SKS Microfinance sees mounting macro pressure

Regulatory action has damped its price and investors should refrain from getting in till sector rules are clearer, feel analysts.

Amidst growing uncertainty on the regulations governing the operations of microfinance institutions (MFIs), shares of SKS Microfinance, the only listed MFI in India, have taken a beating of 50 per cent since October.

Brokerages expect SKS to show earnings per share (EPS) of Rs 39 for 2010-11, versus Rs 49.7 estimated earlier, due to reduced lending rates, higher funding costs, lower loan growth and increasing non-performing loans. The loan growth is seen at 30-40 per cent over the next two-three quarters, say analysts at Citigroup.

While the new Andhra microfinance law continues to impact the business of SKS significantly, experts believe the worst is not over for the stock. And, that investors should consider exiting it, due to greater downside risks. Clarity on the regulatory framework will provide cushion to the stock's southward trip and till such time, investors should refrain from making fresh investments despite the fall. However, a geographically diverse loan portfolio, with Andhra Pradesh (AP) contributing about 28 per cent of its loan book and lower leverage (total assets/equity) of 3.2x (September) gives SKS an edge over its peers, which it can capitalise once the current uncertainty dies.

SLOWING DOWN
In Rs crore	FY09	FY10	FY11E
Total Income	359	670.50	967
Net interest income	312	596.40	865.70
Net interest margin (%)	15.40	17.30	19.20
Net profit	80.20	174.80	209.60
P/ABV (x)	5.10	4.90	2.80
E: Estimated               ABV: adjusted book value               Source: Citigroup report

Impact
The Andhra Pradesh Microfinance Institutions Bill, 2010, passed by the State Assembly recently, places restrictions on recovery practices and limits collections of debt to once-a-month from once-a-week earlier. If implemented (the parties concerned have challenged it in the high court), the provisions would adversely impact MFI operations.

SKS recently reduced its effective lending rate by two per cent. This, coupled with higher funding costs (due to banks reducing exposure to MFIs), will squeeze the net interest margin of the company. Loan spreads can fall by at least two to three per cent (from 15 per cent), believe analysts.

Loan growth has moderated due to a freeze on fresh loans by MFIs in AP and slowing disbursements in other states. Collections for MFIs in AP have dropped to 15-20 per cent from the erstwhile levels of 99 per cent, hitting asset quality. The Act intends to limit an individual to loans from one self-help group (SHG) and one MFI only at a time. This will further dent loan growth, as multiple MFIs usually lend to individual borrowers. Also, since borrowers earn daily or weekly income, a monthly collection cycle will impact the repayment efficiency.

Ahead
Quick resolution of this situation could curb losses. However, clarity is expected only after RBI creates a regulatory framework for MFIs by March 2011, based on the recommendations of the Y H Malegam committee on the sector.

Further, the central government is looking at introducing a Bill over the next five months and this is likely to override the Andhra one. Experts believe the MFI business will attain normalcy only by the April-June 2011 quarter.

Despite the current turmoil, MFIs have a strong presence in India, due to the strong underlying business economics (and demand). Their distribution reach is very large and this is a major positive, as this aligns well with the government's aim of financial inclusion. MFIs need to modify business models towards asset-light lending and broadening the product base, to continue being classified as priority sector lending.