Subir Roy: Lessons for micro-finance from 2010

The year 2010 was a tumultuous one for micro-finance institutions (MFIs) in India. It began with the highly successful SKS Microfinance public issue, which prompted other prominent MFIs to announce similar plans. It ended with the tumult in Andhra Pradesh which was marked by the state’s legislation to regulate the sector, severely impairing its ability to survive. MFI recoveries are down and they, in turn, have fallen behind in their repayment to banks. What are the lessons?

  First, all the trouble is in Andhra Pradesh. MFIs are working smoothly in other states. Those with a broader reach and more dispersed operations across states are less affected. The basic flaw with the MFI phenomenon is its excessive concentration in one state (Andhra) and more broadly in the south. If large for-profit MFIs were to go by the fundamental principles of management, they would have started to de-risk their business long ago by spreading it more widely. So everything apart, their managements have performed poorly on this score.

Second, it is all about large for-profit MFIs. They are the ones who matter, accounting for a lion’s share of MFI operations. There are innumerable self-help groups all over the country, many of them linked to banks, which are outside the pale of the controversy. Micro-finance began with such groups and will continue with them, as long as we have the poor with us. The issue is whether for-profit MFIs, a late entrant that revolutionised micro-finance and held out the promise of rapid expansion by streamlining procedures through modern financial institution practices, will survive.

With hindsight, two realities are clear. Market mechanisms, induction of risk capital and servicing of such capital can go counter to the basic goal of attacking poverty as the marketplace has its own frailties. Besides, it should be clear to all that micro-finance on its own cannot remove poverty. It can at best make a dent in income poverty. A setback, be it a flood or drought or illness, can and does take a family back to destitution. For a for-profit sector to anchor its whole business model on a 98 per cent plus rate of recovery is to provoke serious scepticism. If to this you add group guarantee and peer pressure on a defaulter, you know why suicides can happen. MFIs rightly say that not a single suicide has been investigated and linked to coercive recovery, but in the public mind the case against them rests on grounds of plausibility.

All this does not mean that the for-profit model should be abolished. It alone has brought a sea change in efficiency which has given micro-finance both scale and viability. So, it is good to be driven by the profit motive but only up to a point. Investors in micro-finance should be happy with a lower than the market-determined rate of return.

Third, there is urgent need for effective regulation. Two entities have failed to deliver this. One is the Micro-finance Institutions Network, representing the for-profit MFIs, which has been in existence for nearly a year but is yet to bring out norms by which all can know what is the effective rate of interest charged by an MFI. This inability to promote transparency must damage the reputation of the whole tribe.

The apex institution which has failed to enforce effective regulation is the Reserve Bank of India (RBI) which is mandated to regulate for-profit MFIs that are registered as non-banking financial intermediaries and come under its supervision. These are the big boys who matter and the poor are suffering because of the absence of effective regulation. The wrong things that happened in Andhra did so under the RBI’s watch. Worse is the role of the banks. They were happy to lend to MFIs, buy loan portfolios from them to meet their priority sector lending targets and when the trouble began, wanted to stop lending. Neither is the role of NABARD becoming. It wants to be both a regulator and promoter of micro-finance.

Fourth, the issue of excessively high rates of interest charged by for-profit MFIs is a red herring. A short-term income-generating loan, say to a vegetable seller, can be nominally high but not so to her because of the resulting income. What is important is return on assets. By this measure, MFIs outperform banks. So they, in the aggregate, are making good money but again it is really the large MFIs which are doing so. It is RBI that has to monitor them individually and there aren’t that many of them to track. The top ten account for a large share of the market.

Fifth, the regulation that we now have in Andhra is badly put together and flawed. It asks for a degree of grass roots-level registration of micro-finance operations that is impractical and hugely cumbersome. The Andhra reaction came about for two reasons. The state functionaries got hopping mad as the field agents of for-profit MFIs began poaching on the client base of the state-sponsored micro-finance initiative which pre-dates the advent of the former. The troubled politics of the state after the death of Rajasekhara Reddy led to micro-finance-related suicides being widely publicised, forcing the government to be seen to act.

So, large for-profit MFIs and their regulators will put controversy behind them provided they make the following new year resolutions: stop picking on low-hanging fruits in Andhra, come clean on the effective rate of interest, stop taking group guarantees and ensure hands on regulation that keeps an eye on MFI earnings so that the poor get a share of them via declining interest rates.

Courtesy: Business Standard

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.

Rogue Micro-Finance Companies: Naxalites have no confusion who they are.

 “WARANGAL: Taking a tough stand against micro finance institutions (MFIs), the Maoists have asked MFI managements to close their operations in villages immediately in the wake of series of suicides by women.

Maoist party KKW (Karimnagar-Khammam-Warangal) secretary Sudhakar warned MFIs of dire consequences if they do not call it quits. In a statement here on Friday, he said agents and representatives of MFIs are humiliating rural women and insulting their family members because of which several villagers have committed suicide.

He termed the government ordinance on MFIs as a sham since agents continue to collect loan instalments from women forcibly. He also warned SKS Finance chief Vikram Akula, Share Finance company owner and member of Rajya Sabha V Hanumantha Rao, L&T, Swayamkrushi, Chaitanya MFIs' owners of serious consequences.”   Times of India

Maoists or Naxalites also called the Naxals is a loose term used to define groups waging a violent struggle on behalf of landless labourers and tribal people against landlords and others. They aim to fight oppression and exploitation to create a classless society. 

 The above quotes are their cry for annihilation of class enemy, which in this case are micro-finance institutions (MFIs).  From their statement, it is clear that they are not against all MFIs in particular, but only the biggies. They loath these biggies so much so that they warned them to shut shop in Andhra Pradesh or suffer dire consequences. 

 

On the other hand, the biggie MFIs shrug off the blame to “Rogue MFIs”  for the present crisis in the industry: “Dr Akula admitted there were “rogue” elements operating in the microfinance market and they needed to be checked. Do not destroy the entire industry because of the actions of a few rogue players,” he said”. Wall Street Journal - livemint.com

 
“Mr Alok Prasad, CEO,MFIN, pointed to some fly-by-night, small-time moneylenders who are working under the garb of MFIs and giving the sector a bad name. These are unregistered players who are not RBI-regulated NBFCs. The government should go after them rather than come after registered MFIs, Prasad said” www.karmayog.org

 “On the harassment allegedly caused to the public by MFIs, Mr Mahajan said that there are many other companies which are pretending to be MFI, but are not registered”.  Deccan Chronicle

Notice, the biggie MFIs are careful not to name these rogue elements, creating doubts who they are. Are then these biggie MFIs scapegoats for a problem caused by a minuscule clutch of rogue MFIs? Or are Naxalites simply targeting MFIs just because of ideological revulsion. We researched and came across some interesting industry statistics in a blog administered by Ramesh Arunachalam, a MFI practioneer, called Candid Unheard Voice of Indian Microfinance:

This data reveals that just 6 large NBFC MFIs accounted for a whopping 95% of all active MF borrowers in the country. Despite a gripping monopoly within the industry, Vikram Akula in his interview to CNBC-TV18 10 days ago hinted of further industry consolidation - a euphemism for mergers and acquisitions viz swallowing up the smaller players by the biggies. This leaves us with the question, just who are these biggies? Ramesh Arunachalam's statistics prove helpful again: 

So the biggie MFs are SKS, Spandana, SHARE, BASIX, Asmitha and Trident who accounted for 94.7% of the total active borrowers. These 6 MFIs added a whopping 12.20 million clients in the last 5 years ending March 2009. Of these, as much as 9.76 million clients were added in the last two years. So it is readily apparent that the same 6 biggies are the dominant, fast growing and large scale institutions, operating under the RBI regulatory framework. So dominant that there cannot be any widespread  MFI induced suicides, without their involvement. 2.07 crore households were given loans as per the available data as of 2009. But the total households of AP, as per the same source, are 1.6 crore and the poor households 25 lakh. This means the loans were given more than eight times the number of poor. In other words, MFIs were engaging in multiple lending in a significant way. - indebting the not-so-poor segments and pulling them into the vortex of poverty.

Devinder Sharma in his blog gives us an insight to the scale of profiteering:

"Dainik Jagran, the largest selling newspaper in India (it is in Hindi), has carried today (Nov 27, 2010) an interesting report that should serve as an eye-opener. It says that the Ministry of Finance had a couple of days back held a discussion on microcredit in which a document detailing the profits earned by the MFIs was placed before the members. The details are shocking, and show how the MFIs have been extracting their pound of flesh in the name of poverty eradication.

 An analysis of 13 major non-banking MFIs shows that the profits these firms accumulated by charging exorbitant interest from the poor borrowers had swelled from Rs 677.3 crore in 2007-08 to Rs 3776.93 crore in 2009-10. In other words, their profits had multiplied by 5.5 times over a period of two years. Since the MFIs have failed to expand the borrower base, it is quite evident that the profit increase is based on the interest amount they have managed to garner.

So while the poor took the fatal route to escape the humiliation that comes with coercive recovery of outstanding loans, the MFIs have made it rich. Bandhan Microfinance has broken all records. Its profits swelled by 34 times in two years. Some of the other players -- SKS Microfinance, Ujjivan Microfinance, BSS Microfinance, Share Microfinance, Sampada Safurti, and Grameen Financial -- have also managed to collect huge profits.

The 100 odd cases booked by the Andhra Pradesh police for coercive practice and abetting suicides overwhelming come from staff of this group of six. Further, these are the same MFIs the Naxalites singled out to target.

Quite a series of coincidences,  you would say! Still consider this. These statistics further indicate that 2007-2009 was the period these 6 biggies of the MFI industry historically clocked their fastest growth - growth almost in geometric proportion. 

How dangerous such a pace of blistering growth was brought home in 2005-2006, even when MFIs were clocking one-twentieth of this pace. The industry then experienced the Krishna crisis, wherein they attracted similar charges as they are today. To disarm public ire and backlash against them, they then came up with a tactic of evolving a voluntary Code of Conduct that among other things promised reducing their interest rates, avoidance of multiple lending and adoption of coercive recovery practices.

Since this Code was merely meant to be tactical and not a serious commitment, they instead upscaled their past misdemeanors, more so as these Biggies were all planning to go public through the IPO route. As they transformed themselves to for-profit institutions, they began to give more and more representation within their governing boards to private equity (PE) firms and venture capitalists. Since the latter had huge financial stakes in this class of MFIs, they begun to slave drive MFI managements to higher and higher Return over Assets (RoA) ratios to enable better valuations of their shares on listing so that they could exit with mind boggling profits. As a result, the objective of facilitating social capital was jettisoned lock-stock-and-barrel as these MFI biggies went berserk on an over-extended profiteering spree that placed increased reliance on more and more coercive recovery practices. These MFIs became solely lending enterprises, niche bank operators competing primarily with money lenders.

In identifying the rogues in the MFI industry, we need to keep these statistics and history in mind to understand the present MFI crisis in order to better understand plausibility. While the MFIs and their apologists hardly deny that this had been the case, what they desperately try is to erase the taint of these biggies being the cause of the  suicides of their borrowers. MFIs mercurial growth has been accounted by piggy backing on images of them being Messiahs of the Poor. Once this mask is removed, and they are exposed as a form of disguised moneylenders, they end up fighting for their basic survival as they are currently. So it becomes important for them to absolve themselves from charges that link them to inducing suicides.

The Suicide Cover-Up

We have in one of our archive postings (read here) exposed how the industry’s spin doctors attempted absolve the industry from charges of inducing suicides by borrowers. Even Vijay Mahajan, the president of the microfinance industry association, has been bluntly critical of MFIs as quoted in the New York Times: "In their quest to grow, they kept piling on more loans in the same geographies…That led to more indebtedness, and in some cases it led to suicides."

A week ago, I reacted to a posting in the blog of Consultative Group to Assist the Poor (CGAP), a World Bank offshoot, titled Crisis by Invitation. The author was Narasimhan Srinivasan, whose profile suggests that he had been a development banker (with RBI and NABARD) and now an international consultant to IFAD, World Bank, ADB, Gates Foundation, DFID, CGAP and many others on development finance and rural development. He has authored the State of the Sector - Microfinance India Report, brought out by Access Development Services for the last three years, 2008, 2009 and 2010. Srinivasan as an industry apologist in this post also ridicules the charge of MFI induced suicides.  My reaction to his post was not published by CGAP, presumably because it was inconvenient to these MFI biggies. Consequently I take the opportunity to publish it in this blog:

 Mr. Srinivasan

 The extracts from your post:

Despite the above, your post incredibly concludes: "Suicides were linked to microfinance in some of the media. While suicides are extreme decisions, the symptom of excessive burden of debt in some cases is not the real cause."

It is of course possible that all cases booked by the police of AP may not be linked to MFIs though prima facie it may look to the contrary.  The courts will determine that and we should await the process of law before making definitive comments. However the logical consistency of the extracts of your post does suggest a high plausibility of MFI induced suicides in most of the cases booked by the Andhra Police.

"AP has an average of 2000 farmer suicides each year—if 54 suicides as reported in some papers are attributed to MFIs- what are the remaining attributed to? Do we need laws restricting some other sectors of the economy for the other suicides?"

If you have some grounding in psychology, you would appreciate that this phenomenon of suicides is rather a complex subject and could be triggered by a variety of factors - both internal and external to the victim and acting in combination. It is usually triggered out of difficulty in coping with despair that includes financial difficulties, troubles with interpersonal relationships etc. It can be also triggered by low blood pressure or mental disorders like depression, bipolar disorder, schizophrenia or substance abuse. It can also be triggered by such factors like humiliation or related to culture. It can be associated with ideology or a military strategy as in the case of suicide bombings or Japanese hara-kiri.

All individuals entertain thoughts of suicide at some point of their lives, though only a few succumb to the thought. There are accordingly individuals with high suicide risk profiles and cultures like Tamil Nadu and Andhra were suicide rates are higher than the national average. Further though poverty may not be a direct cause, it can increase the risk of suicide, as it is a major risk group for depression. Now if you acknowledge that “the exponential growth and high concentration in AP was not accompanied by the required SENSITIVITY in dealing with vulnerable people”, it seems to me that you are accordingly implicitly accepting the reality of MFI induced suicides. The latter are akin to a woman raped ending her life or a student publicly caned ending his life due humiliation.

The manner the MFI as an industry and their spin doctors approached the charges of suicides, they antagonized public opinion. If MFIs first condemned these incidents, compensated victims and brought their collection agents to book, they would have redeem themselves in the eyes of the public. Instead what we see is MFIs in a state of denial and countering arguments that on the face of it appears puerile. SKS gave Rs 4.5 crore life cover for its former CEO. And the insensitive manner MFIs are dealing with client suicide is what puts off the public - the differential values MFIs place on life!

But then this is only the way MFIs sees this whole crisis - the poor not in the radar at all but only the business- here’s your extract: “What is at stake is not only Rs 167 billion ($3.8 billion) in microl-oans in AP, but also the future of microfinance in India. While Rs 52.5 billion ($1.1 billion) is the exposure of MFIs that will be directly affected by restrictions on collections, visits to the borrowers and bundling of weekly installments in to monthly installments, the damage potential is deeper.”

Please remember that MFI growth was on piggy backing on the false image of being the Messiahs of the Poor, once this mask is stripped off, you lay exposed and find that you are in the verge of extinction. 

If Naxalites Are After You, Then You Must Be The Enemy Of The People.

In the seventies, as a little boy in the boarding of one of best known private schools in the country at Bangalore, I had gone to Kerala for the first time to spend the summer holidays with my cousins.  And as I traveled from the railway station to my aunt’s house, we came across a large crowd looking at a head strung up on a pole. My aunt covered my eyes and spared me the gruesome sight.

The only explanation by Aunt gave was that these were Naxals, bad people who love to kill plantation owners and the rich. And this was the impression I carried all through my education career and the initial working days In the late eighties, now a consultant with a donor, I went to Munar, a plantation hill station in Kerala for an evaluation study.  When in Kerala, you must visit the local “toddy shop” to eat fish to be washed down with freshly tapped toddy. There we met an old man, fairly drunk and we got talking. He told me that he was a Naxalite in his younger days and he has annihilated many class enemies including beheading one and putting it on a pole. Why do this ghastly act? I found myself asking him. With no remorse he retorted: 

“Leave alone wage exploitation, how would you react when the estate owner comes to take your wife, daughters for enjoyment by him and his friends in their booze parties. When my youngest daughter, age 12, the apple of my life, came back traumatized with extensive bleeding and bruises died, after her cremation, I knew what exactly I had to do.”    

One may disagree with their violent methods, but not even the government disagrees that the Naxals usually fight a valid cause, even as they crack down on them. And if Naxals have declared MFI biggies as their class enemy, we know there cannot be smoke without fire. This is why biggie MFIs these days walked with a security armed with AK 47s!

  

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.