Quick review of microfinance sector :: Macquarie Research,

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Quick review of microfinance sector
Event
 We spoke to bank managements, microfinance companies and some industry
consultants just to get a quick update on the microfinance sector and banks’
exposure towards it.

Impact
 How is the microfinance sector doing? The outlook is discouraging to us.
Collections in the state of Andhra Pradesh continue to be dismal at 20-30%
levels. If this continues for a couple of more quarters, we expect there will be
substantial write-offs in the offing and things don’t seem to be improving
much. AP alone accounts for 30-35% of the MFI portfolio. Add to this, even
states like West Bengal etc where there are elections, the political parties are
encouraging borrowers not to repay and there have been some one-off
instances observed in some branches of microfinance institutions. Funding
has indeed dried up for these MFIs, but it’s marginally better than what it was
three months ago. SKS Microfinance continues to do relatively well here,
having raised around Rs7bn in the month of March alone from banks and it is
planning to raise more money.
 Do RBI regulations matter or does AP act override? We believe the
biggest issue here is that the AP act infringes on RBI’s regulatory powers and
our checks reveal that RBI is in discussions with the AP Government to arrive
at some “middle” path. We believe this sets a bad precedent for the other
states also as RBI would not have the full powers to regulate them and the
MFI institutions would be compelled to even comply with the local rules. For
example, SKS currently is following all the norms as required by the AP act.
 So what are the implications for banks’ exposure to these MFIs? The total
exposure of banks to MFIs is around Rs250bn in the form of loans and around
Rs50bn in the form of securitised exposures, which together constitutes roughly
80-90bps of the overall loan book of banks. This may not seem significant but
remember that banks are highly leveraged institutions. So even if we assume
20bps will go bad (30% exposure to Andhra out of which 70% goes bad),
assuming a 15x leverage – 3% of net-worth gets impacted/eroded.
 What is the status of restructuring? Banks have been allowed an extension till
June 2011 to do restructuring under CDR. Roughly 30% of the Rs250bn loans to
MFIs are under CDR (corporate debt restructuring forum). So far some MFIs have
started defaulting on payments (i.e. payments are not on time), but the issue is
that they are still not classified as NPL because of the 90 day rule. If the
restructuring package gets implemented by June 2011 they will NOT be shown as
NPLs and hence the earnings impact will be negligible for banks. Currently RBI
regulations don’t permit securitised investments/exposures to be restructured.
Roughly 20-30% of overall MFI exposure for banks is in the form of securitised
investments. Banks have approached RBI to even restructure these exposures.
Outlook
 Not yet out of the woods: Clearly we believe the microfinance sector is not
yet out of the woods and there could be more pain to follow in the form of
political regulatory interference. Consensus has yet to fully factor in the write
downs, in our view.