Detailed Rationale

CRISIL Ratings has assigned its ‘CRISIL A/Stable’ rating to the long-term bank facility of Spandana Sphoorty Financial Limited (Spandana).

 

The rating factors in the established market position and long track record of the company in the microfinance sector in India with regional diversity in asset base, sound risk management policies, healthy capitalisation and above-average 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.

 

After exiting the corporate debt restructuring (CDR) scheme in 2017, Spandana regained its market share and registered a three-year CAGR (compound annual growth rate) of 27% through fiscal 2021, to attain a consolidated assets under management (AUM) of Rs 8,157 crore as on March 31, 2021. It is now 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). After growing at a healthy 48% over fiscal 2020, its growth momentum was disrupted by the pandemic, resulting in a sharp decline in disbursements for most of the first quarter of fiscal 2021.

 

Spandana disbursed Rs 6,426 crore during fiscal 2021, most of which were loans to existing microfinance customers with a good track record. During the fiscal, the company 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. Sustainability of collections for the incremental disbursements will be closely monitored.

 

Risk management policies and operational controls remain sound, as reflected in pre-Covid 30+dpd (days past due) of <3%. After the pandemic, this metric rose sharply to 10.4% as on October 30, 2020. However, driven by restoration in ground level operations, the 30+dpd improved to 7.0% as on March 31, 2021. Overall collection efficiency, after dipping to 85-90% for September and October 2020, improved to 104.6% for March 2021. However, with the onslaught of the second wave, this metric fell to 94% in April 2021 and further to 69% in May 2021. As restrictions are being lifted gradually, collections are expected to have recovered marginally in June 2021. In the near term, the pace of improvement in collection efficiency to pre-Covid levels will remain a key monitorable.

 

Nonetheless, capitalisation of the company remains strong for its scale and nature of operations. As on March 31, 2021, adjusted gearing and capital adequacy ratio (CAR) were comfortable at 2.5 times and 40%, respectively. Networth of Rs 2,749 crore was bolstered by the capital raised since 2016 and healthy internal accrual. Presence of rich pedigree investors such as Kedaara Capital also imparts strength to financial risk profile. Spandana’s 5-year average return on total managed assets (RoMA) of 4.5% till fiscal 2021 is among the best in the sector, supported by its ability to keep operating expenses at low levels and net gain on de-recognition of assets (which were sold down through direct assignment route). However, increased provisioning requirements and accelerated write-offs after the pandemic led to a decline in RoMA to 1.6% in fiscal 2021 from 5.0% for fiscal 2020. Credit costs during the fiscal stood at an elevated 7.0% compared to sub-1% for the last 2-3 fiscals. In the long run, earnings profile is expected to remain above average. However, in the near term, the ability of the company to curtail credit costs remains essential.

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%. Having started the business in 2003, 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 March 31, 2021, the highest microfinance exposure to any single state was 19% against the company’s internal limit of 20% per state; exposure to top three states (Madhya Pradesh, Odisha and Karnataka) was 50% for the microfinance portfolio and 48% at an overall AUM level. Even at district level, diversity in loan portfolio is high with the top 10 districts accounting for 12.1% 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 pandemic and lockdown situation across the country. Preliminary impact of the second wave was witnessed by a blip in monthly disbursements in April and May 2021 to sub-15% of the company’s usual monthly run rate. However, with restoration in normalcy, Spandana’s medium to long term business growth is expected to revive.

 

* Sound risk management practices, 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. On the same date, GNPA and NNPA were 3.26% and 1.52%.

 

Over fiscal 2021, monthly current collection efficiency also exhibited high variation due to the lockdown and moratorium during the first-half. Current monthly collection efficiency[1] (current collections on current demand) declined to 86.4% for November 2021, followed by improvement to 94.4% in March 2021. Overall collections[2] improved to 104.6% from 90.7%. However, after the second wave and sporadic lockdowns, this metric dipped to 94.1% in April 2021 and further to 69.01% in May 2021. With the reduction in coronavirus cases and gradual removal of lockdown restrictions, collection efficiencies are estimated to recover in June 2021. 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.

 

* 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, 2021, reported networth was Rs 2,749 crore and adjusted gearing was low at 2.5 times. Capital adequacy was comfortable at 40%. Over the decade, 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.

 

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

 

Weakness:

* 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 of over 11.0% thus far. Its 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 three 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, second was demonetisation in 2016 and the third is Covid-19 in March 2020. 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-demonetisation 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

Spandana has been spearheaded by its founder-promoter, Ms Padmaja Reddy, since inception. However, stability at senior management has been very low. Over the last three years, churn in the senior management team remained high – especially for important positions such as Chief Financial Officer and Chief Risk Officer. While the leadership team is experienced, their average vintage of association with Spandana is less than 2 years. Considering this level of attrition, reliance on promoter and managing director remains high, exposing the enterprise to high key person risk. 

Liquidity: Strong

Cash and equivalent stood at Rs 1,075 crore on May 31, 2021, which covers debt obligation for the following 2 months by 1.4 times (without factoring in any incremental collections). The company has raised Rs 5,404 crore as external funding over fiscal 2021 and has a healthy 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. As per its ALM statement dated March 31, 2021, the company had cumulative positive gaps across all the time buckets up to 1 year.

Outlook: Stable

The market position of the company will continue to benefit from its established track record and diversified regional presence. Capitalisation is expected to remain healthy and earnings above average.

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

• Continued deterioration in asset quality leading to weakness in overall profitability, as reflected in RoMA remaining below 3%
• Moderation in capitalisation, 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.

 

The consumer durable loans which were earlier extended by promoter company, Abhiram Marketing Services Ltd, will now be on Spandana’s balance sheet. Loan against property extended by CFL will offer gold loans, loan against property and other non-MFI loans. Caspian, which is presently a non-operating NBFC, may apply for a housing finance company licence in the future.

 

Any other information: Not applicable