Udaipur-based Sahayata Microfinance has raised INR 195 Mn through the issuance of listed, secured, redeemable, non-convertible debentures (NCDs), which have now been purchased by DWM (Cyprus) Ltd., a member of the Developing World Markets group of companies. IFMR Capital is the sole financial advisor to the issue. The NCDs are listed on the Bombay Stock Exchange and have been fully subscribed.

This transaction is significant not only because it is the first time that Sahayata has raised funds through listed bonds, but also because this transaction allows the company access to newer funding sources, which will be a robust support system for the low-income households that Sahayata serves across India. With this transaction, Sahayata has demonstrated its ability to attract diversified sources of financing. This transaction also reaffirms the commitment of DWM and IFMR Capital to the microfinance sector.

Commenting on the milestone deal, Ajay Verma, Managing Director & CEO, Sahayata, said “This is Sahayata’s first listed transaction and will boost confidence amongst investors and funders. The NCD transaction has opened up new avenues for funding to the company. Thanks to the DWM and IFMR Capital team for making this possible”.

Congratulating Sahayata and IFMR Capital, Jim Kaddaras, Partner for Debt, Structuring and Legal Affairs at DWM, said, “We are delighted to have brought financing to Sahayata, in order to support thousands of low-income entrepreneurs across India. At a time of uncertainty in the Indian microfinance sector, DWM is committed to financing socially committed MFIs with strong management teams like Sahayata. We hope to provide further financing to the sector in FY2012.”

Vineet Sukumar, Head Origination and Treasury at IFMR Capital said, “This transaction is yet another milestone in IFMR Capital’s efforts to provide high quality originators access to debt capital markets. We are delighted that Sahayata Microfinance, a long standing partner and a participant in all multi-originator securitisations structured by IFMR Capital, has availed of funding from rated, listed instruments that enhance transparency for the company and the sector, and pave the way for alternative and sustainable funding sources”.

By Kalyanasundaram, IFMR Capital

Recently, I had the opportunity to attend a discussion on International Financial Reporting Standards (IFRS)  which was attended by chartered accountants and key financial stakeholders. In my years as an accountant, I have never come across such heated debate or such polarized views on an accounting topic.

Based on these discussions and my reading of IFRS, I am listing below a few important points which may occupy a pivotal role in Banking -IFRS conversion. These points are not exhaustive and comprehensive but cover most important aspects on the topic.

1.      Income recognition
2.      Definition of Debt vs Equity
3.      Identification of Impaired loan
4.      Impairment provision
5.      Presentation of financial statements and disclosures of financial instruments

Banks have to invest in government securities to comply with RBI’s prudential norms. As per current RBI rules, such investments are accounted for at ‘amortised cost’. Under IFRS 9, these securities may have to be accounted for on a ‘fair value’ basis, with the fair value changes taken to the income statement.

Under IFRS 9, when there is high turnover in the portfolio, the entire portfolio would have to be accounted for at fair value, since the bank’s business model is not to hold the securities to maturity. Currently, Indian banks account for loans and receivable at amortised cost. Under IFRS 9, loans and receivable portfolio are accounted on amortised cost basis, provided these loans do not contain any exotic embedded derivatives. Basic embedded derivatives, such as caps and floor or normal prepayment or extension terms, do not taint amortisation accounting.

However, amortisation accounting is not possible if a loan has a contractual interest rate that is based on a term that exceeds the instrument’s remaining life. Similarly, a loan with a convertible option is not eligible for amortisation accounting and will have to be accounted for on a fair value basis with changes taken to the income statement.

Loan portfolio is accounted for on a fair value basis in cases where banks transfer/securitise their loan portfolio. Amortisation accounting is also not allowed for certain non-recourse loans, for example, when a loan to a real estate developer states that the principal and interest on the loan are repayable solely from the sale proceeds of a specific real estate. In such cases, the ‘contractual cash flow characteristics’ is not met and hence, such loans are accounted on a fair value basis.

Cash Flow Characteristics :

IFRS 9 requires an entity to assess the contractual cash flow characteristics of a financial asset. The concept is that only instruments with contractual cash flows of principal and interest on principal could qualify for amortised cost measurement. IFRS 9 describes interest as consideration for the time value of money and credit risk associated with the principal outstanding during a specific period. Therefore, an investment in a convertible debt instrument would not qualify because of the inclusion of the conversion option, which is not deemed to represent payments of principal and interest.

The cash flow characteristics criterion is met when the cash flows on a loan are entirely fixed (e.g., a fixed interest rate loan or zero coupon bond), when interest is floating, or when interest is a combination of fixed and floating.

Financial assets that do not meet the above criteria are required to be measured at fair value, including all equity investments, all derivative assets, all trading assets, and those loans, receivables, and debt securities that do not meet the two criteria described above.

Under RBI norms, investment in equity instruments (other than subsidiaries, joint ventures), are marked to market. Net losses are recognised but net gains are ignored. Under IFRS 9, investments in equity instruments are fair valued. The gains or losses are either recognised in the income statement or in a reserve account. That choice is required to be made at the inception, on an instrument by instrument basis, and is irrevocable. With regards to impairment of loans (not covered by IFRS 9), the IASB in a proposed standard is looking at a model that is based on expected losses rather than incurred losses. In other words, the proposed standard requires estimated credit losses to be included in the determination of the effective interest rate, for purposes of amortisation accounting.

There has been a lot of criticism regarding the complexity of the IFRS on financial instruments.. Taking a cue, the International Accounting Standards Board (IASB) is in the process of simplifying them.  Needless to say, the impact of IFRS 9 on banks will be significant. As India is on the path of IFRS adoption/ convergence, Indian banks will have to closely examine the impact of IFRS 9 not only on their financial statements but also on their capital adequacy, IT systems, taxes and product design, among others.

IFMR Capital recently completed two securitisation transactions. Eta Pioneer with Trichy based Grama Vidiyal Microfinance Limited, and Theta Pioneer with Satin Creditcare Limited.

IFMR Capital structured, arranged and invested in an INR 448.7 million securitisation transaction backed by 51,770 microloans originated by  Grama Vidiyal Microfinance Limited and in an INR 79 million securitisation transaction  transaction backed by 9,399 microloans originated by Satin Creditcare Limited.

Both the transactions were in the form of rated securitisation of receivables credit enhanced through cash collateral from the originator, EIS from pool cash flows and second loss credit enhancement from IFMR Capital. The senior tranche of Eta Pioneer has been rated LA+ (SO) and that of Theta Pioneer has been rated P2+ (SO). As always, IFMR Capital invested in the subordinated tranche.

This is IFMR Capital’s second securitisation with Grama Vidiyal Microfinance and first with Satin Microfinance as a single originator. Satin had earlier participated in three multi-originator transactions structured and arranged by IFMR Capital. Through this structure and investment by IFMR Capital, the window of funding continues to be made available for Grama Vidiyal Microfinance while for Satin Microfinance it is an important graduation from multi-originator to single originator securitisation, emphasizing the positive impact of securitisation on the efficiency of microfinance companies. IFMR Capital continues to demonstrate its commitment to providing efficient and reliable access to capital for institutions that impact low-income households

Details of the transactions (INR):

By Kshama Fernandes, IFMR Capital

The goal of an investment professional is to maximise the risk-adjusted return on the overall portfolio through diversification within and across asset classes. High repayment rates, low volatility of returns and low correlation with other asset classes make microfinance an interesting asset class.What drives the high repayment rates and low volatility of returns? How can unsecured loans made to borrowers with no credit history be of higher credit quality than more established asset classes? To understand these questions, one has to look at the underlying model.

Social collateral

The joint liability group (JLG) system is an operationally intensive model with strong emphasis on adherence to simple, yet well-designed processes. The product is typically a one-year loan with equal weekly repayments. A group of borrowers get together and form the basic unit — the joint liability group. Coming from the same neighbourhood, they know each other well enough to understand the cash flows and requirements of households, and have insight into the ability and willingness of the members to repay.

The group members collectively guarantee the loan given to members in their group. If a member fails to pay an instalment, the others in the group pool together and pay.Very often, non-payment of an instalment is due to reasons of liquidity, not wilful default. Most low-income households have no collateral to provide. The model effectively replaces physical collateral with social collateral.

While this may appear simple, the implementation is complex. Borrowers, who have never availed loans in the past or experienced the discipline of repayments, need to be educated about the product, group formation process and the liability they take on being a member of the group.

Educating borrowers

MFIs spend a lot of time educating their borrowers through a well-defined CGT (Continuous Group Training) and GRT (Group Recognition Test) process before a loan is sanctioned and disbursed. While most MFIs insist on borrowers engaging in an income generation activity, often the loans are utilised to smoothen lumpy cash flows, typical of an agriculture-based economy.

Most rural households engage in multiple income-generating activities. They grow seasonal vegetables, rear livestock and work as daily wage labourers. Thus, repayments often come from within the existing household balance sheet, rather than from new business income.

The small weekly repayments match well with the high frequency cash inflows. The group guarantee, based on self-selection, repayment discipline with close group monitoring, and a financial product that matches the household’s cash flow patterns, results in high repayments.

The low correlation observed between returns on this asset class and mainstream asset classes, such as equities, bonds, commodities and bullion, is because in the short run, the small-scale activities and occupations engaged in by borrowers continue irrespective of the happenings in mainstream markets.

As markets for end products/services produced by clients are largely local, the micro economy continues to function irrespective of whether inflation skyrockets, stock index nosedives, interest rates strengthen or exchange rates collapse.

Distinctive features

The features distinguishing microfinance from other asset classes are:

Very high granularity resulting in portfolio diversification: Microfinance loans have small ticket sizes that average Rs 12,000. As explained earlier, these loans are used for income generation, to smoothen cash flows and repay high-cost debt. The granular nature of loans with diversified business activity underlying them makes for a well-diversified underlying loan portfolio;

Short-term assets: These are short tenor loans where the frequency of repayment is far higher than standard loans. The principal outstanding steadily reduces with every week of repayment. Hence the duration of a typical loan with a one-year maturity is around six months. From a risk-return perspective, this is an attractive feature; and

Superior credit quality due to underlying model: Except for instances triggered by political risk, losses in this sector have been in the range of 1.5-2.5 per cent. Pool performance has been consistently good for originators who have tapped capital markets through well-structured securitisation transactions; this enables investors to take an exposure to this asset.

Efficient geographical diversification can be achieved by pooling loans originated by multiple MFIs across States and districts. The collection efficiency of such transactions structured by IFMR Capital has been 99 per cent. These numbers are far superior to those exhibited by other retail asset classes.

Wider Investor Base

For an investor pursuing risk-adjusted returns, microfinance is certainly an asset class worth looking at. MFIs have been able to tap capital markets through securitisation transactions and non-convertible debentures (NCDs), attracting mainstream investors such as mutual funds, bank treasuries, and private wealth investors. As the investor base for microfinance diversifies, the sector is also likely to experience lower liquidity risk.

For instance, after the recent Andhra Pradesh crises, while banks reduced lending to the sector, NBFCs continued lending, preventing a liquidity crunch.

The professionalism and rigour of capital markets has resulted in increased transparency, operating efficiency and improved risk management practices in this sector. Market oversight and performance monitoring by investors and rating agencies will go a long way in establishing microfinance as a high-quality asset class.

 
This article first appeared in The Hindu Business Line.

IFMR Capital recently structured and arranged an INR 165.5 million securitisation transaction. The transaction is backed by 25,768 microloans originated by well-known Bangalore based MFI, Grameen Financial Services Pvt. Ltd., popularly known as Grameen Koota. This is the third rated transaction with Grameen Koota as originator. Closing the transaction at this point of time in the sector is an achievement in itself and a demonstration of IFMR Capital’s commitment to providing efficient and reliable access to capital for institutions that impact low-income households.

Epsilon Pioneer IFMR Capital 2010, the Special Purpose Vehicle created for the transaction has issued the securitised instruments rated by CRISIL in the form of a 79% senior tranche rated P1(so) and a 21% unrated subordinated piece subscribed by IFMR Capital. The P1(so) tranche has a tenure of 5.49 months. As in all transactions till date, IFMR Capital is a primary investor with investment in the subordinated piece, signalling its commitment to connecting high-quality institutions with capital markets.

Till date IFMR Capital has provided financing to the microfinance sector worth, INR 5.2 billion in the form of microfinance debt capital market securitisations and senior secured bridge loans.