Microfinance in doldrums. Will this company outperform, again?

The true litmus test that differentiates high-quality lenders is whether they have “best-in-class” non-performing asset (NPA) ratios during crises. This applies to all kinds of lenders in all kinds of lending segments.

The average gross GNPA in 2020-21 across more than 100 lenders in the segment was 10.85%, according to data from Sa-Dhan (a self-regulatory organization for microfinance players) quarterly reports. During 2021-22, the average GNPA across more than 225 lenders was 12.8%.

During FY21 and FY22, CreditAccess Grameen reported GNPAs of 4.4% and 3.6%, respectively. This was amongst the lowest reported GNPAs. Of course, a percentage of the portfolio was also written off, which reduced the GNPA, but the comparison with other players still holds.

The other top-notch players included Equitas Small Finance Bank and Arman Financial Services. However, Equitas has a small percentage of the total book as microfinance, and the microfinance portfolio had an NPA of 3.41% and 5.93% in FY21 and FY22, respectively.

Also Read: Microfinance comes crashing again. Two stocks could buck the trend.

Our point is that CreditAccess is among the best of almost all lenders operating in the microfinance segment (banks, NBFC-MFIs, etc.).

There are several reasons why CreditAccess could be a potential comeback player in the microfinance sector as and when it turns around. We cannot foresee when that will happen, but if history is a reliable guide, the next four quarters should help clean the slate.

What does CreditAccess do differently?

Conservative provisioning: Almost every year since 2020, CreditAccess has maintained a provision coverage higher than its reported GNPA. This means it consistently holds higher provisions, which is a hallmark of a conservative lender. It also taken the pain quickly as opposed to delaying taking a hit to the income statement.

For example, after taking a large provisioning hit in Q3FY21 (a bad quarter for all MFIs), it stated in the next quarter that “strong profitability in Q4 was utilized to absorb the accelerated write-offs and build additional provisioning buffer ahead of FY22”. This means they take hits quickly and build provisions for the future quickly. That is a good sign.

Segment analysis: For an MFI, segment analysis is largely borrower profile analysis, given the unsecured nature of group loans. But CreditAccess has 90% in unsecured group loans, i.e., IGL (income generation loans).

About 4% of the retail finance segment includes unsecured personal as well as gold, car, and affordable housing loans.

Three metrics signal CreditAccess has as sound a business model as can be in a segment fraught with significant risk.

Also Read: Let’s not conflate microfinance with self-help-group financing

First, CreditAccess has maintained the lowest lending rates compared to peers. In a time when many MFIs are being criticized for charging “usurious” rates, it’s comforting to know CreditAccess is “behaving well”.

Low yields along with a low cost-to-income ratio (CI ratio) means CreditAccess is operating in line with the first principles of the lending business—the lowest risk (in the segment) and the low(est) cost of operations.

This has translated into a cross-cycle return on equity (RoE) of 15%.

If nothing else, it’s proof that CreditAccess has been able to manage risks well over cycles, even in a challenging segment such as microfinance. It also hasn’t incurred a loss in the last 10 years.

But as Mark Twain has said, “History doesn’t repeat, but it rhymes."

CreditAccess may or may not hold up as well as in previous cycles. If you’re an investor, you can only hope that it does, based on the relatively high-quality operation it has run over the last 10+ years.

Is it different this time?

There are some concerns. MFI is a concentrated business. The top 10 states account for 85% of the gross loan portfolio. As much as 57% of the outstanding microfinance portfolio is concentrated in five states: Bihar, Tamil Nadu, Uttar Pradesh, Karnataka, and West Bengal. According to a report on MFI by HDFC Securities, these larger states no longer remain “underpenetrated”.

Also Read: MFI stress may weigh on small finance banks’ loan growth, asset quality in short term

As a result, over the last three years, a larger percentage of the growth has come from adding newer borrowers. Growth in newer geographies comes with risks that are less understood. Think of these borrowers like the new-to-credit (NTC) set of borrowers for banks. They’re certainly riskier.

Second, CreditAccess has a higher-than-industry average ticket size. This is usually considered risky(er). The percentage of borrowers that are under three years is also increasing. This somewhat corroborates the above idea that GLP growth has increasingly come from newer borrowers. Remember: the Reserve Bank of India enhanced the definition of microloan borrower from one with a household income of up to ₹1.25 lakh to up to ₹3 lakh. This increased the so-called TAM (total addressable market). A natural consequence of that is newer borrowers becoming eligible for microloans.

Granular-level data offers more insights.

Firstly, the ATS is much higher in their home state of Karnataka, Tamil Nadu, and other core states.

CreditAccess's 20% assets under management (AUM) come from Tamil Nadu, which is showing signs of stress. Among the top five states, the percentage of loans, which are due more than 30 days and less than 180 days (PAR 30-180), is the highest at 5.6% in Q2FY25. CreditAccess's Tamil Nadu portfolio is relatively stable at 2.6%.

CreditAccess’s exposure to Bihar, which is emerging as one of the troubled states due to the floods and a higher percentage of borrowers with 4+ lender associations, is minimal at 6% of the portfolio. The asset quality is also comforting.

What is NOT comforting is that nearly 25% of the portfolio is exposed to borrowers with 3+ lender associations. Of this 25%, around 15% of the portfolio is exposed to borrowers with less than four years of relationship with CreditAccess.

This subset also has the highest PAR 15+ (portfolio at risk–due more than 15 days).

The bottom line is that microfinance seems to be entering yet another phase of stress, this time primarily because of overleveraging (4+ lenders per borrowers’ portfolio) and inflation. In the past, a player like CreditAccess has survived such crises and come out relatively better going in. As always, this time, there are unique challenges, and we shall find out where the dice fall over the next few quarters.

For more such analysis, read Profit Pulse.

Note: We have relied on data from www.screener.in and www.tijorifinance.com throughout this article. Only in cases where the data was not available have we used an alternative but widely used and accepted source of information. 

The purpose of this article is only to share interesting charts, data points and thought-provoking opinions. It is NOT a recommendation. If you wish to consider an investment, you are strongly advised to consult your advisor. This article is strictly for educational purposes only. 

Rahul Rao has been investing since 2014. He has helped conduct financial literacy programs for over 150,000 investors. He helped start a family office for a 50-year-old conglomerate and worked at an AIF, focusing on small- and mid-cap opportunities. He evaluates stocks using an evidence-based, first-principles approach as opposed to comforting narratives.

Disclosure: The writer and his dependents do not hold the stocks/commodities/cryptos/any other asset discussed in this article.