Detailed Rationale

CRISIL Ratings’ long-term rating on the bank facility of Spandana Sphoorty Financial Limited (Spandana) continues to be on 'Rating Watch with Developing Implications'.

 

The rating was earlier placed on watch due to the potential impact on business operations following the sudden resignation of the founder and erstwhile managing director (MD) – Mrs. Padmaja Gangireddy in November 2021. Post that, the attrition in the middle and lower management also increased marginally. However, the management committee which was constituted immediately after the promoter’s exit, has been able to fill up most of the important positions. The management committee is chaired by Mr. K. R. Kamath (former Chairman & Managing Director of Punjab National Bank and Nominee Director of Kedaara Capital, the single largest shareholder and co-promoter) to provide strategic direction to the business operations in the interim as part of the transition plan. In the interim, with effect from November 29, 2021, Spandana had appointed Mr. Nitin Agarwal as its interim Chief Executive Officer (CEO) and Mr. Amit Mittal as its interim Chief Financial Officer (CFO).

 

On March 18, 2022, the company officially announced the appointment of Mr. Shalabh Saxena as its MD & CEO and Mr. Ashish Damani as its President & Chief Financial Officer; both of them have taken charge with effect from March 19, 2022.

 

CRISIL Ratings has also taken note of the media reports on cause filed by Mrs. Padmaja Gangireddy dated March 8, 2022, regarding her re-appointment as Managing Director of the company.

 

CRISIL Ratings also takes note of the increased strategic involvement of Kedaara Capital in the company’s decision making and governance process. The same is substantiated by Rs 230 crore of capital infusion made by Kedaara Capital into Spandana, in March 2022. Of this, Rs 145 crore was made in the form of equity whereas balance Rs 85 crore was issued as share warrants against which Rs 75 crore was received by Spandana upfront. Beyond this, Rs 70 crore of equity capital has been raised from Valiant Group.

 

CRISIL Ratings will resolve the rating watch once adequate track record of stable operations has been established as the new management settles and, there is clarity on underlying asset quality and profitability. Additionally, CRISIL Ratings will monitor the trend in incremental fund raising and potential impact on existing borrowings due to covenants linked to this development.

 

The rating continues to factor in the established market position and long track record of the company in the microfinance sector in India with regional diversity in asset base, its sound risk management policies (though collections and credit costs remain near term monitorables), healthy capitalisation and above-average operating profitability. These strengths are partially offset by average resource profile, inherent susceptibility of the microfinance business to socio-political issues and the modest credit risk profiles of borrowers, and low stability in senior management.

 

The company’s AUM grew to Rs 8,157 crore, registering a 3 year CAGR of 27% till March 31, 2021. During the fiscal 2021, Spandana extended Rs 8 crore as interim loans to its borrowers and did not opt to restructure any of its loans under the RBI (Reserve Bank of India) scheme. However, driven by customer demand and product strategy, the company has altered the repayment schedule for most of its existing loans from fortnightly to monthly. In addition to disbursing loans to selected fresh borrowers, the company also offered to pre-close the loans of existing borrowers and disbursed fresh loan of longer tenure to provide them with additional liquidity to revive their businesses, resulting in significantly higher prepayments in the fourth quarter of 2021. This has led to an increase in the tenure of the outstanding portfolio.

 

Subsequently, driven by the collective impact of the second pandemic wave and unforeseen changes in the leadership followed by IT related challenges and momentarily high attrition at field level, the company’s AUM declined to Rs 6,695 crore over nine months of fiscal 2022.

 

Monthly collection efficiency, which had declined to 69% in May 2021 after the onslaught of the second wave, had improved to 95% in October 2021. In November 2021, this metric dipped to 81% owing to the operational disruption after the leadership change. However, it started to correct soon after and stood at 91% for December 2021. Gross Non-Performing Assets (GNPA) and Net Non-Performing Assets (NNPA) stood at 5.5% and 2.8%, respectively, as on December 31, 2021. The company also opted to restructure loans over Q2 2022 and as on December 31, 2021 – total restructured portfolio stood at Rs 1183 crore which forms 18% of the consolidated AUM as on December 31, 2021.

Analytical Approach

For arriving at its rating, CRISIL Ratings has considered the consolidated credit risk profiles of Spandana and its two subsidiaries – Criss Financial Ltd (CFL) and Caspian Financial Services Ltd (Caspian). Spandana holds 100% stake in Caspian and 98% stake in CFL.

 

Please refer Annexure - List of entities consolidated, which captures the list of entities considered and their analytical treatment of consolidation.

Key Rating Drivers & Detailed Description

Strengths:

• Established market position and track record with regionally diversified presence

After exiting CDR in 2017, Spandana has grown to become the second-largest NBFC-MFI (non-banking financial company/microfinance institution) in the country based on microfinance loan portfolio and the third-largest in terms of consolidated AUM (including non-microfinance loan portfolio) as on March 31, 2021 – registering a 3-year CAGR of 27%. Over the first nine months of 2022, the company’s consolidated AUM declined by 18% (non-annualized) to Rs 6,695 crore, owing to sporadic lockdowns amidst the second pandemic wave restricting field movement followed by operational challenges in the third quarter due to the erstwhile MD’s sudden exit from the company. Nonetheless, the company has a long track record of operating across business cycles and navigating through landmark challenges such as the Andhra Pradesh crisis in 2010, demonetisation and the ongoing pandemic. Market position also benefits from the geographical diversity in loan portfolio.

 

On December 31, 2021, the highest microfinance exposure to any single state was 18% against the company’s internal limit of 20% per state; exposure to top three states (Madhya Pradesh, Odisha and Karnataka) was 49% of the microfinance portfolio. Even at district level, diversity in loan portfolio is high with the top 10 districts accounting for ~12% of the AUM. This is backed by the policy of the company to house not more than 2% of its AUM in any single district.

 

In the near term, growth prospects shall remain susceptible to the pace of recovery in ground level situation and, the company’s own operational changes. And, with restoration in normalcy, Spandana’s medium to long term business growth is expected to revive. With RBI’s revised regulatory framework for microfinance entities allowing NBFC-MFIs to hold 25% of their total assets as non-microfinance loans, Spandana’s ability to expand into adjacencies also improves giving way to segmental diversity.

 

• Sound risk management policies; collections and credit costs remain near term monitorables

After undergoing major challenges post-2010, the company has strengthened its operational mechanism and risk management practices. Its risk management policy stipulates requirements around geographical concentration, collections, delinquencies, operational metrics such as per unit (branch, loan officer) AUM concentration, leverage and other key parameters, which are strictly adhered to. Ever since Spandana exited CDR in 2017, its asset quality remained sound evidenced by 30+ dpds of sub 3% until March 2020. Thereafter, as ground level challenges arose after the pandemic and lockdown, 30+ dpds exhibited a sharp rise to 10.4% as of October 30, 2020 from 0.6% as on March 31, 2020.

 

Driven by revival in operational activities during the second half of fiscal 2021 and accelerated write offs of non-paying accounts, 30+ dpd of Spandana reduced marginally to 7.0% as of March 31, 2021 however, following the second wave, it has surged to 22% again as of July 2021 and has remain at the same level as of December 31, 2021. On March 31, 2021, audited (including cross defaults) GNPA and NNPA were 5.6% and 3.2%, respectively whereas on December 31, 2021, reported GNPA was 5.5% and NNPA was 2.8%.

 

With the gradual removal of lockdown restrictions across the country and restoring stability in operational activity after November 2021, collection efficiencies are estimated to recover further in the near to medium term. For fiscal 2021, credit costs were 7.0% of which 3.9% were write-offs. In the aftermath of the second wave now, credit costs for fiscal 2022 shall also remain elevated and will be a monitorable. From a long term perspective, the company will have the option of risk based pricing aided by the revised regulatory framework for microfinance lenders which, should provide better coverage.

 

• Healthy capitalisation metrics

Bolstered by successive rounds of capital infusion over the last five fiscals, capital position is robust in relation to scale and nature of business. On March 31 and December 31, 2021, reported networth was Rs 2,749 crore and Rs 2,733 crore, respectively. The decline in networth over the quarter was accredited to changes in fair value account balance and losses made in Q2 2022. On the same dates, adjusted gearing was low at 2.5 times and 1.8 times. Capital adequacy, as on both these dates, was comfortable at 39.2% and 46.8%, respectively and, is expected to increase after the additional capital infusion in March 2022

 

Between 2011 to 2021, the company has raised about Rs 665 crore as fresh equity (including its initial public offer [IPO]) and Rs 791 crore (excluding premium/discount) through debt conversion during CDR. Incrementally, Rs 354 crore (excluding premium/discount) was raised as fresh Cumulative Convertible Preference Shares (CCPS) which were eventually converted into equity. Apart from that, the company has generated Rs 1,462 crore of cumulative profits over fiscal 2014-2021, which offset the accumulated losses of Rs 1,185 crore as on March 31, 2013. Recently, in March 2022, the company has further raised Rs 290 crore as a combination of equity and share warrants and another Rs 10 crore pertaining to share warrants issue in the month, is expected to be received in Q1 2023.

 

On a steady state basis, capital position shall remain healthy, backed by the company’s philosophy of maintaining gearing at sub-5 times and capital adequacy at above 25%. Support of established investors like Kedaara Capital also adds to this strength.

 

• Above-average operating profitability, though momentary pressure expected due to the pandemic

Earnings profile has remained above average as reflected in 5-year average RoMA of 4.5%. With the stipulated interest margin cap of 10%, which has been applicable to MFIs thus far, Spandana’s ability to maximise its operating efficiency and curtail operating expenses has been a key driver for its profitability.  Operating expense ratio has remained below 4% over the last four fiscals, as compared to industry average of 5-6%. Net gain on de-recognition of assets (which were sold down through direct assignment route) has also boosted profitability.

 

However, due to the increased credit costs after the pandemic, RoMA for fiscal 2021 declined to 1.6% from 5.0% for fiscal 2020. During fiscal 2021, the company made provisions of Rs 283 crore and wrote off an additional Rs 362 crore, as a result of which credit costs for the year stood at an elevated 7% as compared to <1% for the preceding 4-5 years. For nine months ended December 31, 2021, the company reported a muted RoMA of 0.6% (annualized) whereas its credit costs were 7.0% (annualized).

 

Over the medium term, profitability will remain a monitorable due to susceptibility to external shocks linked to the pandemic.

 

Weaknesses:

• Average resource profile

The share of assignments and securitization in the company’s funding profile has remained high.  49.0% of the total borrowings outstanding as on March 31, 2020 comprised direct assignments and securitization. While this share has declined to 27.3% as of March 31, 2021, it is still significant. Of the Rs 5,404 crore raised in fiscal 2021 as resources, the contribution of securitisation and assignment was 20%. The 33 lenders of the company are mostly private banks and NBFCs. For fiscal 2021, 48% of the funding raised was sourced from private banks and NBFCs whereas that sourced from public banks was 15%.

 

Historically, the company’s reliance on private banks and NBFCs as funding avenues has been on the higher side, leading to an elevated borrowing cost thus far. In the first nine months of 2022, the company has raised Rs 1374 crore. The company’s ability to increase the share of public banks in its funding base over the medium term remains a monitorable.

 

• Susceptibility to local socio-political issues in the microfinance sector and inherent weakness in the borrower credit risk profile

The microfinance sector has witnessed two major disruptive events in the past decade. The first was the crisis promulgated by the ordinance passed by the Government of Andhra Pradesh in 2010 and the second was demonetization in 2016. In addition, the sector has faced issues of varying intensity in several geographies. Promulgation of the ordinance on MFIs by the Government of Andhra Pradesh in 2010 demonstrated their vulnerability to regulatory and legislative risks. The ordinance triggered a chain of events that adversely affected the business models of MFIs by impairing their growth, asset quality, profitability, and solvency. Similarly, the sector witnessed high level of delinquencies post-demonetization and the subsequent socio-political events. 

 

For Spandana, the impact of demonetisation was relatively less as compared to peers. Since March 2020, collections have remained weak in most of the states due to on and off lockdowns and vulnerable cash flows of the borrowers. This indicates the fragility of the business model against external risks. As business involves lending to the poor and downtrodden sections of the society, MFIs will remain exposed to socially sensitive factors, including charging of high interest rates and consequently, tighter regulations and legislation.

 

• Low stability in senior management

Over the last three years, churn in the senior management team has remained high – especially for important positions such as Chief Financial Officer and Chief Risk Officer. In the month of September 2021, the officiating Chief Financial Officer and the Chief Strategy Officer, tendered their resignations with notice periods of 1 day and 1 month 15 days, respectively. This was followed by the exit of the founder-promoter, Ms Padmaja Reddy who was spearheading this organization since inception, on November 2, 2021.

 

Prior to the new MD and CFO joining the company, - seasoned directors from the board provided strategic guidance to the company – by being part of a management committee. This low stability in the senior management can potentially impact on the company’s ability to maintain smooth operational workflow and thus, will be monitored closely.

Liquidity: Strong

Cash and equivalent stood at Rs 1120 crore on March 15, 2022, which covers debt obligation for the following 3 months by 1.0 time (without factoring in any incremental collections). The company has raised Rs 5,404 crore as external funding over fiscal 2021, Rs 864 crore in the first nine months of fiscal 2022 and, has an adequate pipeline of sanctions under process. Business model provides it with an inherently positive asset-liability maturity profile, driven by the shorter tenure of its advances in comparison to that of its liabilities, thereby keeping liquidity comfortable.

Rating Sensitivity factors

Upward Factors

• Improvement in resource profile with gradual reduction in cost of borrowings
• Overall profitability (RoMA) remaining consistently above 4% while maintaining adjusted gearing at below 3 times

 

Downward factors

• Attrition at senior management level remaining high and, or lack of smooth transition in the leadership leading to adverse impact on the company’s financial profile.
• Continued deterioration in asset quality leading to weakness in overall profitability, as reflected in RoMA remaining below 3% for a prolonged period
• Moderation in capitalization, as evidenced by adjusted gearing remaining above 5 times commensurate to decline in tier I CAR below 18%

About the Company

Spandana is a public company in India, incorporated under the provisions of the Companies Act, 1956 on March 10, 2003. It was registered as a non-deposit accepting NBFC with the RBI and got classified as an NBFC-MFI effective April 13, 2015. The shares of Spandana were listed on the stock exchanges in India in August 2019 pursuant to the IPO of equity shares.

 

Spandana, together with its subsidiaries, is primarily engaged in lending, providing small-value unsecured loans to low income customers in semi-urban and rural areas. The tenure of these loans is generally spread over 1-2 years. While Spandana extends microfinance loans, its subsidiaries extend other services such as loan against property, gold loans, business loans and personal loans.

Key Financial Indicators

Particulars	Unit	Dec-21	Mar-21	Mar-20
Total managed assets	Rs crore	7995	10,077	8,422
Total income	Rs crore	1181	1396	1,240
Profit after tax	Rs crore	41	145	352
Gross NPAs (90+ dpd; excluding legacy Andhra Pradesh portfolio)	%	5.7%	5.6% ^	0.27%
Gearing	Times	1.57	1.95	1.15
Adjusted gearing	Times	1.79	2.50	2.07
Return on managed assets	%	0.6%	1.6%	5.0%

^audited, including cross defaults

Any other information: Not applicable

Annexure - Details of Instrument(s)

ISIN	Name of Instrument	Date of allotment	Coupon rate (%)	Maturity date	Issue size (Rs. Crore)	Complexity Level	Rating assigned with outlook
NA	Proposed Long Term Bank Loan Facility	NA	NA	NA	3500	NA	CRISIL A/Watch Developing

 

Annexure – List of entities consolidated

Names of Entities Consolidated	Extent of Consolidation	Rationale for Consolidation
Criss Financial Ltd	Full	Subsidiary
Caspian Financial Services Ltd	Full	Subsidiary