Microfinance (MFI) – Blame it all on COVID?

Just when the MFIs were trying to write-off the Covid losses and re-start their growth journey, the 2 nd wave came and hit them. Given that this wave has penetrated the depth of India’s hinterland, the MFI sector has been very vocal is demanding an emergency credit line of Rs.15,000crs, government relief through Partial Guarantee scheme and enhancement the lending rate.

As investors, we may be tempted to think that last few quarters should be treated as “exceptional” due to cyclones, special situation in Assam & West Bengal, and finally the Covid pandemic. It’s surely a good thing to be hopeful and try and see light at the end of the tunnel. But it may not be a bad idea to try and understand if COVID was the only reason for the current state of the industry!

Let’s rewind a little to 2018 The NBFC sector was the epicenter of the IL&FS storm, when credit markets froze in Sep, 2018. Even the well-run NBFCs were lying low and waiting for the tide to subside. But one sub-sector seemed to be quite unaffected and never faced funding crunch, thanks to the priority sector status. The MFIs became the darlings of investors – unfazed, unaffected, and delivering on the promise of 30% CAGR and sub 2% credit losses for the entire FY19 and FY20!

Loan Growth over 24 Months prior to Covid Loan growth in Covid year
Bandhan 67% 26%
Credit Access 99% 15%
Ujjivan SFB 48% 4%
Spandana 116% 19%

Source: Company presentations

Did the average rural customer need so much money?

The MFI sector was flush with funds, both debt and equity. And they were in a hurry to grow and deliver on the 30% CAGR promise. The MFIs wasted no time and took the path to easy growth i.e.lend more to the same set of existing clients. Bandhan Bank increased its ticket size by 2-3x under the narrative of “completely dominating” the ustomer; Credit Access designed innovative products to lend more to the same customer.

Ultimately, there was low consideration for the basic question i.e. did the rural borrower need so much money? And will she be able to repay? A look at the below table can summarize what transpired in the microfinance sector in the five years preceding the pandemic. Given the slowness in Indian economy, an average rural household could only grow its income by 23%. However, his outstanding debt increased by 106% over that period, thanks to the zealous growth targets of MFIs.

2016 to 2020 Total Growth
Loans outstanding 125%
Ticket size growth 106%
Rural wage growth 23%

Source: Economic Times, MFIN, SADHAN

Overleveraged customer could be the bigger cause; Covid was just the trigger!

As we saw in the table above, we might be in a situation where millions of rural folks have more loans on their heads than they could afford to repay. And then Covid struck. While Covid is no small event, we do know that even a medium sized pot-hole is enough to topple an overloaded vehicle. The signs of stress among the borrowers are clearly visible from the decline in repayment rates over the years. Most of the MFIs explained that they are giving longer duration loans but that doesn’t explain the extent of drop in collections.

Repayments (% of previous yr loans)
FY19 FY20 FY21
Bandhan 148% 126% 97%
Credit Access 121% 107% 83%
Ujjivan SFB 105% 105% 58%
Spandana 119% 127% 75%

Source: Company data, GreenEdge

Is there light at the end of the tunnel?

The current outcome is a far cry from original promise of the microfinance model i.e. there is tremendous growth opportunity in rural India; and that lending exclusively to groups of women is an extremely low risk model. Four large MFIs have reported combined provisions / losses of ~Rs6,000crs or 7% of their pre-Covid portfolio and the damage caused by the 2 nd wave is yet to unfold.

Provisions (% of previous yr loans)
FY19 FY20 FY21
Bandhan 3% 4% 8%
Credit Access 1% 3% 7%
Ujjivan SFB 1% 2% 6%
Spandana 1% 6% 9%

Source: Company data, GreenEdge

We need to understand that an average rural Indian family cannot remain unscathed when faced with two bad events in a single year. Hence, microfinance companies may experience similar levels of pain in FY22 as well. But the good part about all the external problems is that they come to an end.

The 2 nd wave will end in a few months and most of these large companies either have a strong capital base or will raise capital to absorb the losses. The regulator on its part is doing all it can to ensure that MFIs have access to liquidity till the pandemic ends. Hence, the worst will be over in FY22. The stock prices & valuations of these MFIs somewhat reflect this optimism.

Book Value Price P/B(X)
Bandhan 100 300 3.0
Credit Access 240 610 2.5
Ujjivan SFB 19 30 1.6
Spandana 405 565 1.4

Source: Based of Mar’21 financials

The bigger question for the long-term investors should be “is it sustainable to grow at 30-40% when your under-lying customer is growing only at 6-8%”. In the past, investors have expected nothing less than 30% growth from MFIs and managements have promised only more! Microfinance sector will continue to see boom & burst cycles unless growth ambitions & aspirations are re-calibrated.