Mumbai: India’s lone listed microfiance company SKS Microfinance Ltd has seen a 91% erosion of its share value from its peak on 28 September 2010 till date and a 72% slump on its loan book after a state law in Andhra Pradesh (AP) forced it to exit the southern state that made up close to 30% of its business. Collection levels in AP dropped to 5%, forcing SKS to shrink its loan book in other states and use the money to provide for the AP bad loans.
In a rare interview, the company’s CEO and managing director M.R. Rao and chief financial officer S. Dilli Raj said on Thursday that the worst is over for SKS and things can only get better. They admitted that the for-profit organization made the mistake of staking larger-than-life claims of empowering the poor and eradicating poverty. They also conceded that intense competition in the sector did not lead to a price war that would have benefited tiny borrowers and instead diluted the process of sanctioning loans. Edited excerpts:
After seven successive quarters of losses—over all Rs.1,733 crore—SKS is back in the black with a Rs.1.2 crore profit in December. Is the worst over for the company?
Raj : Yes, absolutely and this turnaround is real and sustainable. The first and foremost reason for losses in the last seven quarters is primarily the credit cost on AP portfolio. When the crisis broke out in October 2010, we had Rs.1,430 crore exposure in AP. We collected some Rs.129 crore. So we had to provide for about Rs.1,300 crore. We did that over seven quarters so that it doesn’t ignite a crisis of confidence. Also, since we went through a credit shock, bank funding dried up. So, we had to reduce the outstanding loan portfolio in other states and find cash to repay the banks. Because of high credit cost on AP loans and the portfolio was dwindling, we were operating below the optimal size. These have been corrected now and we have Rs.1,496 crore of non-AP portfolio.
Before the AP crisis broke, the state’s share in your total loan book was 29.2%. Now, it is nil. At the same time, share of Karnataka has doubled from 11% to 22%. Is Karnataka becoming another AP?
Raj : Not really. The biggest lesson learnt from the crisis is to avoid the concentration risk. When the crisis broke out, we had 70% of our assets outside AP and we were well capitalized. The AP exposure was a fraction of our net worth and so we had solvency and that helped a great deal.
Our exposure to any single state will not exceed 15% of the total portfolio outstanding and, most importantly, will not be in excess of 50% of the reported net worth. Karnataka is an exception and we can’t overnight bring down the portfolio from 22% to 15%. But we are already on a corrective course. In absolute terms, the Karnataka loan book will rise but in percentage terms, the portion will come down to 15% from 22% in a year.
At one point, collection level in AP dropped to 5%. In Gujarat, it is less than 60% and, in West Bengal, about 80%. It seems that credit culture is turning bad in other states as well.
Raj : In Gujarat, we had a very small exposure of Rs.11 crore and a different kind of issue. We had an issue of recruiting staff at a salary level we could not afford. When we had this supply-side shock and started rationing capital, we completely stopped disbursement in Gujarat. We have cleaned the exposure and we are not going back to Gujarat in next two-three years. Gujarat is a very progressive state and has a pro-business government but microfinance works better in markets where there is a density of rural poor.
In West Bengal, we are present in 17 districts. In Cooch Behar (north Bengal) and a few small adjacent districts, we had a problem of commission agents. They exploit rural women borrowers saying that the only way to get loan from this company is to pay a 5% cut to them.
There could be two approaches to tackle this. One is to turn a blind eye and you will get money back because these women used to pay 40-50% to money lenders and they will pay 24.5% interest and an additional 5% to the agent. But, we did not take this approach. We filed criminal complaints and sacked the staff. This process took six to eight weeks and, during that time, it was difficult to hold the meetings with borrowers and without such meetings, we could not collect money from them. After the clean-up, either we closed the business in that district or told the members to come to us directly. In the last three quarters, the collection efficiency in West Bengal has increased.
Since the AP crisis, your branch network has shrunk to 1,298 from 2,407 and employees from 27,054 to 11,195. Will this trend continue?
Raj: This structural readjustment—branch and headcount rationalization—is behind us. Probably, you will see some more attrition in the next there months to around 10,000 employees but branches will remain around the same level.
The non-AP portfolio was Rs.3,900 crore at its peak in October 2010 and this has come down to about Rs.1,500 crore. The only reason we had to shrink our non-AP portfolio was to come out of the supply-side shock. We had to repay Rs.5,900 crore to the banking system and we repaid without a day’s delay. We have started getting bank funds from the January-March quarter of fiscal 2012. In calendar year 2011, we raised Rs.956 crore from banks and in calendar 2012, Rs.2,150 crore. The non-AP portfolio has started increasing in last two quarters.
So, AP is history and you wouldn’t go back there.
Rao : We are waiting for a relief. We have appealed to the Andhra Pradesh high court against the state Act. Another relief can happen through the central government’s MFI Bill. In any of these cases, we will go back and start operating in AP. The primary focus will be to recover whatever we had to write off—about Rs.1,300 crore. As and when these developments take place, we will be able to re-establish contact with customers in the state.
Will you continue to remain an MFI?
Rao : As a part of the de-risking strategy, along with the geographical de-risking, we also need to de-risk our products... We have piloted certain initiatives at a very small level and when we reach a particular mass, we will scale up. The gold loan is one such initiative. We started a pilot with five branches and have subsequently expanded to 50 branches with a portfolio of about Rs.50 crore. The idea is not to scale up in the pilot phase but fine-tune the processes as secured lending is something the organization has never tested.
We also launched an insurance product and have around 2.9 million customers who pay Rs.20 per week for five years.
Raj : Microfinance remains our core business. All that we are trying to do is creatively disturb the asset-revenue earning mix. The non-MFI business will be just be 10% of our assets, but it could contribute 15% of the revenue and 25% of the profit.
What is your cost of funds?
Raj: Our cost of borrowing is 13.2% and we charge 24.55% to borrowers and 1% processing fee. Our operating cost is 12% as we are operating at a sub-optimal level. We expect the borrowing cost to come down by 1.5% to 2% and operating cost will come down to 9% once we reach a portfolio size of Rs.2,000 crore.
Will you seek a banking licence?
Raj: It is premature for us to comment as we are still awaiting the final guidelines on banking licence. We must admit that we have to cover a lot of ground in terms of several aspects, including technology, if we want to become a bank. It is something that we keep on evaluating as there are lot of merits in being a bank. First and foremost, it mitigates the political risk.
It also makes sense to customers as we will be able to deliver products at a much lower cost. MFI is probably the only financial services model where the operating cost is more than the funding cost.
Rao: Today, we are providing credit facilities to the borrower apart from insurance, etc. If we become a bank, we could tap the surplus savings of the customers, which today they are investing in gold.
What’s the political risk?
Raj: You do have a structural disadvantage of being an non-banking finance company (NBFC) apart from the cost of funds and access to funds. Beyond a particular size, there could be forces who say that this sector has grown too big but if you grow as a bank with a higher level of supervision from the Reserve Bank of India, nobody is going to frown upon that. That is what we mean by the political risk mitigation.
What went wrong in SKS? A victim of political risk?
Raj: The AP crisis was definitely an external event. It was a state intervention but this is not to say that everything was alright with the sector in 2010.
The first mistake was all of us started as non-profit organizations and we embraced for-profit model for good reasons—to achieve scalability and sustainability. What is the point in doing some good to some people if you can do more good to more people? But when we embraced the for-profit model, we should have discarded the larger- than-life claims and mission statements like empowering the poor and eradication of poverty. The for-profit model doesn’t go with this.
When we had our initial public offer, people looked at our numbers, portfolio size and, most importantly, the individual incentive system like the ESOPS (employees stock options) and the salary levels. They were all relevant for a for-profit mainstream operation but the claim of eradicating poverty did not gel with that.
The second mistake at the sector level was that in 2009 and 2010, there was intense competition. There were 400-600 companies and even smaller firms were getting funds—be it debt or equity. If we go by the text book definition, intense competition should result in a price war but we had intense competition and no price war. Everyone was charging 31-32%.
The trouble was in the absence of playing the price card, process dilution became the selling proposition. Everyone was in the bar and all were drinking.
The customers also started playing one against the other on the processes and forced us to dilute them.
The state intervention put these things in the spotlight. In a way, we want to credit Andhra Pradesh government for the wonderful job of inviting nationwide attention on this issue. But for the intervention of AP government, the borrower would not have got the attention she is getting now.
But...Andhra Pradesh, the pioneer of financial inclusion, today earns the dubious distinction of having the largest number of defaulters—9.2 million—and 10 years of hard work in inculcating discipline in rural borrowers has just been washed out.
Who do you blame—state law or yourself?
Rao: It’s mix of all factors. If you drive the car, you can look at the rear view but you can’t be driving all the time looking at the rear view. Today, after two-and-a-half years, 9.2 million borrowers are defaulters and are cut off from the mainstream. They are the largest chunk of non-performing borrowers anywhere in the world. Let’s bring them back to the mainstream. Allow us to do the incremental lending.
There have been allegations that SKS did not follow corporate governance standards, especially regarding the sale of shares to different shareholders at different prices.
Raj: Our compulsory convertible preference shares (CCPS) were closed in October 2008. We had accessed fresh equity of $75 million. The price discovery was a major concern because this was just a week after the collapse of Lehman Brothers that led to global financial meltdown. We requested the investors to put in money but the price was not discovered and the structure was a combination of shares and CCPSs at 1:3.
The CCPS were allotted on 26 March 2009 at Rs.300.
At that time, we felt the need to access a domestic investor. Our financial capital requirements were taken care of by $75 million and we grew the book even in the global financial meltdown.
We raised Rs.50 crore from Bajaj Alianz Life Insurance in August 2009 and at the same price—Rs.300 per share. The CCPS were converted into shares at same price in December 2009 and N.R. Narayana Murthy’s private equity fund Catamaran invested Rs.28.12 crore in January 2010, just one month later, at the same price.
SKS had not differentiated between its investors and it charged the same price to all— Rs.300. However, in just two months, on 31 March 2010, a secondary sale was done by a set of people at Rs.600 plus a share. How could the price double in two months? We had filed the draft prospectus for our IPO (initial public offering) on 25 March 2010 and the market view was that IPO is a certainty and everyone was expecting it to perform.
You created an advisory board chaired by Narayana Murthy but the board never met. Was that done just to give a big push to the IPO?
Raj: This is wrong. Let me set the record straight. The advisory council was indeed formed. It consisted of (Narayana) Murthy and (then SKS chairperson) Vikram (Akula). It had several meetings but there was no formal structure. (Narayana) Murthy was extremely generous and kind to us in giving his time. Let me confess and take responsibility on behalf of the executive management of SKS—this instrument has not been utilized to its fullest potential.
Have you abolished the advisory board?
Raj: Yes. Vikram is not there. The board is not operating any longer.
What is Akula’s association with SKS now?
Raj: Vikram is the founder— a visionary and a social entrepreneur who created scale and sustainability for the sector as whole and let me use the phrase—a founder is a founder. He stepped down on 23 November 2011. He has converted a part of his ESOPS—900,000 shares, a little less than 1% stake in the company. He has another 1.7 million ESOPs but that’s under water now (given at Rs.300 and the current stock price of SKS is roughly half of that). He has no operational role in the company.
Do you blame him for the AP crisis?
Raj: Absolutely not. Every single operator converted themselves to for-profit model and each one of them continued with the positioning of eradication of poverty. Let me repeat, everyone was in the bar and all were drinking. It’s a matter of second guessing and no individual could have been any wiser.
Was the listing a mistake?
Raj: On the contrary, but for the IPO, this company would not have continued as an operating entity. We accessed capital in August 2010 and the crisis broke out in October. At the time of the crisis, our net worth was Rs.1,781 crore and the AP exposure was Rs.1,496 crore. This was possible because we raised money from the public. Had that not been the case, our net worth would have been wiped out. In a financial services business, you are sitting on a mountain of credit risk and all that you do is remain well-capitalized and adequately liquid.
How do you plan to recover money from Andhra Pardesh?
Raj: The credit discipline in AP has been wiped out and the biggest task is to bring it back. We have to start incrementally lending to those who are willing to repay. This will also motivate others to bring back the credit discipline. Many studies have shown that women borrowers in AP are starving for credit and want MFIs back in business.