India: PE investments in microfinance firms after 2010 crisis see better returns

Microfinance firms Equitas Holdings Ltd and Ujjivan Financial Services Ltd, which are in the process of converting into small finance banks, have seen strong interest in the primary markets. Equitas, which listed on stock exchanges on 21 April, saw its stock touch an intra-day high of Rs.147, about 33.6% above its IPO price of Rs.110 per share.

Private equity investors in the company, however, have seen mixed returns.

According to a Mint analysis based on data available in the IPO prospectus filed by Equitas, investors such as Sequoia Capital, WestBridge Capital and Aquarius Investment Advisors Ltd who invested in the company in 2010 have seen returns of only 8-14% on their investment in dollar terms.

The analysis shows that the returns made by private investors in Equitas show sharp divergence based on whether the investments were made before or after the 2010 Andhra Pradesh microfinance crisis.

In October 2010, driven by allegations of the coercive collection policy of microfinance institutions (MFIs) that drove many borrowers to commit suicide, the Andhra Pradesh government promulgated an ordinance to curb the activities of MFIs. The impact was felt across the country. Bad loans piled up as borrowers refused to pay back and banks declined to give loans to MFIs.

In December 2011, the Reserve Bank of India put in place regulations for the microfinance industry. The central government, too, chipped in by introducing a bill in Parliament and credit bureaus were set up.

Investors such as World Bank arm International Finance Corp. (IFC), Lok Capital (through its fund Sarva Capital), Dutch development finance institution FMO and Creation Investments who invested in Equitas after 2012 have seen their investments grow at an annual rate of almost 30-50%.

The trend is similar in the case of Ujjivan, with investors who came in after the crisis pocketing superior returns when compared to those who invested earlier.

Impact investor Lok Capital’s first fund, which invested in Ujjivan in 2008 and completely exited the firm in 2015, managed to generate returns of 18.19% annually. On the other hand, Lok’s second fund Sarva Capital, which invested in the company in 2012, has as of IPO generated returns of around 29.2%.

A Sequoia Capital spokesperson declined to comment. Emails sent on Friday to WestBridge Capital, Aquarius Investment and Lok Capital went unanswered.

According to industry experts, the reason for this divergence is the sharp fall in valuations after the 2010 microfinance crisis.

“The years 2008-10 witnessed the boom phase for the industry. MFIs were touted as double bottom line businesses with extremely high growth rates. They demanded and got very attractive valuations. The October 2010 ordinance of the Andhra government created an altogether new reality. Heightened risk perceptions, stringent regulations… the halo around the industry was gone,” said Alok Prasad, an independent industry expert and former CEO of industry body Microfinance Institutions Network (MIN).

With this “new normal”, the investor-MFI dynamic changed quite dramatically, he said. “Scarcity of capital coupled with investors adopting much harder negotiating positions meant significantly lower pricing for MFI paper during 2011-13,” he said.

Regulations put in place by the RBI after the crisis brought much-needed clarity to the sector and resulted in strong growth for the industry and good returns for investors, say others.

“Post the Andhra crisis, once there was clarity on the regulatory framework, the sector has attracted a larger pool of investors, including traditional private equity houses. Banks too were more forthcoming in lending funds to the sector,” said Ritesh Chandra, executive director and head (consumer, financial institutions group and business services group), Avendus Capital Pvt. Ltd.

In the post-crisis period, the availability of abundant capital (both debt and equity) aided by a clear regulatory framework provided a significant impetus to the industry and this led to the high growth witnessed over the past few years, he said.

“In addition, companies have worked extensively on optimizing costs aided by technology, which has resulted in margin expansion. Valuations of tier-I assets, too, have been pretty consistent in this business in recent times, ranging between 2.5-3 times the book value,” he added.

As of 31 March 2015, the loan portfolio of MFIs had grown at a rate of around 33% year-on-year to Rs.40,138 crore from Rs.16,813 crore as of 31 March 2012, data from MIN shows.

According to data from Grant Thornton India Llp, in 2012-15, the sector had seen private equity investments of almost $626 million, almost double the amount invested in the previous four years.

While not all private equity funds have seen strong returns, interest in the sector remains high.

“People continue to find the industry attractive. The conversion of 10 large microfinance companies into small finance banks (SFBs) will open up a pool of medium and small specialized microfinance institutions, which will become attractive for private equity funds. In the next 6-12 months, they will occupy the space that has been vacated by the SFBs,” said Rajeev Yadav, group CEO at Fincare Business Services Pvt. Ltd, the parent firm of Disha Microfin.

Disha is one of the 10 firms that have received in-principle approval to become an SFB.

This article was first published on Livemint.com

Singapore Reporter/s

In Singapore, we are looking to double our reporting team by this year-end to comprehensively cover the fast-moving world of funded startups and VC, PE & M&A deals. We want reporters who can tell our readers what is really happening in these sectors and why it matters to markets, companies and consumers. The ability to write precisely and urgently is crucial for these roles. Ideal candidates must have to ability to work in a collaborative, dynamic, and fast-changing environment. We want our new hires to be digitally savvy and ready to experiment with new forms of storytelling. Most importantly, we are looking for hard-hitting reporters who work well in a team. Collaboration and collegiality are a must.

Following vacancies can be applied for (only in Singapore).

Following vacancies can be applied for (only in Singapore).   

  • A reporter to track companies/startups that have raised private capital, and have the potential to become unicorns. SEA currently has over 40 companies with a valuation of over $100 million and under $1 billion.
  • A reporter who can get behind the scenes and reveal how funding rounds are put together, or why they’ve failed to materialise. She/he in this role will largely focus on long-format stories. 
  • A journalist to track special situations funds, distressed debt and private credit (from the PE angle) across Asia.

Singapore Reporter/s

In Singapore, we are looking to double our reporting team by this year-end to comprehensively cover the fast-moving world of funded startups and VC, PE & M&A deals. We want reporters who can tell our readers what is really happening in these sectors and why it matters to markets, companies and consumers. The ability to write precisely and urgently is crucial for these roles. Ideal candidates must have to ability to work in a collaborative, dynamic, and fast-changing environment. We want our new hires to be digitally savvy and ready to experiment with new forms of storytelling. Most importantly, we are looking for hard-hitting reporters who work well in a team. Collaboration and collegiality are a must.

Following vacancies can be applied for (only in Singapore).

Following vacancies can be applied for (only in Singapore).   

  • A reporter to track companies/startups that have raised private capital, and have the potential to become unicorns. SEA currently has over 40 companies with a valuation of over $100 million and under $1 billion.
  • A reporter who can get behind the scenes and reveal how funding rounds are put together, or why they’ve failed to materialise. She/he in this role will largely focus on long-format stories. 
  • A journalist to track special situations funds, distressed debt and private credit (from the PE angle) across Asia.