By,Anand Tajpuriya (C058)Ajinkya Zingade (C062)Shrey Agarwal (D002) Saurabh Agrawal (D004) Karan Ahuja (D005) Abhey Bansal (D010)

1SKS Microfinance

Grameen Bank

• Grameen Bank (GB) was initiated as a challenge to the conventional banking which had no place for the poor

• Began as the Grameen Bank Project in 1976; which was established as a Bank in 1983

• Promotes Credit as a Human Right• Grameen Bank gives collateral-free loans. Provides loans and

financial services without any legally enforceable contact• Preference for giving loans to women• Provides services at the door-step of the poor• Owned by the poor borrowers

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Grameen Bank – Contd.

Some Key Points related to GB:• Loans can be received in a continuous sequence• All loans are to be paid back in regular installments• More than one loan can be received simultaneously• Has both compulsory and voluntary savings• Replicated in more than 100 countries around the worldWhy does SKS require Capital?Facts & Figures (as on Oct ‘11):• GB has 8.349 million borrowers. Of which, 97% are women• Branches -2,565 ; Villages covered - 81,379 villages covering

more than 97% of total villages in Bangladesh

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Professor Yunus and Ms. Taslima Begum with Nobel Peace Prize, 2006

(efforts in Economic & Social Development)

4SKS Microfinance

• Microfinance is an effective tool that can help reduce poverty and spread economic opportunity by giving poor people access to financial services, such as credit and insurance. SKS distributes small loans that begin at Rs. 2,000 to Rs. 12,000 (about $44-$260) to poor women so they can start and expand simple businesses and increase their incomes.

• SKS uses the group lending model• Borrowers undergo financial literacy training and must pass a

test before they are allowed to take out loans.• Weekly meetings with borrowers follow a highly disciplined

approach.• Re-payment rates on our collateral-free loans are more than

99% because of this systematic process.

Case Overview

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Founder and CEO of SKS MicrofinancePhD from University of Chicago, BA from Tufts UniversityManagement Consultant with Mckinsey prior to SKS

COO of SKS MicrofinanceHead- Alternate Channel ING Vysya Life Insurance2004 – 2006 (2 years)AVP 1992 – 1995 (3 years) Esanda FinANZ, a subsidiary of ANZ Grindlays Bank plcPrior to this he worked with American Express and Standard Chartered Bank

CFO of SKS Microfinance1 year with NGO, 4 years in equity research with Merril LynchJennifer Leonard

Organization

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M R Rao

Vikram Akula

3 C’sLack of capitalCapacity constraintsHigh cost of delivering micrloans

Lack of trust in SKS and on Vikram AkulaResulted in volunteer-run foundation “the Indian Development Service” Managed to raise start-up capital $52000 to found SKS as NGONeed of Highly efficient service delivery model

SKS grew at an impressive rateBorrower base expanded by 200%-300%By 2007,

• SKS became 3rd largest MFI• 380000 members• Portfolio of Rs 175cr• Expanded to 11 states

Loan PortfolioFragmented structure

Snapshot of SKS Microfinance

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• SKS Microfinance follows the Joint Liability group Model. The methodology involves lending to individual women, utilizing five member groups where groups serve as the ultimate guarantor for each member.

• SKS follows a clear process in its operations– Village selection– Projection meeting– Group Formation– Compulsory Group Training– Centre Meetings

SKS Approach

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MFI Operating IncomeInterest rates higher as compared to the banks

• Labor intensive business• Weekly loan officer visits• Extensive traveling• Low ticket size• Poor Infrastructure

Higher interest rates of around 23.6% to 28.1%

Operating Income = Income generated through interests from

loan products- Salaries - Benefits - Other Costs - Provisions

But this customer segment would not get loans from bank and even if they got it the

cost of commute to & fro was high

How did SKS reduce cost?Reduced manual processing errors

and confusion from variance in process by installing Portfolio Tracker

The system captured all the data and tracked delivery of loansSKS was nicknamed “Starbucks of India

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Client• Typical customer – Rural, poor woman,

earning less than $1-$2 a day• Potential market size for this profile – 150

M households• Estimated Credit Demand – Rs 30K• Occupations they were typically involved in

– Production, blanket weaving, candle making, flour grinding etc

What all does the customer do to get a loan?

•Bears the transaction cost•Uses up saving to make initial payments•Attend 5 one-hour training•Attend weekly centre meetings

Market Sizing– Estimated market size Rs

4.5 Trillion– Even if probabilities are

taken into account market size is Rs 200 Billion

– Current penetration is less than 6%

The SKS way

Why loans only to Women?• Lesser risk• More cooperative• Likely to re-invest• Positive impact

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The Structure

5 or so units formed an areaAt maturity an area was projected to have 30 branches, 135 thousand customers, a portfolio

of $20 Million, and an annual revenue of approximately $10 Million

• Conducted meetings in the day time• Recruited new clients in the night• Served 330 clients each

Each Branch had a cashier, 5-7 loan officers and a branch manager

Each unit had 6 or so branches under it

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CompetitionThe Competitors

– Large Commercial banks ruled out– RRBs and Cooperatives

– Had Government subsidiesBut Were bureaucratic, high transaction

costs, corrupt employees and required cleints to travel– SHG model which was adopted but had poor repayment rate– Money lenders

Other MFIs were the strongest Competitors•There were 10 large MFIs and there were 1000 small MFIs but the small MFIs had only 20% of the market as compared to the large MFIs

SKS’s Competitive advantage

• Customer focus (door step delivery and emergency loans)

• Rapid expansion 12SKS Microfinance

Performance of SKS

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• Based on the recommendations of the Malegam Committee, RBI introduced a new category for MFIs, known as Non Banking Financial Company-Micro Finance Institutions (NBFC-MFIs)

The criteria for classifying an NBFC as an NBFC- MFI is:• Minimum net owned funds of Rs. 5 crore.• Not less than 85% of its net assets are ‘qualifying assets’.• The income an NBFC-MFI derives from the remaining 15% of assets

shall be in accordance with the regulations specified in this regard.• An NBFC, which does not qualify as an NBFC-MFI shall not extend

loans to the microfinance sector, which in aggregate exceed 10% of its total assets.

Malegam Recommendation - RBI Guidelines

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Qualifying asset’ shall mean a loan, which satisfies the following criteria:•Loan disbursed by an NBFC-MFI to a borrower with a rural household annual income not exceeding Rs. 60,000 or urban and semi-urban household income not exceeding Rs. 1,20,000.•Loan amount does not exceed Rs. 35,000 in the first cycle and Rs. 50,000 in subsequent cycles.•Total indebtedness of the borrower does not exceed Rs. 50,000.•Tenure of the loan not to be less than 24 months for loan amount in excess of Rs. 15,000 with prepayment without penalty.•Loan to be extended without collateral.•Aggregate amount of loans, given for income generation, is not less than 75 % of the total loans given by the MFIs.•Loan is repayable on weekly, fortnightly or monthly instalments at the choice of the borrower.

Malegam Recommendation

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• All new NBFC-MFIs shall maintain a capital adequacy ratio of not less than 15%

• Existing NBFCs to be classified as NBFC-MFIs, those with asset size less than Rs. 100 crore will be required to comply w.e.f April 01, 2012. Those with asset size of Rs. 100 crore and above are already required to maintain minimum CRAR of 15%.

• The CRAR for NBFC-MFIs, which have more than 25 % loan portfolio in the state of Andhra Pradesh will be at 12% for the year 2011-2012 only. Thereafter, they have to maintain CRAR at 15%.

Capital Requirement

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With effect from April 01, 2013:The aggregate loan provision to be maintained by NBFC-MFIs shall not be less than the higher of:a)1% of the outstanding loan portfolio, orb)50 % of the aggregate loan instalments, which are overdue for more than 90 days and less than 180 days andc)100 % of the aggregate loan instalments, which are overdue for 180 days or more.

Provisioning norms

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Why does SKS require Capital?

• Growing number of borrowers and branches and to finance its ambitious expansion plans

• SKS depended on interest from loans given for operating income. So, not possible to give loans to new borrowers from this income

• Not allowed to take deposits from general public• Increased demand from commercial bank, therefore wanted

to achieve first mover advantage• Maintenance of capital adequacy ratio of 9%• Very high debt equity ratio would increase distress costs and

was very risky. So, could not depend very much on debt and needed equity

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• FCF = EBIAT + Depreciation – Capital Expenditure – Increases in Working Capital

• The WACC(Weighted average cost of capital) approach values the tax shield by adjusting the cost of capital

• The APV(Adjusted Present Value) approach values the tax shield separately from the un-levered free cash flow

• The CCF(Capital Cash Flow) approach values the tax shield by incorporating it in the cash flow

Valuing the Firm

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• Cost of Debt – Rd, Cost of Equity – Re, T – Tax Rate• Debt – D, Equity – E, Value(V) = D+E• Return on Assets(Ra) = D/V*Rd + E/V*Re

WACC• Calculate Cost of equity capital using CAPM method

Ke = Risk free rate + Beta (Market premium)• For calculating beta for equity:

Beta of Asset = Beta of debt (D/E+D) + Beta of Equity (E/E+D)• Then calculate after tax cost of debt• Cost of debt can be estimated from the firm credit rating and default risk

or from yields on publicly traded debt • Calculate WACC by the formula:

Cost of debt (1-T) (D/E+D) + Cost of Equity (E/E+D)• Calculate FCFF= EBIAT + Dep - Capital expenditure - Working capital

expenditure• Calculate terminal value= (Last year FCFF*Growth rate)/(WACC-Growth

rate)• Discount FCFF and terminal value to its present value to calculate NPV

WACC

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• Separate the values in 2 components:– Value of firm without debt– Benefits and cost of borrowing

• Value of the firm = Value of the un-levered firm + Present value of interest tax shields – Costs of financial distress

• Value of Unlevered Firm = Discounting FCF at Ra

APV(Adjusted Present Value)

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• APV at constant D/V– Interest tax shield is as risky as firm– Discount Interest tax shield at Ra– Results in same answer as WACC

• APV at constant Debt– Interest tax shield is less risky than firm but as risky as

debt– Discount Interest tax shield at Rd– If tax saving till perpetuity then

• Present value of tax shield = T * D

APV Calculation

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• CCF = FCF + Interest Tax Shield = FCF + T*Rd*D• CCF are discounted at Ra• Assumes interest tax shields are as risky as firm• If D/V is constant then yields same result as WACC• CCF retains his simplicity since the discount rate, the return

on assets, is independent of the capital structure and can be used for every forecast period

CCF(Capital Cash Flow)

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• Reasons of Popularity– Less assumptions– Simpler to Understand– Reflect the current mood of the market since measures

relative value and not intrinsic value

Using Multiple method

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• Potential Pitfalls– Inconsistent estimate of values where key

variables like risk, growth and cash flow potential are ignored

– Result in high valuation when markets is over valuing and less valuation when it is under valuing

– Scope for bias making vulnerable to manipulation

Using Multiple method

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Offers and TermsName Pre- Money

Valuation(USD Millions)

Amount of investment (USD Millions)

Desired Stake Terms

Bombay Brokers

18.3 3 11.41% None

Global Bank 15.5 8 34% IPO in 36 months

Sequoia 15.3 8 34.78% Preferred Stock

India Ventures 10 3.5 NA None

Tri Partners 14 2.25 10.25% IPO in 60 months

Amount to be raised- $8 million

Highest Valuation offered with a minimum stake of 11.41%No terms and ConditionsNo mentorship and contactsDid not meet the funding requirements

Highest Valuation offered with a minimum stake of 11.41%No terms and ConditionsNo mentorship and contactsDid not meet the funding requirements

Desired one of the highest stake as compared to the biddersThe funding met the SKS requirementTerms of coming with an IPO in 36 months

Desired one of the highest stake as compared to the biddersThe funding met the SKS requirementTerms of coming with an IPO in 36 monthsDesired the highest stake as compared to the biddersThe funding met the SKS requirementTerms of having a preferred stock arrangement

Desired the highest stake as compared to the biddersThe funding met the SKS requirementTerms of having a preferred stock arrangement

Desired the lowest stakeTri Partners had a condition to come up with an IPO in 60 monthsDid not meet the funding requirementsFunding would increase the leverage of SKSz

Desired the lowest stakeTri Partners had a condition to come up with an IPO in 60 monthsDid not meet the funding requirementsFunding would increase the leverage of SKSz 26SKS Microfinance

Criteria Bombay Brokers Global Bank Sequoia India Ventures Tri Partners

SKS scaling 1 4 4 3 3

Domestic Equity 5 1 4 2 2

Comfort 1 2 5 5 5

Low interference 5 2 2 2 2

Investments in other MFIs

1 4 1 1 1

Control 1 3 4 2 2

Commitment to Social Mission

1 3 2 2 2

Brand Reognition 1 4 5 3 3

Presence in India 4 1 4 3 3

Desired Stake 1 4 5 1 2

Total 21 28 36 24 25

Rating Scale used 1 to 5 where 1 is the lowest score and 5 being the highest score

Qualitative Comparison

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Best Alternative- Sequoia Capital Best Alternative- Sequoia Capital

• Other Alternatives• Portfolio Buyout• A portfolio buyout occurs when a bank (or other agent) purchases the rights to the

future payment stream from a set of loans granted by the MFI• It includes a clause which specifies that the MFI is responsible for making up any

loss in repayment up to a certain percentage of the overall portfolio (typically 10%)• MFIs can only sell off as much of their portfolio as is financed by accumulated

earnings or equity, not term loans from banks, in a portfolio buyout• Securitization• Securitization of microloans refers to a transaction in which the repayments from

a set of microloans from one or more MFIs are packaged into a special purpose vehicle, from which tradable securities are issued

• Securitisations require a rating and the ability to re-sell securitised microloans may attract more potential buyers

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SKS Microfinance: The company that got too big

Silver Lining• Completed a Rs 230 Crore QIP at share price of Rs 75.4 Deutsche Sec buys 9.15% stake• Will help in restarting lending

Dark Times• Andhra Pradesh Microfinance (Regulation of Moneylending) Act 2010• Suresh Gurumani – Quit after the IPO• Vikram Akula – Was shown the exit door

Challenges Changed Customer PerceptionRegulatory environment not favorable

Source: http://www.thehindubusinessline.com/industry-and-economy/banking/article3700191.ece?homepage=true&ref=wl_home 29SKS Microfinance

SKS Microfinance employees embezzle Rs 15.8 cr

• Auditors of the company have reported that there was cash embezzlement by the employees to the tune of Rs 2.5 crores and loans given to non-existent borrowers was Rs 13.3 crores

• Employee fraud is an inherent risk in the business

Initiatives taken by SKS to prevent this

Indemnity bond from every field staffPersonal guarantee of a third personEvery Bank transaction requires two associates

Fidelity Insurance Strong box controlled by two keys

Source: The Hindu & The Economic Times

SKS Microfinance soars on hopes RBI will ease bad loan norms

• Provisioning Norms for bad-loans to be relaxed

• Asset Classification guidelines have been pushed

In 2011 RBI mandated that MFI’s make 100% provisioning for loans overdue for a period of more than 180 days

MFI based out of AP are facing tough times

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Top 5 Current Players and Leaders in MFI Industry

1. SKS Microfinance Ltd (SKSMPL) {HQ – Secunderabad (AP); Loan Outstd. 18227 mn}2. Spandana Sphoorty Financial Ltd (SSFL) {HQ – Hyderabad (AP); Loan Outstd. 18227 mn}3. Share Microfin Limited (SML)

{HQ – Hyderabad (AP); Loan Outstd. 8568 mn}4. Asmitha Microfin Ltd (AML) {HQ – Hyderabad (AP); Loan Outstd. 4944 mn}5. Shri Kshetra Dharmasthala Rural Development Project

(SKDRDP) {HQ – Dharmasthala (Kar); Loan Outstd. 4050 mn}

(as per Crisil analysis)31SKS Microfinance