SKS Microfinance 3rd Quarter Unaudited Results

Reuters:

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."

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.

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.

Where's the Microfinance Coercion? Here's the Proof!

 What is Coercion in Repayment; A Client Perspective from Indian Micro-Finance
Courtesy: Ramesh S Arunachalam

We have been hearing the term coercive repayment and this is what we have understood from our interaction with about 52 microfinance clients in the field in India, during the last 6 weeks. These items represent a compilation of what several clients (especially, those with multiple loans) and/or their families told us as we talked to them in various places in Andhra Pradesh, Tamil Nadu, Karnataka, Orissa and West Bengal: 

 Note: There are Video Clips/Recordings available of what clients said for the record

Client A: “The fact that fieldworkers/agents came day after day (for week after week) and pressured me to pay back is itself a sort of harassment and coercion. As I (and family) do not have serious livelihood means, we have to either borrow from another MFI (this would help consumption and also repayment for some time) or borrow from money lenders (at even 10% per month) to pay them and get them off our backs. The idea is WE HAVE TO SOMEHOW PAY THEM or they will not leave. When all options of borrowing run out, we either have to migrate or die. This is what is happening to other women and may happen to me someday soon”

Client B’s Husband: “My wife who committed suicide, had taken 8 loans and had to pay back 2 loans on Monday, 1 Tuesday, 1 Wednesday, 1 Thursday, 1 Friday, 1 Saturday (every fortnight one), and 1 once a month. There was no respite during the week and on Saturday, she felt happy that Sunday was the next day but that was short lived as we had to make payments from Monday again and the whole cycle continued…When one has to pay loan repayments on 6 days a week and people will not leave without collecting payments, it is downright harassment.”

Client C: “The collection agents/staff came and stayed put with us until we paid the instalments and this built our pressure as they would be watching us, often passing snide remarks and insulting us. They would even ridicule our children and basically try to embarrass us – so much so that, we would even not hesitate to go to a money lender and get the instalment amount as a loan at 5-10% rates of interest and send them off.”

Client D: “One MFI had the practice whereby if the 1st staff did not return within a stipulated time of 2 hours, other staff will successively join him. Soon, by 10/11 AM, there could be 4/5 people sitting near our house and making all sorts of insulting remarks. They also publicly shamed us in the village. I once ran here and there and finally paid them off at 4.30 PM in the evening and I was traumatized at the end of it all. Now, I dread their coming every time…

Client E’s Husband: “Some collection agents were really rude-after my wife committed suicide.” They came and said, “If you cannot find means to repay, then you should send out your two beautiful daughters, and get them to earn money by other means (prostitution…) and then repay to us.” One of them even said, “If you cannot do that, send them to me and I will use them and pay off your instalments. They are very beautiful and would be able to earn a lot. I wept as I heard this…”

Client F: Another client says she is unable to bear the harsh language of MFI staff and, as a result, was pressured to take loans from local money lenders @4% interest per month to pay back instalments. She also claimed to have sold off her jewels to repay MFI loans as their staff were abusing her, whenever they came to the village for collections.

Client G’s Husband: One client’s husband said that the staff said, “We do not care if your wife died. You better pay when we come back tomorrow”. The husband further said that, “I had to borrow at 12% to pay them the next day as otherwise, they had threatened to chain me to the Big Tree, outside of the village and make me a laughing stock”.  

Client H: Another client said, “The earlier support (SHG) groups have now become pressure groups that insult. So there is no respite and harassment is 24x7 as group leaders and other members live at the village itself and they obstruct participation in village activities if the loan instalments have not been paid. You just cannot get away without paying as they have a lot of local influence and can do anything…” 

Client I: A client remarked that in the case of defaulting members, if the defaulter did not repay the loan over dues, the group leaders and MFI centre leader simply took over the defaulter’s assets into their possession and then, they repaid the loan amount by liquidating it.

Client J: A client said that, “once at the time of weekly repayment, there was a death in the neighbour’s house who was also a member and the collections agents told the bereaved family that unless she paid the last two overdue instalments, they would not allow the body to be lifted or rites to be performed. Then, the client claimed that, she went to a money lender in a nearby bigger village and got an emergency loan at 7% and helped her neighbour pay back the instalment”.

While the above is by no means a scientific study, it nonetheless provides some (initial) indication into the kinds of coercive mechanisms that could be used at the field level (not exhaustive) by some MFIs and it does converge with the findings of previous research into coercive repayment (APMAS and others). These have been compiled into key coercive recovery strategies that could be used by some MFIs and these are summarized below:

Strategy # 1 - Life/Work Obstruction: Field workers, agents, centre leaders and/or group leaders/members may hinder and obstruct the normal life and work of clients and/or their families and thereby, force them to repay, using several means (borrowing from money lenders, take over assets etc) that may not necessarily be in the clients’ interest and one which could cause undue hardship to them.

Strategy # 2 - Threats: Collection agents/field workers could threaten the clients that they would resort to violence and/or physical abuse if money is not repaid; they may also carry the threat out, if money is not forthcoming from the clients;

Strategy # 3 – Verbal Abuse: Field workers/agents may (verbally) insult, abuse and/or intimidate the borrowers and their family members and get the repayment

Strategy # 4 - Following the Client and Pestering: Field workers/agents could continually follow the borrowers and their family members from place to place and pester them for payment and keep on embarrassing them, until the money is paid;

Strategy # 5 - Repossession and Sale of Property: Sometimes, the centre leaders and/or group leaders/other members may even take over property owned or used by clients and sell that and take the repayment

Strategy # 6 - Satyagraha Outside Clients House/Place of Work: Field workers/collection agents could sit outside the house or places of work (like fields/shops) for hours and hours and keep on harassing for payment and leave only after they get it

Strategy # 7 - Embarrassment Strategy: Field workers/collection agents may sometimes even talk to business customers and/or guests of the clients and embarrass clients and thereby get them to repay

Strategy # 8 - Physically Take Over Assets/Documents as Collateral: The centre leaders, group leaders and/or other members could forcibly remove assets/documents of the borrower (like ration card etc.,)  and not return it until the repayment is made by client

Strategy # 9 – Physical Intimidation: Field workers/collection agents may physically intimidate the clients and get local toughs to rough them up once or twice, so that repayment is forthcoming thereafter

Several questions arise from the above discussion and the RBI sub-committee would surely have to look into the (range of) mechanisms that have been and are being used by (some) MFIs to collect loans at the grass-roots.

A rigorous scientific study will have to be commissioned and undertaken by a neutral set of people and only that can reveal the real extent to which such coercive tactics and strategies are used by (some) MFIs on the ground...

 

SKS Micro-Finance Drifting into a firm Bear Grip

As expected, bears hammered the SKS script from Rs 992 levels at the start of the week to Rs 919.85 closing this week. When we started this campaign, SKS traded around the Rs 1010 range. Accordingly, if 100 SKS shares were sold at the time of our first posting, this would have realized a profit of a cool Rs 90,000 by now. 

Technicals however show a mixed signal, suggesting that the script maybe range bound in price movement this week. However, being a new script with little price movement history, reading too much into technicals may not be advisable. Last Monday and Thursday saw bulls trying to break out on double the daily average volumes. Despite this, if SKS entered up losing over net 7% during the week indicates huge selling pressure, suggesting the share increasingly falling under a firm bear’s grip. The very fact that the bull charge was not sustained uniformly throughout the week is perhaps yet another indicator  - bulls left to marshal their resources for a charge in sporadic spells. 

Bulls perhaps realize that they are badly trapped in this script and hoping to exit at higher levels. However, from Rs 910 downwards, we are entering the first of the series stop loss zones. Accordingly, bear’s are in with an opportunity this week to create panic selling that could see high volumes. As and when these stop loss points are triggered, we could witness a blood bath for bulls. The flow of bad news doesn’t seem to stop for micro-finance companies, This not only put a big question on their future earnings but also financial solvency as a going business.  

The latest news flows are as follows:

1.  Micro-finance companies, including SKS are running scared, so much that they have closed down their websites. Official website of one of the largest microfinance institution in India, Spandana Spoorthy Financial Limited has been “out of order”  for the last few weeks. The website of Share Microfin Limited was also ”down” this week. Both these institutions are based out of the Indian state of Andhra Pradesh, which has come under severe stress since the issue of microfinance ordinance, by the state government. The official website of SKS Society, a sister concern of SKS Micro-finance, was also hacked prior to its initial public offering in the month of April this year. (Read more here) 

2.  SKS Micro-finance is playing down its identity and going into preservation mode. At its modest office in a residential colony in Warangal district, India’s largest microfinance company has taken down its board. At its head office in upmarket Begumpet in Hyderabad, it hung a cloth mesh in front of its plush, six-storey glass building, ostensibly to protect it from the public ire over suicides. (Read more here)

3.  TV5 News a regional Telugu news channel has broadcast a news report yesterday alleging that more microfinance clients have committed suicides and that the ordinance has been ineffective in reigning in micro finance institutions. (Read more here). This may provoke the High Court to be less lenient towards the stay plea of MFIs against the Andhra Ordinance. Even worse, as long as Telegu TV and print media keep the focus on suicides and MFIs, repayment prospects of loans will suffer. As this situation extends weeks and month, it can lead to cash flow problems that could lead to MFIs being unable to pay staff salaries and layoffs, which in turn can accentuate collection of loan amounts.

4.  For the first time, Naxals have thrown their hats into the ring and kidnapped field staff of micro-finance companies. (Read more here). From now on micro-finance tycoons like Vikram Akula (SKS), Uday Kumar (Share) comes immediately under the radar of Naxals and we could expect from now on see their likes moving with AK47 armed security cordon. It would be sensational if Naxals manage to kidnap one of these MFI tycoons and in Al Qaeda style make them confess their crimes against public on tape. Vikram Akula in his book Fistful of Rice had admitted that he faced death threats from Naxals. Accordingly, the Naxal threat is no empty threat to be taken lightly and as long as it persists, MFI staff will be hesitant to visit villages and use strong arm tactics that affect loan repayment again. 

5.  The Microfinance Institutions Network, a self-regulatory body of a clutch of 44 NBFC MFIs, has asked Rs 1,000 crore in the form of business continuity facility, a euphemism for emergency money, to ensure survival. Rumours are circulating that some MFIs are so cash strapped that they soon would not be able to pay staff. (Read more here).This news in particular can’t be good for bulls. Even if a tier-III MFI files for bankruptcy, the news can trigger bear hammering of SKS script to Rs 300 levels. MFIN said liquidity with MFIs had almost dried up, with collections during the past month having fallen a dramatic 50-90 per cent. MFIN felt this could be addressed if banks set up a Rs 1,000-crore liquidity easing channel. "Obviously, banks will price their loans based on the risk assessment," said Alok Prasad, chief executive officer of MFIN. He said an increase in bank rates would put a spanner in the plans of MFIs to reduce rates for borrowers. MFIs also seem wary of approaching the banks for new loans. "There are no requests for new loans from the MFIs," said the managing director of State Bank of Hyderabad, Renu Challu. No new microfinance loans were being given in Andhra Pradesh, which accounts for a third of the total outstanding of about Rs 30,000 crore. Read more here. Pinched by bank funding drying up, leading microfinance firm Basix has cut its advances to a third in the past month. In the past month, Basix has disbursed only Rs 100 crore against the up to Rs 300 crore it would have otherwise done. Read more here.

6.  The State government’s decision to review the operations of micro finance institutions has opened quite a can of worms as it exposed them, including SKS of charging usurious rates.  Contrary to what MFIs say, they are in fact charging very high interest. Most companies impose an interest rate of 30 per cent on a population that is largely poor. Countering criticism of their high interest rates, MFIs had claimed that the interest was 24 per cent, but the affidavits they have had to provide at the time of registration have exposed this as a lie. Interest rates are as high as 36 per cent and more. (Read more here). 

7.  The Micro-finance Bill, which was ready, is now to be re-formulated again, taking into account the recent developments in Andhra Pradesh. Within the Congress, there is a strong move to cut MFIs to size and instead promote NGO-SHG-bank linkage as the flagship development programme of UPA II (NREGA being the flagship development programme of UPA I). If this is accompanied by the withdrawal of priority lending status to MFIs, this will sound the death bells for MFIs in this country. 

To what extent MFIs are pushed to the walls is indicated by the fact that these MFIs are registering themselves in the districts despite their public opposition to the Andhra Ordinance.  The ordinance issued by the AP government halted all MFI operations until they register with the district authorities. In our archive post, Vijay Mahajan, the high priest of micro-finance admitted that days of business as usual is over and the need for MFIs to adopt a new business model if they want to exist. Read more here  

UPDATE: 18/11: JP MORGAN OUTLOOK

• We believe that the headwinds for SKS and the MFI industry are still not over – we cut our estimates by ~25-35% for FY11-13 and reduce our PT by 30% to Rs 700. The stock is still expensive at 1yr fwd PB of 2.6x, and we think the issues with the sector are quite deep. Despite Tuesday`s 12% correction and the possibility of a technical bounce notwithstanding, we maintain our (still) contrarian UW, and don’t believe that it’s too late to exit the stock.

• Deep earnings cut, by 25-35%. Our key earnings changes capture the AP situation on multiple fronts: a) a drying up of disbursements in the state b) margin pressures from rising fund costs, lower yields and negligible securitization, c) higher credit costs from one-time losses in AP and d) lower opex as we see inevitable cost cutting in AP.

• Non-AP issues still not significant. We have not captured any issues outside AP. Media reports (ET, 14 Nov) suggest that MFIs are cutting rates in West Bengal (SKS’ second biggest state), but we think it’s a bit early to start capturing that in our earnings. Government intervention in states outside AP, however, remains a risk to our earnings forecasts.

• Too early to write off business model. The microfinance business model is being challenged in public debates on multiple fronts – efficacy in poverty alleviation, impact of high interest rates on borrowers, existence of over-leverage among borrowers, to name a few. We think MFIs could continue to exist, and profitably so, though aggressive overregulation is a risk to that assumption.

• Cut TP, retain UW, still too expensive. Our new Dec-11 PT (Sep-11 earlier) share is based on a 3-stage Gordon Growth Model and implies a PT of Rs700 vs Rs1000 earlier. We think SKS is still very expensive at 2.6x 1-yr fwd PB–we think the risk reward still favours the private banks given better scalability and earnings visibility. Maintain UW. 

Key risks: Court ruling against AP ordinance (it’s still in court) or that AP ordinance does not convert into law from Centre.

Centre.