It may not be end of the road for SKS Microfin

It's not often that the investment decisions of George Soros and Vinod Khosla, the billionaire investors, go awry. While critics are in a hurry to write the obituary of Vikram Akula, the poster boy of the Indian microfinance sector, the story of the epic rise and abrupt fall of SKS Microfinance is far from reaching its climax, according to its investors and top executives.

The summer of 2010 saw the Indian share market going gaga over the initial public offer (IPO) of SKS, the country's largest microfinance institution, which counted the funds promoted by Soros, Khosla and Infosys co-founder N R Narayana Murthy among its investors.

SKS was listed on the local bourses in August 2010 at a 5.6 per cent premium on its issue price of Rs 985. It appeared a bet that could hardly go wrong. Broking firms like Edelweiss Capital, Angel Broking, HDFC Securities and India Infoline had recommended to their clients to buy shares of SKS.

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The company exhibited strong financials, with net profit expanding to Rs 174 crore (Rs 1.74 billion) in 2009-10 from Rs 1.6 crore (Rs 16 million) in 2005-06. SKS' net worth was Rs 950 crore (Rs 9.5 billion) in March 2010, compared to Rs 16 crore (Rs 160 million) in March 2006.

Two months later, however, the dream turned into a nightmare after a boardroom battle led to the unceremonious exit of the then chief executive, Suresh Gurumani.

The external environment was also not conducive, with the government of Andhra Pradesh - the state that was at that time the largest market of SKS - introducing a law to curb loan recoveries of microfinance companies.

Shares of SKS plunged 75 per cent to touch an all-time low of Rs 255 following the crisis, with broking firms including JP Morgan reducing the price target and earnings estimate.

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When SKS announced its financial performance for the quarter ended March 2011, the crisis was reflected in the earnings. It incurred a net loss of Rs 70 crore (Rs 700 million) in January-March, compared with the Rs 63 core (Rs 630 million) net profit it earned in the corresponding period of the previous year.

Even as the end of SKS' dream run appears near, top executives and investors of SKS firmly believe that the company will turn around in the medium term because of its extensive branch network, surplus liquidity and strong financials relative to its peers.

"Leaders always emerge stronger out of a crisis. The competitive landscape has changed to SKS' advantage, post-crisis. There will be some pain in the near-term, but we are highly positive about our mid-term outlook and bullish over our long-term plans," S Dilliraj, chief financial officer, said.

While most microfinance institutions opted to recast their debt with banks, SKS' surplus liquidity, thanks to the Rs 1,600 crore (Rs16 billion) it raised through the IPO, allowed the company to opt out of a debt restructuring programme.

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As on March-end, SKS had a cash and bank balance of Rs 558 crore (Rs 5.58 billion), a net worth of Rs 1,781 crore (Rs 17.81 billion) and a capital adequacy ratio of 45 per cent.

Banks, which have halted fresh loan approvals to the microfinance sector since October, also appear comfortable doing business with SKS.

Since October, SKS has secured loans totalling Rs 1,200 crore (Rs 12 billion) from banks, which include Rs 200 crore (Rs 2 billion) of securitised transactions.

"After the crisis, banks are scared to lend to the microfinance sector, as these loans may turn into non-performing assets. SKS' financials are better than those of other firms in the sector. Hence, we continue to do business with them," a senior executive of a Mumbai-based private sector bank said.

Industry analysts said uncertainty over the regulatory environment in the microfinance sector has also reduced after the Reserve Bank of India (RBI) adopted the broad recommendations of the Malegam Committee report.

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In a note to its clients on SKS' completion of a Rs 50 crore (Rs 500 million) securitisation transaction with YES Bank, Avendus Securities said "(the deal) signifies increased availability of funds post the acceptance of Malegam Committee recommendations. It is likely to positively impact the company's growth outside Andhra Pradesh. Sentiment is positive."

Analysts noted that while some of the recommendations of the Malegam Committee on margin and interest cap may hurt the profitability of some microfinance institutions, SKS' earnings are unlikely to suffer, as it already complies with the proposed norms.

In January, SKS had reduced its effective interest rate, including all charges, to 24.55 per cent. RBI has said banks can classify their loans to microfinance companies as priority sector advances, if the micro lenders charge 26 per cent or less interest to their poor borrowers.

SKS' effort to expand its business outside Andhra Pradesh has also been positive for the company and is seen as one of the key factors that will help the company turn around in the next few years.

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The non-Andhra Pradesh portfolio of the micro lender is currently estimated to be Rs 2,800 crore (Rs 28 billion). SKS' total borrowing is about Rs 2,200 crore (Rs 22 billion).

"We have proved our solvency. Our non-Andhra Pradesh exposure is higher than our existing debts. This has convinced lenders to lend us additional funds," Dilliraj said.

"We have a network of 1,781 branches across 19 states. We are not a regional player. Our exposure in Andhra Pradesh is only a fraction of our total business and not a multiple. We are confident of running our business profitably in the coming years," he added.