Date of Issuance
Coupon Rate (%)
Size of Issue (billion)
Principal protected market linked debentures (PP-MLD)
IND PP-MLD emr B+/Stable
The suffix ‘emr’
denotes the exclusion of the embedded market risk from the rating. Ratings of
the market-linked debentures is an ordinal assessment of the underlying credit
risk of the instrument and do not factor in the market risk that investors in
such instruments will assume. This market risk stems from the fact that coupon
payment on these instruments will be based on the performance of a reference
index or equity share (detailed in the information memorandum of the issue).
PP-MLD refers to full principal protection in the equity linked notes wherein the issuer is obligated to pay the full principal upon maturity.
Approach: JHL’s PP-MLDs are junior to its existing debt and will mature before the
maturities of JHL’s existing non-convertible debentures (NCDs). Under the conditions
of an initial public offering, any liquidity event or default on the NCDs from
Caladium Investment Pte. Ltd. (INR1 billion) and Edelweiss Capital Limited (INR1.55
billion) will have a senior claim on JHL’s assets, or initial public offering or
refinance proceeds. The claims of PP-MLDs would be pari passu to the NCDs
raised from TPG Capital Asia (INR4.03 billion).
The rating is based on the profiles of both JHL and Jana Small Finance Bank’s (JanaSFB). The two companies have limited financial strength. JHL is a non-operating financial holding company (NOFHC) of JanaSFB and the value of its investments is derived solely from its 43.98% shareholding in JanaSFB. The investment value is largely subject to incremental performance of JanaSFB (banking operations commenced in July 2018) and the ability of the bank to manage the credit costs emanating out of its legacy portfolio.
KEY RATING DRIVERS
Holding Company of
JanaSFB, Bank’s Legacy Asset Quality Overhang: JanaSFB commenced its banking operations
in July 2018 and inherited significant asset quality issues from when it
operated as a non-banking financial company(NBFC)-microfinance institution
(Janalakshmi Financial Services Limited; JFSL). JFSL grew its loan book to
INR109.8 billion in FY16 from INR37.7 billion in FY15 and was among the largest
microfinance NBFC in terms of its asset size. However, some of its growth came from
moderate controls on the lending system and conflicting targets for the field
staff. As a result, demonetisation exposed these shortcomings and JFSL was more
severely affected than its peers. Its 0 days past due (dpd) in FY17 increased
to 39% (FY16: 1%). It had to focus on collections on priority and had to write-off/provide
INR26.2 billion over FY17, FY18 and 1HFY19. However, the company managed to
raise substantial capital (INR29.42 billion) over the same period and this
helped it survive. In addition, the management plans to raise INR6 billion of
equity for JanaSFB (INR3 billion that JHL is raising through PPMLD and another
INR3 billion by other investors directly in the bank).
The bank’s gross NPAs in 1HFY19 were about 35% while net NPAs weare about 13%. Based on the partial payment and recovery analysis, the agency expects a recovery of INR2 billion-3 billion during November 2018-March 2019. The credit costs in 2HFY19 could be significantly lower than observed in 1HFY19 (INR10 billion, 13.8%).
Bank to face Medium-term Profitability Pressures: In the agency’s assessment, the bank may not see significantly higher credit costs on the newly originated portfolio (post-December 17 disbursement); however, it could face profitability issues in the medium term as there is a need to achieve a certain scale to cover operating costs out of gross income. Ind-Ra expects marginal profitability in FY21 under the business as usual scenario, i.e. 45% growth in the loans under management over FY20-FY21; most of the growth in the secured asset classes and other non-microfinance products. At net profit levels, the company had made a profit of INR1.7 billion in FY17, and losses of INR25.0 billion in FY18 and INR12.9 billion in 1HFY19. Ind-Ra also expects the bank to suffer net losses in FY19 and FY20.
Setting up Governance and Monitoring Structures within Bank: Post demonetisation, JanaSFB has attempted to set its house in order; tightening monitoring by setting up monitoring systems at various levels, independent risk vertical, technology-based checkpoints at the front-end and limiting operating geographies of the branches among others. The monthly reviews provide opportunities to various sub-committees of the Board Risk Committee to analyse and narrow down the problems. Almost the entire top management has changed over the last two years and the incumbents are strengthening the processes. Ind-Ra expects these systems have been put in place to avoid ‘growth at any cost’, given the growth compulsions to achieve profitability.
Bank’s Liquidity Management Challenging; Deposits See Traction: In a bank form, liquidity management is more complex; especially when the access to certificates of deposits is restricted either by the credit rating of the bank or it is awaiting ‘scheduled’ status. At end-September 2018, the asset funding gap of the bank was in a modest surplus in the short term (0.1% of total assets). However, the bank would need to continue to operate with a surplus, given that microfinance is likely to constitute bulk of its loans under management over the medium term. The bank has excess statutory liquidity reserves of about INR2.3 billion in addition to the cash reserves that it needs to maintain. It has also intensely focused on the marketing of longer tenor deposits which has been successful; in the five months of bank’s operations since July 2018, it has mobilised INR21 billion of deposits, of which 46% are of tenor more than one year.
Bank’s Asset Diversification Positive; but Segments are Competitive and Yields Could be Lower: The bank expects to grow largely in non-microfinance loan products. Although these are capital-conserving products, there is reasonable competition among them as the number and size of NBFCs and banks serving this segment has increased in the last few years. As a result, the bank could see a decline in yields; depending on the asset mix, the bank would have to grow at a faster pace and at lower yields to achieve profitability; early delinquencies for the bank in these products would be a key monitorable.
Bank Capital Constrained: Ind-Ra is of the view that microfinance heavy institutions should operate at low leverage (advances to net worth). JanaSFB’s net worth was INR5.4 billion in 1HFY19 with advances of INR50 billion, which indicates a leverage ratio of 10x which is higher than most other SFBs. Divestment ability is limited as JHL has to hold at least 40% in the bank for a minimum of five years. Also, the bank may have substantial accruals only by FY22 and hence leverage may only increase. A significant increase in leverage without a commensurate improvement in the asset quality could result in a negative rating action.
High Refinance and Valuation Risk: The proposed three-year PPMLDs face refinance risk; there are limitations to JHL regarding diluting its shareholding in the bank on account of regulatory requirements and share pledges (3.98% pledged to existing lenders). The PPMLDs would have to be refinanced to the extent of principal and the rate of return promised to the investors. The NOFHC is required to hold at least 40% of the bank for a minimum of five years. Any increase in JHL’s shareholding on account of a proposed infusion may not be enough to pay off the existing obligations and hence, the valuation risk is significant.
COMPLEXITY LEVEL OF INSTRUMENTS
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