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Back to growth ways; credit costs to be materially lower

As microfinance sector enters a new upcycle, we believe it is pertinent to look into the rear view mirror with respect to performance of players in the past 3 years which was one of the toughest phases for the sector. In this note, we have attempted to deep dive across asset quality and growth performance for some of the key players in the sector. We observe that write offs over FY21-23 (across players considered – Fusion, Spandana, CREDAG, Ujjivan SFB, Bandhan, BHAFIN, Satin - UNRATED) stood at c.16% (% of avg. FY20-21 AUM, Exhibit 11) with Bandhan Bank being relatively more impacted given the sharper impact on Assam portfolio. On the AUM growth front, customer additions over the past 3 years has been only 4% CAGR vs AUM growth of 11% CAGR for the key players considered. As we enter FY24E, we expect the AUM growth to be driven on the back of higher customer acquisitions as MFIs have restarted onboarding of new customers at a healthy pace and expect the sector to grow at 20-25% CAGR over the next few years. FY24E could be a year with meaningfully lower credit costs though we see incremental push by MFI players to increase share of individual loans and non MFI loans in their portfolio. Despite outperformance over the past 6 months (c.20% avg outperformance vs NIFTY), we see the sector delivering meaningful outperformance given earnings momentum is expected to continue and valuations still remain favourable. Fusion and Bandhan are our preferred plays in the space.

* Back to growth ways: Microfinance which was one of the worst affected sectors during Covid-19 pandemic has shown remarkable turnaround and MFI players have emerged stronger coming out of multiple Covid-19 waves. Growth for the sector which was tepid for FY20-22 (CAGR of 11% as MFIs had turned increasingly cautious on fresh lending and new customer acquisitions is starting to see signs of normalising in FY23 (Exhibit 1-3) and we expect the sector to see strong growth going ahead in FY24E. As displayed in Exhibit 4-10, FY23 growth was largely driven by increase in ticket sizes (partly aided by new MFI regulations) for majority of the players (including CREDAG, Spandana, USFB and SatinUNRATED); though, we see FY24E growth to be driven on the back of strong customer acquisitions as MFIs have restarted onboarding of new customers at a healthy pace. We expect the sector to grow at 20-25% CAGR over the next few years aided by revival of business momentum and regulatory tailwinds.

* Credit costs to be meaningfully lower in FY24E after tough 3 years: Asset quality of microfinance players was impacted during Covid-19 due to lockdown restrictions which in turn hampered the usual collection activities and also impacted the source of livelihood for MFI borrowers – leading to increase in overdues and NPLs. However, MFI players witnessed write-offs of c.16% (% of avg. FY20-21 AUM) of their portfolio during FY21- 23 (Exhibit 11 and 12). Incrementally, we expect FY24 could be a year with meaningfully lower credit costs though we see incremental push by MFI players to increase share of individual loans and non MFI loans in their portfolio.

* Valuation rerating expected to continue: Given that the MFI sector is facing various tailwinds in the form of a) regulatory impetus, b) revival of sector growth and c) robust asset quality parameters resulting in lower credit costs which in turn has led to run-up in stock prices for MFI players. We expect the rerating to continue for MFI players as they stay on a strong growth path along with materially lower credit costs which in turn should drive faster return expansion. Despite outperformance over the past 6 months (c.20% avg outperformance vs NIFTY), we see the sector delivering meaningful outperformance given earnings momentum is expected to continue and valuations still remain favourable. Fusion and Bandhan are our preferred plays in the space.

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