In my last post, we saw how SKS’ write-offs levels went up from 0.29% in FY2008 to 0.60% in FY2009, and then up again to 0.86% in FY2010, and that PAR numbers followed a similar trend. Today, we’re going to look into this in more detail, and then ask why this might be an issue for SKS.
Tracking the increase
Before we go any further, let’s cross-check the numbers we got from MixMarket. Their numbers are generally very good, and allowing for reporting period disparities, differences in interpretation of similar terms, or differences in how something is bucketed, there is broad agreement in most cases with the numbers one gets from MFIs.
This is no different for SKS, which notes the following for it’s write-off figures in its Annual Report for 2009-2010:
(Source: Schedule 19, SKS Annual Report 2009-2010, p.g. 82)
Ok, SKS agrees that write-offs levels increased between FY2009 and FY2010. What’s their story for FY2008 to FY2009?
Turn to page 203 of the Red Herring, and you’ll learn that the increase in bad debt write offs was a whooping 2,205.8%!
Yes, that’s right, bad debt write-offs were up 22 times in FY2009, compared to FY 2008. Umm… what!?
And let me take this opportunity to say again why I am really happy about getting my hands on the Red Herring document – SKS has gone out of the way to provide an abundance of information, and it’s all very informative. There are two primary reasons that account for this, albeit partly:
- Under their provisioning policy, they used to write off 50% of the loans overdue between 25 to 50 weeks (or 6 to 12 months, roughly) in FY2008. In FY2009, they wrote off 100%, i.e. the entire amount. Makes sense that this increased write-off, since this change doubled the number of loans they had to bump off the books for that category of loans, all other things remaining the same.
- The portfolio grew during this period, to the tune of 81.5%. Again, makes sense that this increased write-offs – if you give out more loans, proportionately more loans will also have to be written-off, all other things remaining the same.
Here’s what’s interesting – once you normalize for these changes, (essentially deflating the 2,205.8% number by 100% and then by 81.5% again to account for the explanations) the write-offs still go up by approximately 600% … ! Gonna have to say it again – umm… what!?
Something is pushing up SKS’s bad loan count, and pushing it beyond what seems to be the average for Indian MFIs. As we saw in the previous post, the average write-off for the market was 0.52% in 2009; SKS’ figure was 0.73% for the corresponding period.
SKS needs to identify the drivers behind bad loans. I could hazard a couple of guesses:
- Quality of staff – any any given point, three-quarters of SKS’ staff has been around for less than year. This is partly because of phenomenal growth leading to continuous hirings, and partly because of high staff turnover.
- Characteristics of new markets – borrower demographics, existing competitors etc.
- Credit policy – particularly those related to due diligence on loan disbursal and procedures for loan recovery
- Resource focus on growth, as opposed to consolidation
Without looking at more detailed numbers or talking to SKS staff though, we’d be hard pressed to know which of these, if any, are key drivers of deteriorating portfolio quality.
Additional Mitigating Factors
Irrespective of the underlying drivers, there are two effects to keep in mind that make deteriorating portfolio quality a particularly pernicious issue for MFIs enjoying rapid growth:
- Lag Effect: Loan vintages (i.e. loans given out during the same period – say a month) do not display full delinquency levels until a few months after disbursement. Given that most SKS loans have a 50-week term, a short 3 month catch-up period would mean that ¾ of the portfolio are displaying full delinquency levels, while a 6 month one would imply that only ½ of them were doing so – assuming 0% portfolio growth. This also means that if, for some reason, the overall portfolio quality deteriorates, it will not manifest itself fully for a good couple of months.
- Dilution Effect: Of course, SKS’ portfolio is not growing at 0%. It grew 99% between FY2009 and FY2010, and according to the 2009-2010 Annual Report, has a CAGR of 150% over the last 4 years. Consider what this means for the lag effect. The earlier vintages that are now displaying full delinquency levels are essentially watered down, and the low or non-existent delinquency levels of newer vintages have a higher per-rupee weight. How much watering down happens is dependent on the vintage disbursement amounts, but in general, the dilution effect depresses the delinquency levels further.
Why is this an issue? Well, SKS cannot continue to grow at a CAGR of 150% for too many more years. The Indian MFI market is getting increasingly saturated, and the industry as a whole will need to slow down. As growth slows, the delinquency and write-off levels will catch up. If SKS does not anticipate this catch-up and prepare accordingly, investor confidence will take a blow, along with portfolio quality.
Vintage-level Analysis Has Some Answers
One can get a sense of what will happen in the future by literally seeing how loans in SKS’ portfolio age. Loans given out during the same period, usually a month, are said to be in the same vintage. I have not found any public information on SKS vintages, let alone their delinquency profiles. It’s generally not very helpful to guesstimate on this because such profiles can vary greatly between MFIs with similar top-level PAR and write-off numbers, and can differ substantially for different products even within the same MFI, so I’m not going to dive into a modeling exercise.
It’s not too difficult to figure out the lag and dilution effect though, if one has access to granular portfolio data. SKS would have to take each vintage, figure out its delinquency profile, derive historic trends by superposition, and account for differences based on product characteristics, branch office location or any other salient factors. It can then combine projected performance of existing vintages with internal growth targets, and see where the PAR and write-off numbers end up at.
Sure, the past is not necessarily the best predictor of the future, but given the purported out-of-the-box nature of SKS products in particular and microfinance products in general, and the short loan lifecycles that reveal profile changes relatively quickly, this should be a pretty useful exercise.