Rating Rationale

Strengths
* Strong market position in the microfinance space in the east with long standing presence in Odisha
Annapurna Finance is one of the leading non-banking financial companies operating as a microfinance institution (NBFC-MFIs) in eastern India with loan assets under management (AUM) of Rs 2,035 crore as on June 30, 2018. The company has increased its loan portfolio by nearly 5 times in the last three years, expanding its presence to 451 branches spread across 192 districts and 14 states as on June 30, 2018, from 116 branches in 63 districts and 6 states as on March 31, 2015. Annapurna Finance has a longstanding presence in Odisha where it has developed fairly good understanding of local economic activities benefitting from its association with People's Forum, a not-for-profit organisation engaged in social and developmental activities including self-help group formation for over two decades.

* Improved capital position
Annapurna Finance has strengthened its capital position by raising Rs 155 crore of compulsorily convertible preference shares in the first quarter of fiscal 2019. As a result, the company's networth and adjusted gearing improved to Rs 399 crore and 5.0 times as on June 30, 2018 from Rs 229 crore and 8.9 times as on March 31, 2018. Given the idiosyncratic risks inherent in the sector, the company has changed its philosophy on gearing and is in final stages of raising Rs 150 crore of additional capital to support its medium term growth plans while maintaining adjusted gearing at below 5.5 to 6 times on steady state basis. The overall capital adequacy will also be above 20% with Tier I capital being at least 15-16%. CRISIL has considered the additional capital of Rs 150 crore to be raised by fiscal 2019. Any material change in quantum and timing of capital raise remains a key rating sensitivity factor.

* Improved asset quality performance
Asset quality performance of Annapurna Finance has improved considerably in the past 12 months after witnessing a sharp decline in the aftermath of demonetisation due to socio-political issues in the Vidarbha region of Maharashtra and adjoining regions of Madhya Pradesh. The collection challenges were minimal in Odisha throughout this period. Portfolio delinquencies, measured in terms of 30 days past due (30+ dpd), has also improved to 2.1% as on June 30, 2018 from 7.7% as of March 31, 2017. The improvement is on account of two folds: focused efforts of the management to improve recovery and writing off of bad loans with limited recovery prospects. On static basis, incremental disbursements since June 2017 have also reported cumulative collection efficiency of over 98%. Average monthly collection efficiency for six months ended June 30, 2018 improved to 98%, from 93% for the corresponding period previous fiscal.

* Strengthened risk management practices
Annapurna Finance has also strengthened its risk management practice in the last few years. The company has established an in-house geo information system to facilitate early identification of any potential issues across geographies. This not only enables the company maintain sound asset quality performance in its existing regions but also assists in identification of newer regions with high growth potential and low risk. Self-help group model of lending along with sound ground level and internal audit processes have also helped Annapurna Finance maintain strong asset quality performance in its core geographies of Odisha and Chhattisgarh over the years. However, considering the rapid growth in loan portfolio and significant expansion into newer geographies in the past few years, asset quality performance in newer geographies remains a key monitorable.

* Comfortable liquidity position
Annapurna Finance's business model provides it with an inherently positive asset-liability maturity profile, driven by the shorter tenor of its advances than that of its liabilities. As on June 30, 2018, assets maturing over the next 12 months is comfortable at 1.60 times of liabilities maturing during the same period. Also, cash and cash equivalents were also comfortable at Rs 392 crore on the same date. The company also maintains significant liquidity in the form of cash and bank balance, unutilised bank facilities, and refinance lines from financial institutions.

Weaknesses
* Regional concentration of operations in Odisha
Annapurna Finance's portfolio is geographically concentrated with Odisha accounting for ~46% as on March 31, 2018 although the company has diversified its operations to 451 branches in 192 districts and 14 states. Moreover, top 5 districts accounting for 20% of the portfolio are all located in Odisha and most of them are adjacent to each other, therefore exposing the company to concentration related risks. However, the management is taking focused effort to improve geographic diversity and reduce the exposure to a single state to below 30% over the medium term. Additionally, they have put limits on branch and district exposure linked to networth of the company.

* Moderation in earnings on account of asset quality challenges in the aftermath of demonetisation
Annapurna Finance's profitability for fiscal 2018 was impacted due to higher provisioning requirement because of asset quality challenges accredited to socio-political issues in the Vidarbha region and bordering districts of Madhya Pradesh in the aftermath of demonetisation. The company reported a net profit of Rs 10 crore and return on managed assets (RoMA) of 0.5% for fiscal 2018 owing to Rs 49 crore of provisioning and write-offs, as against a net profit of Rs 19 crore and RoMA of 1.3% for the previous fiscal. RoMA though has improved to 2.4% (annualised) in the first quarter of fiscal 2019 and is expected to improve further as the company has already provided for most of its gross non-performing assets (NPAs) as on June 30, 2018. Moreover, increase in scale of operations are expected to result in an improvement in operating expense ratio. Profitability, measured in terms of return on managed assets (RoMA) is therefore expected to improve to above 2.5% over the medium term.

* Inherently modest credit profile of the borrowers
A significant portion of the portfolio comprises microfinance loans to clients with below-average credit risk profiles and lack of access to formal credit. Typical borrowers are cattle owners, vegetable vendors, tailors, tea shops, provision stores, small fabrication units etc. The income flow of these households could be volatile and dependent on the local economy. Pressure on households' cash flow due to unforeseen circumstances may affect the repayment capability of these borrowers.

* Potential risk from local socio-political issues in the microfinance sector
The microfinance sector has witnessed two major disruptive events in the past decade. The first was the crisis promulgated by the ordinance passed by the Government of Andhra Pradesh in 2010 and the second was demonetisation in 2016. In addition, the sector has faced issues in several geographies of varying intensity. Promulgation of the ordinance on microfinance institutions (MFI) by the Government of Andhra Pradesh in 2010 demonstrated their vulnerability to regulatory and legislative risks. The ordinance triggered a chain of events that adversely affected the business models of MFIs by impairing their growth, asset quality, profitability, and solvency. Similarly, the sector witnessed high level of delinquencies post-demonetisation and subsequent socio-political events. This indicates the fragility of the business model vis-a-vis external risks. Since business involves lending to the poor and downtrodden sections of the society, MFIs will remain exposed to socially sensitive factors, including charging high interest rates and, consequently, to tighter regulations and legislation.