Rating Rationale

Strengths
* Strong market position in the Indian microfinance industry
Satin Creditcare is one of the leading non-banking financial companies operating as a microfinance institution (NBFC-MFIs) with loan assets under management (AUM) of Rs 6,026 crore as on June 30, 2018. The company has a large distribution network comprising 1017 branches spread across 307 districts in 18 states and has tripled its loan AUM in the last three years to establish its position as one of the largest NBFC-MFIs in the country. Sizable presence in underpenetrated regions along with business correspondent arrangement with IndusInd Bank Limited will provide Satin Creditcare ample headroom for growth and sustain its strong market position in the microfinance business.

The company has also improved on its geographic diversity and reduced its exposure to Uttar Pradesh to 24.4% at the end of June 30, 2018 from 43% three years ago. Focused effort of the management to expand Satin Creditcare's presence in east and south will result in further improvement of geographic diversity over the near to medium term.

The management is also focusing on improving product diversity by expanding its presence in housing finance and micro, small and medium enterprise (MSME) financing segments. Contribution from microfinance loans though will remain sizable over the medium term.

* Demonstrated ability to improve asset quality performance despite having sizable exposure to states severely impacted by demonetisation
With 70% of loan AUM housed in states which were impacted due to local socio-political issues in the aftermath of demonetisation, Satin Creditcare's collection efficiency declined to 71% for November and December 2016. The company undertook various measures like extending emergency and top up loans to selective customers and deploying more human resources for improving collections performance in stressed geographies. Focused effort of the management along with strengthened systems and processes resulted in a gradual revival in the asset quality performance and overall collection efficiency has now stabilized at 98%. Collection efficiency of newly acquired clients since January 2017 was even higher at 99.7%.

Portfolio delinquencies have also improved considerably. 30 days past due (dpd) and 90 dpd has improved to 5.0% and 3.9%, respectively, as on June 30, 2018 from 26.6% and 14.4% as on March 31, 2017.

The company has also increased the frequency of interactions with the borrowers by transitioning to fortnightly collections from monthly collections during the pre-demonetisation period. These measures will help Satin Creditcare maintain sound portfolio quality and reduce the severity of impact of local socio-political issues in future. Ability to maintain sound asset quality performance on a sustainable basis nevertheless remains critical and is a key rating sensitivity factor.

* Improved capital position
Satin Creditcare has considerably strengthened its capital position after demonetisation by raising Rs 404 crore of additional capital in fiscal 2018 through multiple rounds of equity infusion. The company's consolidated networth increased to Rs 904 crore at the end of fiscal 2018 from Rs 563 crore a year ago. Tier I and overall capital adequacy ratios were also comfortable at 20.30% and 23.65%, respectively, at the end of fiscal 2018. Adjusted gearing (including managed portfolio as business correspondent and securitised portfolio in external debt) also improved to 6.5 times at the end of fiscal 2018 from 8.4 times a year ago.

As a prudent measure, Satin Creditcare is expected to maintain overall capital adequacy at over 20% over the medium term. This will be aided by its demonstrated ability to raise capital at regular intervals and presence of renowned investors as shareholders.

* Strengthened systems and processes
Satin Creditcare has implemented an in-house software system for real-time tracking of portfolio performance at a granular level. This enables the senior management take prompt corrective action in case of any ground level issue. The new system is also expected to result in a significant improvement in operating efficiency through automation of processes. The company has also resorted to fortnightly collections to increase the frequency of interaction with the borrowers. Portfolio monitoring and internal audit mechanisms have also been strengthened post demonetisation. However, considering the rapid pace of growth and gradual expansion of business into newer geographies, portfolio monitoring and internal audit team needs continuous strengthening to keep asset quality under control.

* Diversified funding profile and comfortable liquidity
Satin Creditcare has a fairly diversified funding profile amongst NBFC-MFIs with nearly 25% and 19% of its overall borrowings (including securitisation) raised through securitisation and capital market issuances, respectively. The company also has a large lender base with around 80 lenders which include most large public and private sector banks. Cost of borrowing is also competitive and comparable with large-size NBFC-MFIs. The company has also entered into business correspondent arrangements with IndusInd Bank Limited and Capital First Limited for microfinance and non-microfinance business, respectively, which is expected to lend further diversity to the company's funding profile.

Liquidity is also comfortable. Satin Creditcare'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. The company also maintains significant liquidity in the form of cash and bank balance, unutilised bank facilities, and refinance lines from financial institutions.

Weakness
* Moderation in earnings on account of asset quality challenges in the aftermath of demonetisation
Satin Creditcare's profitability for fiscal 2018 was impacted due to higher provisioning requirement because of asset quality challenges accredited to socio-political issues in the aftermath of demonetisation. The company reported a net loss of Rs 2.7 crore for fiscal 2018 owing to Rs 237.5 crore of provisioning and write-offs in fiscal 2018, as against a net profit of Rs 24.9 crore in the previous fiscal.

Profitability though is expected to improve significantly as the company has already provided for a large part of its gross non-performing assets (NPAs) as on June 30, 2018. Moreover, increase in scale along with automation of processes 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% 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.