Collections¹ of microfinance institutions (MFIs), which had plunged to near zero in April because of the nationwide lockdown to stem the Covid-19 pandemic, have rebounded to 70-75% in July, with restrictions being lifted gradually.

While the bounce-back has been faster than that envisaged earlier, improving it to the pre-pandemic levels of 98-99% will be an important monitorable from an asset quality perspective. To create a buffer for potential pandemic-related credit costs, MFIs are expected to focus on raising additional equity capital over the near to medium term.

Collections had wallowed in single digit through May because of the moratorium granted by MFIs to their borrowers on an opt-out basis, but sprang to 55-60% in June and continues to improve. They have been relatively resilient given that only home loans and gold loans, among the major asset classes of non-banking financial companies² (NBFCs), have clocked higher collection efficiency.

This is despite MFI borrowers having relatively weaker credit profiles and field-intensive operations involving high personal touch, such as home visits and physical collection of cash. Additionally, disbursements during this period have been negligible.

Says Krishnan Sitaraman, Senior Director, Crisil Ratings, “The lifting of lockdown-related restrictions and resumption of local economic activity was faster in the rural and semi-urban areas. Consequently, MFIs with greater presence in these areas have reported better collection efficiency. Among states with the largest microfinance presence, Karnataka and Bihar reported better collections because they have managed to control the spread of the afflictions in the rural areas so far. However, Tamil Nadu and Maharashtra, which were facing the brunt of the pandemic and observing more stringent, localised lockdowns, saw sluggish collections.”

Given the momentum in collections, and outflows largely limited to operating expenses, liquidity levels have improved over April. Most MFIs received moratorium from banks and hence had low debt repayments, while disbursements were negligible. MFIs have also raised ~Rs 2,000 crore through bond issuances under the targeted long-term repo operations and partial credit guarantee schemes.

The strong recovery in June and July notwithstanding, there is still a significant way to go before reaching pre-pandemic collection levels of 98-99%. With the Covid-19 affliction rate still high and steadily percolating in hinterland, the ability of MFIs to further improve collections will be a key monitorable in the near term. Intermittent lockdowns and localised restrictions could hamper the collection momentum, too.

Considering these potential challenges, in addition to the standard provisioning, many MFIs have made special Covid-19 provisions in the last quarter of fiscal 2020 and the first quarter this fiscal. The aggregate special provision accounts for 2.5-3% of the March 2020 loan book. That’s significantly lower than the credit losses seen during demonetisation, which was in the 3-13% range.

Given the material gap between current and pre-pandemic collection levels, there is a risk of increase in credit losses and its potential impact on capitalisation metrics after the moratorium ends this month. The applicability and benefit to MFIs emanating from the recent resolution framework for Covid-19 stress is also uncertain. Nevertheless, due to its unsecured nature, the underlying impact will be evident by December 2020.

Says Poonam Upadhyay, Associate Director, Crisil Ratings, “In this milieu, we expect MFIs to focus on raising additional equity over the next few quarters as a buffer against potential credit losses or higher provisioning. In fiscal 2017 and 2018, too, after demonetisation, MFIs (including some which are small finance banks now) raised equity aggregating over Rs 4,000 crore. On a risk-adjusted returns basis, the MFI sector is expected to continue to attract interest, especially from specialised investors who focus on financial inclusion.”

From a credit profile perspective, Crisil will continue to focus on three areas in the road ahead:

• Collection efficiency over the next few months after the moratorium is lifted, since it will lead-indicate potential credit losses
• Equity-raising plans to mitigate the impact on capitalisation, if any
  
• Adequacy of liquidity to cover upcoming debt obligations and operating expenditure
  

In terms of Crisil-rated investment-grade MFIs, majority are backed by parent/s with strong credit profiles and benefit from the resultant financial flexibility. For the standalone rated MFIs, leverage is typically low or they are already in advanced stages of raising equity to shore up capitalisation levels.

¹ Monthly collection efficiency = {current + overdue collections (excl prepayments)} / scheduled billing assuming no moratorium
² NBFCs including housing finance companies, but excluding government-owned NBFCs