India: SKS Microfinance Rides on Microcredit Resurgence
India, June, 28 2015 -
In the past 18 months, SKS Microfinance Ltd shares have gained 140%—more than thrice as much as the BSE 200 index. The clear trigger for this rise is the turnaround in the microfinance firm’s business: its Andhra Pradesh portfolio, the centre of the 2012 crisis, has been written off entirely and return on assets was in excess of 5%.
The second reason for this rise is that SKS is the only listed firm that offers a play on the fast growing industry. While bank credit grew at less than 10% in the last fiscal, microcredit grew by some 61%. With the Reserve Bank of India taking over oversight of this industry, the operating environment for microlenders has improved. SKS has been a clear beneficiary as its disbursements grew 44% last year and assets under management by 35%. Consensus estimates show SKS’s loan book to grow by an annual average of 40% over the next three years.
The third reason for the stock price increase could be SKS’s application to become a small finance bank. Recently, governor Raghuram Rajan indicated RBI would finalize the licence grant for one small finance bank or payments bank by August. That has added to investor excitement. On the face of it, SKS looks well suited for such a transition. Almost its whole loan portfolio will qualify for priority-sector lending classification. It covers 310 districts in over 18 states, has a capital adequacy of 31.7% and follows prudential norms stricter than mandatory norms after scalding itself in the Andhra crisis.
Becoming a small bank would insulate it from political risks such as the Andhra Pradesh ordinance. It would be able to diversify its revenue by generating more fee income and lending to more categories. On the liabilities side, there will be more sources of funds other than just bank borrowing such as from the National Bank for Agriculture and Rural Development, or Nabard, and the Small Industries Development Bank of India, or Sidbi. Raising deposits—wholesale or retail, though the latter may take time—could lead to cheaper cost of funds.
But these have to be weighed against costs. RBI has said small finance banks should maintain mandatory reserve ratios from the first day of operations. Secondly, operating expenses should rise in the initial years as SKS will have to spend on technology to smoothen the transition and new hiring.
More importantly, becoming a small bank will necessitate equity dilution. RBI norms specify promoter holding should be at least 40% and gradually brought down to 26%. SKS has foreign promoter holding of 9% and domestic public holding of some 30%. According to Emkay Global Financial Services calculations, this will necessitate equity dilution of some 44% to raise around Rs.2,500 crore from domestic investors. That could be an overhang for the stock even if the additional equity boosts net interest margins.