SKS Microfinance: Not lost the race yet

Company's business appears intact in the short to medium term but there are challenges it will have to face for sustaining profitable growth

The market was perhaps rude on the stock of SKS Microfinance (SKS) on Friday, beating it down by 15.5 per cent on the news that the company’s application to operate as a small bank had not got approval from the Reserve Bank of India (RBI).

Though this means that competition could intensify for SKS, analysts believe the short to medium-term outlook is intact. SKS’ recent record has also been good, while its rebound from the mess it was pushed into after the crisis in the segment in Andhra Pradesh, provides confidence. The stock recovered 4.3 per cent on Monday to Rs 397.

  The market thought SKS was well placed to obtain a small finance bank (SFB) licence, as its lending portfolio was within the framework mandated by RBI, which perhaps partly explains the selloff on Friday. However, a section of analysts also believes that not receiving an SFB licence has its own benefits.

The small bank licence norms require applicants to ensure promoters’ contribution to paid-up equity capital shall be at least 40 per cent and foreign shareholding shall not exceed 76 per cent. In the case of SKS, a little over nine per cent (as on June) is held by foreign promoters and the rest by foreign institutional investors (42.74 per cent), domestic institutional investors (18.4 per cent), non-institutional investors (29.62 per cent) and corporate groups (7.19 per cent). Had RBI permitted SKS to operate as an SFB, it could have resulted in equity dilution of as much as 36 per cent, estimate analysts at Credit Suisse, while the gains of converting into a bank would have accrued in the longer run (over five years).

On the downside, competition is likely to intensify for SKS in the next 18 months. Eight of the top 25 micro finance institutions (MFIs) have got the licence and have this much period to fulfil the requirements to operate as a small bank. They'll, then, have an opportunity to cater to a larger market vis-à-vis SKS.

These MFIs could undertake routine banking activities such as accepting deposits and lending to sections such as small businesses, small and marginal farmers and micro and small industrial units, among others. SKS will be restricted to its current line of operations, of lending to the agricultural sector, farmers, self-help groups, women and the poorer sections.

Further, while SKS has demonstrated its abilities to move into newer regions such as Maharashtra, Madhya Pradesh and Rajasthan, as the South Indian market is highly penetrated and matured, the company is likely to face challenges in establishing itself in newer regions. This would expose the company to intense competition from small and other banks’ lending to the priority sector, plus operational uncertainties while experimenting with new strategies.

Another advantage which companies now permitted to operate as small banks have is that they would be not be susceptible to the political risks faced while doing business as an MFI. SKS itself has been vulnerable to such conditions. In 2012, it underwent a massive debt restructuring exercise, as a result of the Andhra Pradesh government's intervention to waive repayment on loans taken by farmers.

Credit Suisse analysts, however, say that after introduction of the NBFC-MFI category in 2011, along with other safeguards, the uncertainty on regulations had ended and political risk is no longer a major issue for the sector.

Operationally, the interest spread SKS currently enjoys despite its lending rates (20.07-22 per cent) being among the lowest in the sector could also be difficult to sustain. The company has managed to operate at optimal levels of borrowing costs, mainly because of its institutional sources for funds. As on end-March, it had managed to bring down its cost of funds to 12.8 per cent from 13.6 per cent in FY14. Going ahead, this could be a challenge, as MFIs now being allowed to operate as small bank will have additional access to capital in the form of equity due to RBI's shareholding norms for small banks. Also in the longer term, if these MFIs are able to mobilise deposits from the public (as small banks are permitted to), borrowing costs could substantially reduce.

Nevertheless, it will take time for the new SFBs to start making a difference, as they will also be subject to meeting the regulatory norms applicable to banks (SLR, CRR, etc). This means their initial costs will remain elevated, unlike the case with SKS. The latter did not respond to Business Standard's queries.

For investors, the medium-term growth story of SKS appears intact. For a longer horizon, one needs to see how the situation evolves. Of the 11 analysts polled by Bloomberg since September 16, five have maintained their ratings while another five have downgraded the same, with upgrades at only one. However, of these, six have a buy, four a hold and only one has a sell rating, with average price at Rs 476.