Microfinance Bill will do little to help SKS. Here's why

It was one of those rare, ebullient days for SKS Microfinance, which saw its shares aggressively bid up by investors. On Friday, the stock jumped 20 percent to Rs 105.7 in mid-morning trade, before losing some of those gains in the afternoon. Currently, it is trading at Rs 99.6.

Nevertheless, chalk it up as a victory for SKS, whose unfortunate investors have seen shares of the company fall to below Rs 100 after hitting a giddy Rs 1,490 during its halcyon days just two years ago.Friday’s change in sentiment was triggered by Cabinet approval of the Microfinance Bill, which looks like the first ray of hope for the company in a long, long time.

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A large chunk of the operations of microfinance companies were felled after Andhra Pradesh, which introduced tough regulations to control the way that companies recovered loans from borrowers. The regulations were triggered by a spate of widespread publicity of a spate of farmer suicides in the wake of their inability to repay their micro loans.

The big change is the Microfinance Bill will over-ride the Andhra Pradesh regulations.No wonder the bourses are celebrating.

But are the celebrations premature? If you take a good, hard look at the facts, it does seem like investors have got just a tad carried away.

One, the Bill has received Cabinet approval and still has to be cleared by Parliament. It will have to get the stamp of approval from the Standing Committee, members of which have already expressed unhappiness at the current form of the bill. Rural minister Jairam Ramesh warned the bill could kill the self-help group movement in India if it is passed. Unless the government itself agrees on the bill, never mind the opposition, this bill is unlikely to become law.

Two, SKS Microfinance’s problems are not entirely due to the Andhra Pradesh’s stringent regulations. Even as back as December 2010, SKS’ Andhra Pradesh operations accounted for 40 percent of its total portfolio of Rs 3,526 crore. Unlike other microfinance players thus, SKS had a substantial chunk of operations outside AP even then.

However, there was a contraction even in non-AP operations for five straight quarters before they tipped back into positive territory in the December-ending quarter of 2011.

Three, the issue of bad loans cannot be blamed just on Andhra Pradesh regulations. As a Business Standard article points out, “What is disturbing is the rising share of other states excluding Andhra Pradesh in the write-offs. In the last six quarters, the company has written off Rs 212 crore in states other than Andhra Pradesh. In 2012, the company wrote off around Rs 180 crore.”

The company has shown non-AP recovery rate at 95 percent.However, in states like West Bengal, which comprises 13.5 percent of the company’s future receivables, the recovery rate is as low as 81.7 percent. Even in AP, the current exposure (loans portfolio) stands at Rs 236 crore and there is no assurance that the company will not have to write off this too.

Four, with the RBI becoming the apex institution to oversee microfinance institutions, the uncertainty on regulations will reduce. But that doesn’t mean the regulations will favour SKS. In 2011, for instance, the central bank capped the rate of interest that MFIs could charge from borrowers for loans up to Rs 50,000 at 26 per cent in May 2011.

That’s a negative against SKS. In its presentation for the March-ending quarter, the company also emphasises that while it has been delivering a steady 4 percent return on assets (RoA), that could come under attack from tighter regulations. If SKS’s RoA is affected, it will cap any major gains on the stock.

Five, despite the knee-jerk reaction in the stock today, it’s doubtful whether the stock can continue to ride higher in future. A lot of things are still unclear about the company, from whether it will be able to grow its portfolio outside Andhra Pradesh to whether the bulk of provisioning for its bad assets are over. Let’s not forget that it wasn’t just AP regulations that brought SKS down, it was also a whole host of corporate governance issues.

SKS will have to purge itself of its past to gain future glory.

At the moment, the company is in restructuring mode. It has decided to shift base out of Andhra Pradesh to Mumbai (indicating its willingness to become a pan-India company), and axed 1,200 employees and shut 78 branches to cut costs.

All of these are steps in the right direction. But there’s still a long way to go.