CRISIL has downgraded its ratings on the bank loan facilities and debt instruments of Janalakshmi Financial Services Limited (Janalakshmi) to 'CRISIL BBB+/Negative/CRISIL A2+' from 'CRISIL A-/Negative/CRISIL A1'.
 
The rating downgrade is driven by higher than expected impact on profitability due to low level of disbursements resulting in shrinkage of performing loan book and continued weakness in overall collection performance resulting in delinquencies remaining at elevated levels. The low level of disbursements was a conscious strategy followed by the company to strengthen its collections infrastructure.
 
The rating centrally factors in CRISIL's belief that the company will raise additional capital, to the extent of losses incurred over and above the estimated losses for fiscal 2018. Further, the rating also factors in the expectation that Janalakshmi will be able to improve its overall collection efficiency to above 90% by March, 2018 and sustain its collection performance at those levels.
 
Janalakshmi is expected to report pre-provisioning losses for fiscal 2018 because of a significant reduction in net interest income. The higher than expected decline in net interest income will be due to a shrinkage in performing loan book following slowdown in disbursements. The company took a strategic decision to hold back disbursals to institute fresh credit measures for originations and strengthen its collections architecture; consequently it disbursed loans aggregating merely Rs 90 crore in the four months ended October 2017. As a result, the performing loan book declined to Rs 6369 crore as on October 31, 2017 from Rs 8972 crore as on June 30, 2017. Provisioning requirements for the second half of fiscal 2018 will also be high as net non-performing assets (NPAs) stood at Rs 1760 crore as on September 30, 2017. Though the company has raised additional capital of Rs 1030 crore in fiscal 2018 thus far, pre-provisioning loss of Rs 569 crore in the first half of fiscal 2018 has resulted in losses before tax of Rs 1569 crore, which is significantly higher than anticipated.
 
Pre-provisioning profitability performance in the second half of fiscal 2018 is expected to be better than the first half as the interest reversal will be significantly lower than Rs 302 crore reported in the first half. The company however is likely to report marginal pre-provisioning losses in the second half of fiscal 2018 on account of reduced net interest income. CRISIL has taken into consideration the company's plan of raising additional capital of ~ Rs 770 crore by December, 2017. Further, in order to sustain capital position going forward in the context of potential pre-provisioning costs and provisioning requirements, the company is expected to raise incremental capital commensurate to losses, if incurred over and above the earlier estimated losses for fiscal 2018. Such incremental capital requirement could be ~Rs.500 crore.
 
While overdue collection efficiency has improved from 45% in June to 58% in November 2017 and collections across regular buckets have improved to 99%+ in October, 2017 from ~80% in December, 2016; overall collection performance has improved to ~81% as of November 2017; however, it continues to remain below earlier expectations. Portfolio delinquency at 90 days past due (dpd) is at ~ Rs.3,400 crore.
 
Factoring in the revised collection infrastructure put in place by the company, improvement of overall collection efficiency to above 90% by March 2018 will be a key rating monitorable.
 
With the recent revamp in collection infrastructure, Janalakshmi had managed to curtail fresh slippages in early delinquency buckets (loans with instalments overdue up to 60 days). The company had also set up a separate collections team, comprising experienced professionals to improve recovery from deeper delinquency buckets (loans with instalments overdue beyond 60 days) and has also made strides in legal recourse. Although unsecured nature of microfinance loans and inherently modest credit risk profile of borrowers makes collection from deeper delinquency segments difficult, an uptick in recovery from deeper delinquency buckets has been observed based on the ground level measures taken by the company.
 
Janalakshmi is also undertaking relevant measures to curtail its operating expenses to improve efficiency. The company plans to close down ~108 Jana centres over the next few months to reduce fixed costs and to focus on zones identified as 'less-risky' or 'attractive markets'. It has reoriented its human capital base both from the perspectives of head count and employee expenses. The benefits of these measures though will materialize over the next few quarters and the company is expected to report significant pre-provisioning losses in fiscal 2018.
 
For fiscal 2019, Janalakshmi, as a small finance bank (SFB), will face the challenge of rapidly building a non-microfinance portfolio to reasonable scale so as to absorb operational expenses and generate healthy pre-provisioning profits. A significant  portion of the SFB costs though are already being borne by the company given its large distribution network of over 200 branches and ~1500 staff trained for banking operations and ready to be deployed. Ability to profitably scale up the book also remains a rating sensitivity factor.
 
The ratings continue to reflect the expected structural benefits of scalability and product diversity after Janalakshmi's transformation into a small finance bank (SFB), its sizable presence in the microfinance industry through its performing book, demonstrated track record of capital infusion, adequate liquidity, and extensive experience of its board and senior management team.
 
These strengths are partially offset by weak asset quality, deterioration in earnings, and significant reliance on funding from banks and financial institutions.

Prolonged weakness in overall collection performance has resulted in a significant deterioration in asset quality parameters. Low level of disbursements in the four months ended October 2017 has also resulted in a shrinkage in performing loan book and will result in a material decline in interest income over the near term. As a result, the company's capitalisation and profitability will remain under stress in fiscal 2018 and fiscal 2019. There is some relief from the capital infusion of Rs 1030 crore which has happened recently, and additional capital infusion of ~Rs 770 crore expected by December 2017. However, capital requirement may be higher to account for higher than expected losses going forward. Additionally Janalakshmi, as a SFB, will have the challenge of profitably building a non-microfinance loan portfolio at a much faster pace.
 
The ratings may be downgraded further if the company is unable to improve its overall monthly collection efficiency to above 90% by March, 2018 and sustain it at those levels alongside accelerating the pace of recovery from loans overdue by more than 90 days over the next few months. The ratings may also be downgraded if the company is not able to raise additional capital over and above the ~Rs 770 crore planned by December 2017, commensurate to losses made over and above that estimated earlier till March 2018 and maintain adequate capital position. The outlook will be revised to 'Stable' in case of substantial and sustained improvement in asset quality and profitability alongside material strengthening of capitalisation through substantial equity infusion.

Janalakshmi, based in Bengaluru, commenced microfinance operations in April 2008, by taking over the portfolio of Janalakshmi Social Services (JSS), a not-for-profit firm promoted by Mr Ramesh Ramanathan. JSS had earlier acquired the urban microfinance programme of Sanghamithra Rural Financial Services and started its own microfinance programme in July 2006. Janalakshmi provides microfinance services to the urban poor. The company also offers other loan products such as enterprise, housing and individual loans. It is on the verge of transforming into an SFB.
 
During half year ended in September, 2017, the company disbursed loans aggregating Rs 1648 crore as compared to Rs 9023 crore and Rs 11516 crore disbursed in fiscal 2017 and in fiscal 2016 respectively.
 
The operations of Janalakshmi are spread across 20 states, with Tamil Nadu and Karnataka accounting for 35.5% of the loan portfolio as on September 30, 2017. For half year ended in September, 2017, the company reported a loss of Rs 1192 crore primarily attributed to high provisioning requirement and write offs of Rs 1000 crore.

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