India Ratings and Research (Ind-Ra) has maintained an overall negative outlook on the microfinance sector for FY22. While the agency has maintained large non-banks microfinance institutions (MFIs; assets under management (AUM) > INR50 billion) on a Stable Outlook, small-mid non-bank MFIs (including those with over 50% of AUM in microfinance) continue to be on a Negative Outlook for FY22.
The Negative Outlook for small-mid
non-bank MFIs is in view of the challenges being faced by them in raising funds
and capital and managing credit costs that could emerge from urban regions post COVID-19 and Assam/West
MFIs. Furthermore, nine states including West Bengal and Assam are expected to
go into state elections in FY22 and the resultant political risk could be a
large overhang on the sector.
While the collections have picked-up especially in rural areas, they continue to lag in urban regions. Large MFIs have been able to raise funding especially since 2QFY21, aided by easing liquidity and policy measures, while fund raising has been slow for mid – smaller ones (AUM less than INR20 billion). The largest ones have a substantial rural exposure where the worst-case eventual credit cost expectations of 4%-8% (on March 20 portfolio) are lower than the expected pre-provision operating profit (PPOP) of 6%-9% for FY21; for others, the range of credit costs could be higher.
Collection Pick-up in Rural, Urban Lags: While the outlook had already turned negative for MFIs in the beginning April 2020 because of the lockdown, Ind-Ra also considered that 60%-70% of the borrowers of most MFIs are in the essential goods and services segments, and hence the initial recovery could be fairly quick. Overall, Ind-Ra had estimated that at least 10%-15% of the portfolio would be difficult to recover. As expected, the pace of collections has picked-up speedily since 2QFY21 across the country. For entities where there is significant exposure to urban regions and / or to West Bengal and Assam (where the easing of lockdowns has been slow), collections are lower at 80%-90% of pre-covid levels while the rates have rebounded to 90%-95% for others. 2%-6% of the clients are such that they are in overdue, but paying delayed EMIs in partial or full and could have limited loss given defaults. Reported collection figures seem optically higher on account of the lower delinquencies in post 1QFY21 disbursements and denominator effect.
PPOP Can Cover COVID-19 Credit Cost of 3%-8% for Rural focused MFIs: If we discount 3QFY21 disbursements (defaults not expected in recent disbursements), Ind-Ra expects 5%-12% gross NPAs on AUM at end-September 2020. The subsequent disbursements would result in a base effect and the headline gross NPAs in December 2020 or March 2021 would be lower at 4%-10% and credit costs at 4%-8%, though it could be higher for urban focused or West Bengal/Assam focused entities. Given the high-rated MFIs’ PPOP being in the 6%-9% and yield compression to the extent of incremental NPAs, the credit costs can be absorbed by 12-15 months of PPOP. This incremental credit costs could also be lower to the extent of covid provisions already made.
Learnings from Demonetisation Result in Stronger Balance Sheets: Especially post demonetisation, MFIs have learnt that while the business is uncomplicated and focuses the most on customer discipline, certain aspects help to deal with increases in credit costs and volatile returns when event / socio-political risks play out. We are witnessing lower leverage ratios, higher capital levels, moderate growth than in the past (where large MFIs have grown over 50%), emphasis on rural penetration, higher proportion of cash on-balance sheet and / liquid securities, and surplus asset and liabilities especially for large MFIs.
Borrower Overleverage and Political Risks Continue to Weigh In: Overall, Ind-Ra opines that the real wage growth has not been high in the past five years. While MFIs’ exposure to a borrower on consolidated basis has not increased significantly in the last couple of years, the average outstanding per unique borrower is high, especially in Assam and West Bengal (INR50,000-54,000 vs national average of INR35,000-40,000). Ind-Ra had pointed out the growing indebtedness in West Bengal in its FY17 report ‘Borrower Overleverage Warrants Course Correction’. There are additional seven states that could hold state elections in FY22 and some of these concerns may be amplified.
Strong, but Liability Strategy Key to Protect Growth Prospects: As MFIs have grown in size and scale, management depth
and operating buffers, the cost of funding has declined (for some permanently)
as they enjoyed rating transitions. These are signs of structural strength, as
this provides them with some ability to deal with borrowers’ overleverage (that
Ind-Ra has been highlighting since FY17) slower economic growth. and limit the
effects or spread of socio-political events etc. MFIs will continue to face
socio-economic and political challenges, in Assam and possibly in more states
where elections are impending. Given MFIs’ structural strength, Ind-Ra expects
large, geographically diversified entities to withstand risk events that
significantly impacts two to three large states simultaneously. Liquidity and
liability strategies would now play a substantial role in determining the
franchise strength especially for these MFIs.
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