell to Rs 193.8 crore from Rs. 304.5 crore in the same period.

Jittery investors have dumped the firm’s shares that hit a new low on Tuesday quoting at Rs 262 before bouncing back to make up for some of the loss and closed at Rs 297.85 a share at BSE. Even at this price Sequoia is sitting on a multi-bagger with SCI II Llc on unrealised gains of 4.8x and SCIGI I with notional gain of 110 per cent.

The value of shares held by the two funds is Rs 152 crore and Rs 147 crore respectively. In effect Sequoia has lost Rs 1,199 crore or $268 million assuming it had sold the shares at the peak of the market as compared to current value. The venture capital firm could well make up for this notional loss in the future, but for now it would be hoping, along with other investors who bet on the microfinance lender at the public offer, to at least get back to the price at which it sold part of the shares in the public issue, soon.

George Soros and other PEs entrapped in SKS Microfinance

An initial public offer by India's SKS Microfinance sparked a debate on the ethics of profiting from the poor. The phenomenal year-to-year growth of MFI prior to the Andhra crisis was fuelled by new sources like private equity (PE), the capital market and debt instruments. 

Private equity has helped push valuations to about 5.9 times book value, or nearly three times the global average. These PEs want maximum returns within the shortest exit and the resultant was the kind of excesses seen in Andhra Pradesh that led to borrower suicides and provoked a backlash against the the whole industry. With PE investment in MFIs, it is the PEs who control the company and who are the legal promoters of the company though their PR continue the facade of a social business.

Within this context, this blog had been advocating that SKS be treated as a proxy for the whole for-profit microfinance industry and that the script be hammered so that these PEs be taught a lesson of their lives. The only way they can do so is by suffering huge losses and never again enter the micro-finance in the country in order to earn mega-profits by exploiting our poor. The Andhra Pradesh Microfinance Act 2010 and the new (Malegam) RBI regulations have significantly curbed the profitability of microfinance institutions. The impact on SKS Earnings Per Share (EPS) is plotted in the graph.
From a high of Rs 1,490, the SKS share touched a low of Rs 255 in the second week of May. Huge volumes prior announcement of Q4 results led the stock exchanges to investigate the script for insider trading violations.
Consequently the share was shifted from the rolling segment (series: EQ) to trade for trade segment (series: BE) with a price band of 5%. Bears caught by this step had to compulsorily square-off and the share rallied to Rs 343 close yesterday.

Among PE investors entrapped in SKS are George Soros firm, Quantum; Sequoia, Treeline etc.  The Business Standard article is republished to give an idea how hard PE investors are hit. RA

 Macro losses for PEs in SKS Microfinance

The dream that turned sour for many a retail investor long before has now begun to hurt the smarter ones, too. Early birds who had bought chunks of SKS Microfinance Ltd before the Initial Public Offer (IPO), at what for a while looked like throw-away prices, are staring at losses.

A set of private equity investors have seen their investment dip below cost price as the SKS stock dived below Rs 300 yesterday. After dipping to an all-time low of Rs 255 on Tuesday, SKS recovered to close at Rs 298.

SKS allotted shares to the public at Rs 985 in its IPO. The shares subsequently hit a high of Rs 1,490 in September 2010. On April 26, the stock dipped below Rs 500 on concerns over results. Even after this, most institutional investors were sitting pretty with gains of over 30 per cent. But last week’s crash after the company reported operating losses has caught many of them off-guard.

Two other investors, who bought immediately before the IPO at much higher prices are already deep in losses. George Soros-owned Quantum (M) Ltd and Tree Line Asia Master Fund had bought shares through secondary transactions at Rs 636 a share. As of March 31, Tree line and Quantum held 2.06 per cent and 2.37 per cent, respectively.

Saurabh Agarwal, director, Kennis Group, an advisory for PE funds, said the funds will continue to hold, as the long-term prospects are good. “Our internal estimates suggest a further downside of 20 per cent. But once the regulatory issues are sorted out, the stock will do well, as the permanent structures for the business are already in place,” Agarwal said.

SKS had placed at least 15 million shares with a second set of PE investors at a substantial premium of 30 times the face value between March 2009 and March 2010. Sandstone Investment Partners, the single largest investor in SKS, with 11.5 per cent stake, bought 8.3 million shares for Rs 250 crore in the company in 2009. Kismet Capital LLC, ICP Holdings and Bajaj Allianz Life Insurance are the other investors who took the stock at Rs 300 a share and are staring at losses. As of March 31, these investors together held a little over 20 per cent in the company.

According to Mukesh Jain, head of private equity, Equirus Capital, the investors have to take heart from the fact that they have the advantage of selling the stake in the open market, as the portfolio is a listed one. He said, “The cloud still over the microfinance space due to the regulatory issues will also reflect on the shares in the future. The money-making process is over and the business model will no longer work as it did earlier.” The dispute between the CEO and the promoters made things worse, he added.

Two funds, Catamaran 1A and Catamaran 1B, owned by Infosys’ chairman N R Narayana Murthy, bought 938,000 shares for Rs 28 crore in January 2010. This investment also went into the red on Monday.

According to the IPO documents filed with SEBI, Catamaran shall be subject to a lock-in for a period of two years, but not if the market value of the equity shares as calculated on the basis of average closing prices in a calendar week goes below Rs 400. Breaching the lock-in has become a distinct possibility, after the share prices dipped much below Rs 400 on Friday. In the past two sessions, the shares have been trading well below Rs 300.


Saturday, April 2, 2011

Which way will SHG Vote Swing?: Battle for Tamil Nadu

In 1994, Chandra Babu Naidu of the Telegu Desam was quick to grasp the huge potential of SHGs to swing tightly fought electoral contests. He then supported the anti-arrack (local liquor) agitation that was spearheaded by Self-Help Group (SHG)s and rode the accompanying wave that catapulted him as Chief Minister of the state for two terms. When he betrayed SHGs by removing prohibition and encouraging for-profit micro-finance agencies like SKS; SHARE; BASIX, SPANDANA etc who exploited the poor; SHGs turned against Naidu, one of the major reasons why he was booted out of office unceremoniously. 

That's the power of SHGs.  From then on, SHGs had been increasingly targeted as a vote bank in many parts of the country. However, they rarely behave as a single vote bank as these are basically disparate groups, showing large variations in their demographic and socio-economic profiles, particularly caste electoral behaviour.

At least 1/6th voters in Tamil Nadu are members of Self-Help Groups (SHGs). There are an estimated 500,000 to 800,000 SHGs within the state with each unit having a membership of 20. Collectively, they comprise half of Tamil Nadu's roughly 30-40 million of the state's total electorate. It is not merely the strength of the membership alone that makes SHGs a significant constituency which no politician can ignore. Research studies indicate that each SHG member could influence the voting pattern of at least 3 other non-SHG members.

Little wonder that the two main alliances in the state are bending backwards to woo SHGs. The DMK alliance promised each member of a SHG Rs 5,000-10,000 as a grant. Its rival, the AIADMK promised Rs 1 million to each SHG, three fourth as loans at soft interest rates and the remainder as a subsidy. 

So how will SHGs vote in the current Tamil Nadu Assembly Elections? 

 We have great pleasure to bring you an opinion poll conducted by Bhakther Solomon,   development practitioner-consultant, Chennai. Bhakther has nearly 40 years of experience within the NGO sector and have previously worked with international agencies such as ActionAid. His organization DPG has a fairly large network of micro-credit SHGs, spread over Tamil Nadu, Karnataka and Andhra Pradesh.

An economist by academic qualifications, Bhakther was magnetically drawn into the science of psephology twenty-five years ago just as several other economists including Pranab Roy of NDTV, the master psephologist in the country. Bhakther's opinion polls have been frequently published in leading newspapers such as Times of India; Kannada Prabha; Dinamalar, The Hindu etc since 1989.

In Tamil Nadu, where two alliances DMK and AIADMK usually alternatively come to power, Bhakther’s surveys have always captured the main change trend and often hit the bulls-eye in terms of both vote and seat shares. In Karnataka, Bhakther’s opinion polls hit the bulls-eye repeatedly and had been among the handful of polls that captured the rise of the BJP to power in the state.

SHGs positive tilt towards a particular alliance has a high likelihood to place that alliance in the lead over its rival. The fieldwork for Bhakther's opinion polls among SHG members was undertaken mid-March. It suggests that DMK holds a healthy edge over its rival AIADMK. But as much as 20% are still undecided and as 13th April, voting day approaches, this category will very quickly dwindle in numbers as people make up their minds. It is really for this 20% undecided category, the rival political alliances are pulling out all stops to woo.

For more details on one of its kind opinion poll, read here:

Thursday, February 3, 2011

RBI (Malegam) Report: What's on the Platter? Guest Post

We encourage you to submit your opinions to RBI by the due date. In the meanwhile we are publishing an excellent reaction by another blog.

The Malegam Committee Report on Micro-Finance: What’s On the Platter? 
Ramesh S Arunachalam

The much-awaited Malegam committee report is laudable because it is the 1st committee report of (some) significance to attempt the creation on of a (national) regulatory framework for MF in India. The Malegam committee report must be strongly appreciated because it seeks to legitimize microfinance as an integral part of the Indian financial sector. By recommending creation of a new category - called NBFC MFIs (with associated conditions which are perhaps open for discussion) - the report has clearly positioned and mainstreamed micro-finance within the framework of the larger financial sector in India. This ensures that micro-finance will come under the purview of the RBI and no longer can microfinance be treated as a fringe activity or as an orphaned child in the larger Indian financial sector.

A second aspect that deserves appreciation is the fact that while the report has recommended continuation of priority sector funds for MFIs, it was however made it conditional - especially after recognizing some of the key problems like ghost lending, multiple lending, over lending and attempting to outline some measure to tackle them as well.

A third issue that merits appreciation is the fact that the report has sought to promote greater transparency with regard to interest rates…through various measures.

Fourth, the report has recognized and stressed the importance of off-site and on-site supervision of NBFC MFIs (including systemically important ones) while also alluding to the need for significantly enhancing the supervisory capacity of RBI with regard to micro-finance.

Fifth, the strong emphasis on corporate governance is note worthy and specifically, the committee has suggested that corporate governance rules will have to be specified (encompassing several issues) for NBFC MFIs by the regulator. A very critical aspect indeed…

Sixth, there are several other aspects in the report that require commendation:

  • The intent to ensure that the aggregate amount of loans given for income generation purposes is not less than 75% of the total loans given by the MFIs;
  • The strong desire to deal with multiple lending, over lending and ghost lending through several measures including better loan origination procedures, establishment of a credit bureau etc
  • The emphasis on having strong client projection measures in place including various codes for MFIs
  • The desire to keep NBFC MFIs out of the purview of state level money lending acts

That said, I am therefore a bit perplexed by the strong (initial) criticisms of the Malegam report…While stakeholders appear to have perceived several weaknesses in the report, I try to list some of these below and provide some explanations with regard to these issues, apart from suggesting ways forward. Many of these issues can (easily) be addressed by dialogue and discussion and do not take away the excellent work done by Malegam committee – that is a point that I would like to make clear upfront…Read on…

1. The first cited issue is that the ‘implementation mechanisms’ proposed with regard to various suggested measures perhaps lack the required depth and detailing - but that is (only) to be expected in any such first cut broad strategy report. I think it would be unfair to criticize the Malegam committee report on the lack of implementation detail - after all, much of this can be detailed out only after the RBI accepts the various recommendations and I am sure that necessary precautions (by the RBI) will be taken with regard to codes of conduct, client protection measures, corporate governance etc

2. A second aspect is the use of caps for annual family income, restricting it to Rs.50, 000/-. This is admittedly a suggestion that perhaps cannot be implemented on the ground. On the contrary, this condition could in fact serve to encourage local level corruption, as more and more clients and MFIs seek to get <Rs.50,000/- annual income certificates from the local village administrative officers (or equivalents). It would be impossible to enforce this and in the spirit of argument - “Do not regulate something that you cannot supervise” – it may even be better to remove this artificial barrier.

3. A third issue is the capping of “overall interest” and “margins” as well as loan size and total loan amount outstanding - they are again not feasible to implement on the ground and can be easily overcome as shown by the past experience with SSI loan and other such (lending) limits.

The committee must also recognize that caps on loan sizes and total loan outstanding may be somewhat restrictive for the clients and perhaps even at variation with current RBI policy. Therefore, this aspect also needs to re-looked and adapted accordingly. Further, the capping of loan amounts and loan outstanding would severely hurt the clients (in the medium and long term) in their efforts to climb out of poverty. Hence, the committee may want to go with the existing RBI ceiling of Rs 50,000 for loan size as well as total loan outstanding and back it up by ensuring that MFIs have good loan origination and appraisal systems (especially, for large non-consumption loans to individuals, which must also be permitted) and appropriate ceilings for consumption loans (as already proposed by the committee)

The capping of interest could severely hurt the prospects of nascent/small MFIs and those operating in difficult terrains. More importantly, the resultant search for greater efficiencies will surely result in more short cuts being taken with regard to client acquisition, client engagement and the like - we all know what problems that (all of) this caused in AP in the recent past. Hence, the committee may consider removal of the capping on overall interest, while continuing to suggest the capping of the margins – but through more appropriate slabs and with greater flexibility to accommodate the diverse nature of Indian micro-finance and MFIs. This would be a pareto optimal solution indeed…

An alternative would be to completely remove these caps and go in for caps on return on equity and/or dividends…as this blog writer had proposed earlier… http://microfinance-in-india.blogspot.com/2010/11/never-waste-crisis-use-it-to-get-micro.html

4. Fourth, given the need for pluralism and choice, it would be appropriate if the committee recognizes and provides legitimacy/space for operation of other legal forms of MFIs including non-profits and mutual benefit institutions. Even if the RBI does not regulate/supervise them (and in all fairness, perhaps cannot do so in a legal sense without amendments to its own acts), this legitimacy provision will go a long way in ensuring that: a) banks lend to these institutions (I have already heard that some banks are telling some MFIs that only large NBFC MFIs will be supported hereafter); and b) usury laws are not used against them, in an operational sense, as has happened in Andhra Pradesh.

5. Fifth, even within the category of NBFC MFIs, the Rs 15 crore net worth requirement seems a big ask for the small and nascent MFIs. Therefore, it would be appropriate if the committee reconsiders this aspect so that all existing small and nascent players – both NBFCs and those NGO MFIs ready and desiring to transform - are not unduly inconvenienced. This seems fair from an equity (pun intended) perspective…
6. Sixth, Sa-dhan has played a very important role in the development of the Indian microfinance industry and the requirement of an association having 33 1/3 % of its members as NBFC MFIs needs to re-looked at from a practical stand point. At any rate, not treating Sa-dhan as an MFI association will again be perceived as patently unfair and hence, this aspect also needs to be reconsidered…and perhaps changed accordingly...

7. Seventh, it would be important for the committee/RBI to take cognizance of the (widely prevalent) agent model of micro-finance in India and address issues related to the use of agents – much of the multiple, ghost, over lending and recovery practices can be traced to the use of this fast tracked model that puts clients as the very last… Read on… http://microfinance-in-india.blogspot.com/2011/01/broker-agent-in-indian-micro-finance.html  

8. Eighth, it would also be useful if the committee looks at the aspect of equity investment in MFIs and build necessary safeguards to ensure that what happened in AP does not recur again. Specifically, the aspect of MFIs growing very, very fast (through multiple, ghost and over lending), perhaps, on their volition and at the behest of (private) equity investors so as to provide greater and faster returns for themselves/investors/shareholders and get further investments at a premium and so on… needs to be looked at closely by the committee/RBI and strongly addressed…Otherwise, we may have a few Satyam like situations down the road…

9. Last but not the least, the report pf the committee, while providing a good framework for the future, perhaps does not adequately address the existing crisis situation (in AP and slowly beginning to unfold in Tamil Nadu) and issues around these – there are a large number of clients and JLG who have been shared at the field level, with each MFI reaching out to them, on a specific day of the week. For example, there are sometimes 6 MFIs sharing a JLG and its clients and this has been the REAL secret of the micro-finance growth story so far…Add to this the huge levels of indebtedness on the ground and I am not sure that the report provides any way out for these aspects…I hope that the committee and RBI look into and address these issues as otherwise, there would be no REAL way forward…

Overall, the Malegam Committee has done a highly commendable job with a very complex problem and that needs to fully recognized and well appreciated. It has shown the right strategic intent and direction for establishing a uniform national regulatory framework for micro-finance in India that attempts to put clients first…Ladies and Gentlemen, let us give the committee a Big Warm Hand…rather than JUST nitpicking on specific issues that can (perhaps) be sorted out through discussion and dialogue…Clearly, it is about time that we - stop being Penny Wise and Pound Foolish and - recognize the huge and legitimate platform for action that the Malegam committee has provided all of us

Monday, January 24, 2011

SKS Microfinance 3rd Quarter Unaudited Results


SKS Microfinance, India's largest and only listed microfinance lender, said on Monday it posted a 38 percent drop in net profit for Oct-Dec to 341.55 million rupees on total income of 3.85 billion rupees.

The firm, which lends to poor borrowers, mostly women, has raised it provisions and write-offs in the quarter to 1 billion rupees from 116.1 million rupees a year ago, it said.

The provision includes 587.4 million rupees relating to the Andhra Pradesh (AP) portfolio and 269.8 million rupees in accordance with guidelines for the microfinance sector provided by a panel appointed by India's central bank.

The company continues to assess the adequacy of provision on the AP portfolio due to the continued evolving environment, with no precedence, following the enactment of AP (MFI) Act and the resultant impact on the field operations in AP."

Thursday, January 20, 2011

India's Central Bank finally give a loud unambigous policy signal: MFIs will not die, only need to be castrated.

Wednesday was a red letter for micro-finance industry. In the morning the Reserve Bank of India (RBI) announced the extension of the Special Regulatory Asset Classification (SRAC) benefit to Micro-lenders till March 31. 

Though a one-off exception, this step allowed a special relaxation in debt restructuring norms for MFIs. This provided the sector a much needed respite, who otherwise were on the verge of bankruptcy. 

The RBI step was in a bid to avoid a serious repayment crisis in the micro finance institutions (MFI) sector following the Andhra Pradesh Government’s restrictions on their activities due to suicides by their borrowers. Under these new norms, banks would be allowed to treat the advances to MFIs as good assets even if such loans are not fully secured. Banks will thus be able to restructure loans provided to the MFIs without much difficulty.

The SKS share that was languishing at Rs 650 levels spurted to an intra-day high of Rs 690.60 but lost most of the gains to close Rs 668.55. Bulls sobered their celebration when they learnt about the RBI caveat - MFIs has to agree to reduce their leverage and growth projections!

The same evening saw the release of the long-awaited Malegam report on microfinance companies. This is a Reserve Bank of India’s committee on microfinance institutions (MFIs) that was constituted in October last year to examine issues of high interest rates, coercive recovery process and multiple lending practices by some MFIs. The committee was headed by YH Malegam. 

Bull operators this morning engineered a huge spurt in SKS share price, triggering the 10% upward circuit breaker. The share hit an intra-day high of Rs 757, advancing 13% over the previous day's close, after touching an intra-day low of Rs 651.10, showing high volatility. SKS whose daily market width thinned to around 50,000 spurted to a whooping 4.1 million. 

The surge in the share was helped by SKS CFO, Dilli Raj giving live interviews on opening bell to financial news channels like CNBC welcoming the report. "The Malegam report brings structural clarity to the industry. Also, clarity on funding arrangement with the banking sector is a big positive. Interest rate capped at 24% doesn’t affect SKS in any significant way," he pointed out. He further added that the report clearly captures that the Reserve Bank is comfortable with lending to MFIs. And, he sees no regulatory gap in the microfinance industry now and said the new guidelines suggested on functional aspects are welcome. 

Vijay Mahajan, Founder, BASIX and Chairman, MFIN too said, "The Malegam committee report is a very good step forward to the whole controversy about microfinance institutions, particularly non-bank finance companies doing micro finance because that comes under RBI purview."
Despite this the rally turned out more in the nature of relief that enabled High Net worth (HNW) and private equity investors in SKS to exit at higher levels. The share lost more than 75% of the intra-day high to close Rs 689.35, advancing 2.93% over the previous day's close. The share has fallen over 60% from its all time high in a matter of months.

"The stock has been hammered badly so I believe this is a relief rally," said Arun Kejriwal, founder of advisory firm Kejriwal Research & Investment Services. "But the issues at hand have not been debated or resolved. It will be a matter of time before people realize we continue to remain where we are," he said.

Another trader in moneycontrolmessageblog.com commented in the same vien "Can't understand the reason for this bounce. In effect, the recommendations would bring severe pressure on the margins of the MFIs, and affect the financials very adversely. And this time the damage would not only be limited to AP but would be felt across India. So no places for MFIs to hide. Sell the stock"
Radhika Gupta, Director of Forefront Capital Management is of the view that investors should stay away from SKS Microfinance. As reported by moneycontrol.com, Gupta told CNBC-TV18, 

"We have been bearish on the SKS Microfinance stocks since the IPO days. I think that sort of continues. There is still a couple of issues surrounding the stock. One is the regulatory environment for MFIs where there is some news that has come out but that is still not clear. Second is the corporate governance issues in the stocks has still not cleaned themselves up. Third, this is a business that does not have too much of a public track record as far as listed entities go. We would advice investors to stay away from it.”

"The 24 percent interest rate cap is too low,” said Sanjay Sinha, managing director of Gurgaon, India-based Micro- Credit Ratings International. “It’s going to limit the operations of some institutions -- especially the smaller ones.” 

Meanwhile, the first detailed analysis of the policy recommendations of the Malegam Committee began to trickle through. Ambit Capital opined that "If implemented, we believe these will significantly erode the growth and profitability of the sector and especially SKS Microfinance." Ambit feels that the move would erode SKS Microfinance's profitability and its RoEs could be reduced to levels below 10%. As  another trader in trader in moneycontrolmessageblog.com that goes by the name "Anupiimi" observed:

"The caps for interest rates permitted under Malegam report are as follows: 1) 24% interest 2) 10% NIM levels. SKS has costs of over 6-7% as operational costs. That leaves margin of 3% for SKS. On that, maximum leverage would be around 3. That would give RoE of less (3%)*4 = 12% before NPAs. That is much lower than its cost of equity. This would cause value to deteriorate. We expect share price to decline. Even now, SKS trades at price-book value P/B levels of over 3. That is higher than most banks that have less riskier business models and higher returns."
[RoE = (earnings/assets)*(Assets/Equity)
=(the margin=3%)* ( 1+ Debt/Equity)
=(3%) * (1+leverage)
=(3%) * (1+3)
=(3%) * 4]
Ambit further feels "SKS's networth (total assets minus total outside liabilities) would shrink up to 50% due to delinquencies in AP." Though RBI permits banks not to treat MFI outstanding as bad debts as of now, this freedom does not extend to MFIs who need to reflect these on their own books. We will get an insight next Tuesday when SKS announces its unaudited 3rd quarter results. Whatever the percentage, it has to be significantly more the normal 1% SKS provides for. This factor takes a further hit on the 12% RoE, maximum leverage projections.

Some MFIs feel disappointed that the report only looks at rural poor and excludes urban poor. The reason is that the committee has recommended the creation of a separate category of MFIs called NBFC-MFIs. These NBFCs can give loans only to families whose total income is not more than Rs 50,000 per annum, and largely for income generation purposes. "Anupiimi" incisively points out, that in addition to non-performing assets (NPA), SKS's operational costs that is currently between 6-7% is poised to increase if the Malegam recommendations come into play that further hits the RoE.

“There are further problems for micro-finance companies highlighted in this report that I have not used but would cause further downside for SKS. They are: 1. Ticket size cannot be more than 25000. That would reduce transaction size and hence raise cost per rupee of lending. 2. More than 75% of lending to be used for investment that would increase paperwork for MFIs and raise operational costs."

This view is confirmed by SKS CFO, Dilli Raj in the CNBC interview. "Philosophically, one may oppose the cap on interest rate or regulatory interest regime. But we need to take things in balance and in holistic manner. Now what you need to do is to go back and reinvent your operational models and bring in lot of financial efficiency, reduce operating costs to maintain the ROI”. 

The fair value of the SKS share more and more look around Rs 200, its book value.