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No End To Troubles

No silver lining is visible in the near term for investors in SKS Microfinance Limited…

SKS Microfinance Ltd. is in the news, but yet again for the wrong reasons. In our December 2010 issue, we had carried an analytical piece on the stock — about the troubles related to the company’s management and the Andhra Pradesh (AP) government’s new bill for regulating the microfinance sector. The company is still not out of the woods. In fact, its troubles seem to have got compounded further.

What has gone wrong
SKS, which received bids amounting to 14 times the total number of shares offered in its initial public offer (IPO) and got listed on the bourses at a premium of 6 per cent, has been reeling under pressure since the AP government (this state was its largest market) clamped down on the microfinance sector’s collection practices.
Grim Q4 results: The troubles with the company’s AP books were reflected in its disappointing March quarter results. The company’s sales registered a fall of 37.47 per cent on a year-on-year (y-o-y) basis. Its PBDIT and PAT declined drastically by 107.8 per cent and 210.9 per cent y-o-y respectively.
A conservative provisioning and write-off policy resulted in additional credit cost of Rs147 crore in Q4FY11 and Rs184 crore for the whole of FY11, in excess of the credit cost as per applicable Reserve Bank of India (RBI) provisioning norms. The AP bad debts of Rs37.88 crore were written off during the quarter and there was a loss of Rs29.39 crore on short collection on assigned loans. Moreover, the net non-performing assets rose to 1.28 per cent in Q4FY11 compared to 0.16 per cent in Q4FY10.

Key concerns
RBI rules still restrictive: The RBI, in its monetary policy statement for 2011-12, has broadly accepted the regulatory framework proposed by the Malegam Committee for the microfinance sector. Moreover, it has also provided specific relaxations for microfinance players in terms of customer eligibility, maximum loan amount, lending rates and net interest margins. Bank loans to microfinance institutions (MFIs) will continue to be recognised as priority sector loans. This is expected to improve the flow of bank credit to the cash-strapped sector. Interest rates have been capped at 26 per cent and margins at 12 per cent. These measures should benefit the entire microfinance sector. However, the margin cap may restrict efficiency in fund raising.
But these developments may not bring any respite. According to a report by J.P. Morgan, RBI’s recommendations may not translate into the AP government relaxing the provisions of the Andhra Pradesh Microfinance (APMF) Act. However, as the report points out, the final RBI rules are less restrictive than the original Malegam Committee recommendations, but are still capable of stifling the sector’s growth.
Increase in credit charge: According to estimates by J.P. Morgan, nearly 75 per cent of AP loans are expected to turn bad in FY12. Moreover, the report estimates Rs1,000 crore of provisioning and write-offs from the company’s AP books in FY11-12E, which could lead to huge losses in FY12. The company’s collection efficiency in AP dropped to 10.5 per cent in Q4FY11. AP contributes nearly 34.2 per cent of its gross loan portfolio.
Collections in a few states like West Bengal have dipped nearly 95 per cent in Q4FY11. The J.P. Morgan report factors in higher credit costs for the non-AP book at 3.5 per cent versus 2.25 per cent earlier.
Liquidity crisis: The write-off in the AP book in FY12 could create liquidity-related stress for the company. Though the management has not yet gone in for restructuring of its bank loans, front-ended write-offs could impact operating liquidity and create the need for more capital.

Will PE investors exit?
Catamaran Management Services, the venture capital (VC) fund promoted by Infosys Technologies founder and chief mentor N R Narayana Murthy, has 1.3 per cent stake in SKS. The VC fund has a two-year lock-in clause with the company which bars its exit till January 2012. But now the agreement has lapsed as the weekly average closing price of SKS fell below Rs400. According to the shareholder’s agreement, the lock-in would not apply if the market value of the shares as calculated on the basis of average closing price in a calendar week declined below Rs400 per share. During the first week of May (from May 2 to May 5, 2011), the average closing price was above Rs400, but in the next week the stock price never went above Rs400 and touched a record low of Rs297.85. That leaves Catamaran Management Services free to exit the company. Whether it will take advantage of this provision remains to be seen.
Other private equity players such as Sandstone Investment Partners, ICP Holdings, and Kismet SKS (all having locked-in shares), who bought stakes in SKS before the IPO, are also running deep losses. These together with Catamaran Management Services and Tree Line Asia Master Fund (Singapore) Pte hold 21.06 per cent stake in SKS. If all these PE funds exit, it will be a big blow for the beleaguered company.

Declining stock price
Between January 3, 2011 and May 10, 2011, the company’s stock price corrected by a drastic 54 per cent. More recently, between May 2 and May 10, 2011, the stock price dropped nearly 33 per cent. After listing, the stock touched an all-time high of Rs1,402.30 on September 28, 2010. But within just eight months, it plunged to an all-time low of Rs270.80 on May 9, 2011.
Earlier, the dispute between the promoters and the chief executive officer had raised corporate governance issues. Now, low earnings visibility and increased asset quality risk due to fall in AP collections have acted as dampeners for the stock. Investors holding this stock should re-evaluate their position.