Detailed Rationale

CRISIL Ratings has removed its rating on the long term bank facilities of Spandana Sphoorty Financial Limited (Spandana) from 'Rating Watch with Developing Implications' while reaffirming the rating at ‘CRISIL A’ and assigning a ‘Stable’ outlook.

 

The resolution of rating watch is primarily driven by increasing stability in the leadership along with restoration in business operations. The sudden exit of the erstwhile managing director in November 2021, along with high attrition in the middle and senior management, had disrupted the company’s overall operations. Further, asset quality challenges due to Covid-19 overhang, added to the challenges being faced by the company in the second half of fiscal 2022. During this period, the company also faced several IT related issues owing to which the declaration of results for the last two quarters of fiscal 2022 was delayed.

 

However, there has been a turnaround since the onset of fiscal 2023. There is more stability in the strategic leadership of the company after Mr. Shalabh Saxena and Mr. Ashish Damani have taken charge as the company’s MD & CEO and as its President & Chief Financial Officer, respectively. Other important offices which were vacant have also been filled during the course of Q1 2023. Apart from this, the company has also been able to resolve the conflict with its founder and erstwhile Managing Director – Mrs Padmaja Reddy. As part of this resolution, the company paid a settlement amount to her and nominal assets pertaining to the subsidiaries of Spandana were also transferred in her name. Pertaining to this aspect, the company is not expected to have any contingent liability hereafter.

 

The rating continues to factor in the established market position and long track record of the company in the microfinance sector in India with regional diversity in asset base, its sound risk management policies and improving asset quality, healthy capitalisation and above-average operating profitability. These strengths are partially offset by average resource profile, inherent susceptibility of the microfinance business to socio-political issues and the modest credit risk profiles of borrowers, and low stability in senior management.

 

Spandana has maintained a healthy capital position supported by timely and frequent capital infusion by Kedaara Capital (Kedaara). This, along with Kedaara’s increased involvement in decision making and strategic management of the company during the challenging time, has also been a driver for the rating action.

 

During the first quarter of fiscal 2023, the company’s disbursements revived to Rs 1220 crore after a muted stint of two quarters due to operational challenges. However, AUM growth was suppressed at negative 16% (q-o-q) as pre-closures and advance payments were high.

 

The company also took a strategic call to take one-time write off of Rs 701 crore during Q1 2023 which resulted in credit costs surging to 19.8% (annualized, 4.9% on a non-annualized basis). Resultantly, the company reported a net loss of Rs 220 crore for the quarter which translates to a RoMA of -12.3% (annualized). Following this write off, the company’s gross and net non-performing assets (including cross defaults and pre-closures) reduced from 17.2% and 7.8% on March 31, 2022 to 6.7% and 3.4% as of June 30, 2022. Majority of this gross NPA as on June 30, 2022 was pertaining to the pre-Covid portfolio. The gradual increase in collection efficiency was also a contributing factor for this. The company’s total restructured portfolio of ~Rs 1300 crore has reduced to Rs 406 crore as of June 30, 2022 of which, 48% was current as on that date. For full fiscal 2023, the company’s credit cost is expected to range between 4.5 – 5.5% and correct to its previous levels of sub 2% thereafter.

 

Nonetheless, the company’s operating profitability has remained resilient over the years barring a momentary decline in fiscal 2022 due to heightened interest reversals from NPAs. Spandana continues to maintain lower than industry average operating expense ratio which aids its earnings profile. RoMA for the fiscal 2023 should also improve driven by reducing credit costs and higher interest margins on the incremental portfolio given Spandana’s ability to implement risk based pricing now under the revised framework for microfinance companies.

 

In terms of capitalization, Spandana had a comfortable CRAR of 47.9% (consolidated) and this metric has remained above 40% for many quarters now. This was supported by Rs 290 crore of capital received from Kedaara Capital in Q4 2022.

Analytical Approach

For arriving at its rating, CRISIL Ratings has considered the consolidated credit risk profiles of Spandana and its two subsidiaries – Criss Financial Ltd (CFL) and Caspian Financial Services Ltd (Caspian). Spandana holds 100% stake in Caspian and 98% stake in CFL.

 

Please refer Annexure - List of entities consolidated, which captures the list of entities considered and their analytical treatment of consolidation.

Key Rating Drivers & Detailed Description

Strengths:

• Established market position and track record with regionally diversified presence

After exiting CDR in 2017, Spandana grew to become the second-largest NBFC-MFI (non-banking financial company/microfinance institution) in the country based on microfinance loan portfolio and the third-largest in terms of consolidated AUM (including non-microfinance loan portfolio) as of March 31, 2021 – registering a 3-year CAGR of 27%. However, the AUM declined over fiscal 2022 owing to sporadic lockdowns amidst the second pandemic wave restricting field movement – further challenged by operational and management related issues. Disbursements, which remained muted for most of fiscal 2022 owing to the second wave followed by company specific internal issues, have started to revive. As against Rs 215 crore disbursed in Q1 2022, the company disbursed Rs 1220 crore in Q1 2023 and plans to maintain an average run rate of Rs 1000-1500 crore on a quarterly basis, on an average. Having started the business in 2003, the company has a long track record of operating across business cycles and navigating through landmark challenges such as the Andhra Pradesh crisis in 2010, demonetisation and the ongoing pandemic. Market position also benefits from the geographical diversity in loan portfolio. On June 30, 2022, the highest microfinance exposure to any single state was 16% against the company’s internal limit of 20% per state; exposure to top three states (Madhya Pradesh, Odisha and Karnataka) was 42.2% for the overall AUM.

 

• Sound risk management policies; collections and credit costs remain near term monitorables

After undergoing major challenges post-2010, the company has strengthened its operational mechanism and risk management practices. Its focus around geographical concentration, collections, delinquencies, operational metrics such as per unit (branch, loan officer) AUM concentration, leverage and other key parameters, increased significantly. This approach allowed Spandana to maintain low delinquencies ever since its exit from Corporate Debt Restructuring scheme (CDR) in 2017. In the recent past, asset quality remained vulnerable due to pandemic imposed challenges – and was further challenged by operational disruptions following the erratic changes in leadership. However, the situation has started to stabilize since then with gradual reduction in NPAs and increase in monthly collection efficiency. GNPAs, after peaking at 17.2% on March 31, 2022, have reduced to 6.7% as of June 30, 2022 – driven by write off of Rs 702 crore in Q1 2023. The company’s NNPA as on June 30, 2022 was 3.4%. In terms of delinquencies, while the company’s own book performance has been stabilizing – reflected in a 30+ and 90+ dpd of 10.2% and 6.7% as of June 30, 2022, the performance of off-book portfolio remains vulnerable. As on June 30, 2022, while 90+ PAR for Spandana’s own book was 5.5%, for the direct assignment book – 90+ PAR was 79%. Nonetheless, the company has provision coverage of 5% over total AUM as on June 30, 2022 of which, 78% is allocated for stage II and III assets. Spandana had cumulatively restructured ~Rs 1300 crore under scheme I and II of which Rs 406 crore was outstanding as of June 30, 2022. Collections, which had declined to 81% in November 2021 owing to lagged recovery post Covid-19 and high attrition in the field staff, revived to 92% in December 2021 and further to 107% for Q1 2023. In addition, the company has recovered a small amount from portfolio that has been written off and expects a cumulative recovery of 15-20% from the total credit losses incurred due to Covid-19.

 

As Spandana has already taken majority of the credit loss hit, incremental impact is expected to be low. With improvement in resolution across early delinquency buckets and sound performance of the portfolio generated post Covid-19, NPAs are expected to stabilize in the near term and improve thereafter. However, performance of the restructured portfolio and ability sustain delinquencies at low levels for the post Covid-19 AUM remain a key monitorable.

 

• Healthy capitalisation metrics

Spandana’s capital position has remained comfortable in relation to scale and nature of business. On March 31 and June 30, 2022, reported networth was Rs 3,090 crore and Rs 2,820 crore, respectively. On the same dates, adjusted gearing was low at 1.42 times and 1.29 times. Capital adequacy ratio on June 30, 2022 was also robust at 47.9%. Over the decade through fiscal 2020, the company has raised about Rs 665 crore as fresh equity (including its initial public offer [IPO]) and Rs 791 crore (excluding premium/discount) through debt conversion during CDR. Incrementally, Rs 354 crore (excluding premium/discount) was raised as fresh Cumulative Convertible Preference Shares (CCPS) which were eventually converted into equity. Apart from that, the company has generated Rs 1,462 crore of cumulative profits over fiscal 2014-2021, which offset the accumulated losses of Rs 1,185 crore as on March 31, 2013. In March 2022, the company has raised another Rs 215 crore as equity share capital and another Rs 85 crore as warrants. On a steady state basis, capital position shall remain healthy, backed by the company’s philosophy of maintaining gearing at sub-5 times and capital adequacy at above 25%. Support of established investors like Kedaara Capital also adds to this strength.

 

• Above-average operating profitability

Pre-provisioning earnings profile of Spandana has remained above average – as reflected in a 5 year PPOP to average managed assets ratio of ~8% through fiscal 2022. This is supported by the company’s low operating expense ratio. Its overall RoMA was also healthy at ~4.5% until fiscal 2020 post which, elevation in credit costs due to Covid-19 resulted in moderation in profitability for fiscal 2021 and 2022. From sub 2% previously, credit costs increased to 7.0% for fiscal 2021 and stood at 5.4% for fiscal 2022. Correspondingly, RoMA – having remained above 4% on an average – declined to 1.6% for fiscal 2021 and further to 0.8% for fiscal 2022. For fiscal 2022, net interest margins also compressed due to increased reversals. With stabilizing collections and asset quality performance and, ability to charge higher yields after removal of cap on interest rate margins for MFIs, the company’s operating profitability is expected to be strengthened further. Over the medium term, the company’s ability to curtail incremental slippages from the restructured portfolio and maintain the quality of book created post pandemic, will remain a crucial factor from an earnings perspective.

 

Weaknesses:

• Average resource profile

The share of assignments and securitization in the company’s funding profile has remained high. 49.0% of the total borrowings outstanding as on March 31, 2020 comprised direct assignments and securitization. While this share has declined to 11.2% as of March 31, 2022 as growth itself declined, its share is expected to remain significant in the normal course of business. As on June 30, 2022, majority funding was sourced as term borrowing from banks followed by capital market issuances. The company’s cost of borrowing has remained on the higher side at ~11%, historically. In Q1 2023, the company raised Rs 155 crore whereas in Q2 2023, it raised Rs 955 crore of which, Rs 559 crore was drawn down. Its ability to increase the share of public banks in its funding base over the medium term remains a monitorable.

 

• Susceptibility to local socio-political issues in the microfinance sector and inherent weakness in the borrower credit risk profile

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 demonetization in 2016. In addition, the sector has faced issues of varying intensity in several geographies. Promulgation of the ordinance on MFIs 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-demonetization and the subsequent socio-political events. For Spandana, the impact of demonetization was relatively less as compared to peers. Since March 2020, collections have remained weak in most of the states due to on and off lockdowns and vulnerable cash flows of the borrowers. This indicates the fragility of the business model against external risks. As business involves lending to the poor and downtrodden sections of the society, MFIs will remain exposed to socially sensitive factors, including charging of high interest rates and consequently, tighter regulations and legislation.

 

• Limited track record of stability in senior management, remains a monitorable

Over the last three years, churn in the senior management team has remained high – especially for important positions such as Chief Financial Officer and Chief Risk Officer. In the month of September 2021, the officiating Chief Financial Officer and the Chief Strategy Officer, tendered their resignations with notice periods of 1 day and 1 month 15 days, respectively. The founder-promoter, Ms Padmaja Reddy who was spearheading this organization since inception, also resigned on November 2, 2021. After that, the attrition across management levels has seemingly increased leading to operational challenges. While the company has been able to fill the key positions and gradual stabilization in leadership is being achieved, operational flow has also smoothened however, the track record in the same is yet to be established.

Liquidity: Strong

Cash and equivalent stood at Rs 706 crore on, which covers debt obligation for the following 3months by 1.04 times (without factoring in any incremental collections). The company has raised Rs 160 crore as external funding over Q1 2023, Rs 955 crore in Q2 2022 (till Sept 25, 2022) and, has a pipeline of Rs 900 crore worth of sanctions under process. Business model provides it with an inherently positive asset-liability maturity profile, driven by the shorter tenure of its advances in comparison to that of its liabilities, thereby keeping liquidity comfortable.

Outlook: Stable

The company’s market position and business operations are expected to stabilize with the induction of new management. This should also translate into better operating metrics. Capitalisation is also expected to remain healthy marked by low gearing and pre-provisioning profitability remaining above average.

Rating Sensitivity factors

Upward Factors

• Increase in scale of operations and market position while maintaining profitability (RoMA) at above 3% on a steady-state basis
• Improvement in resource profile with gradual reduction in cost of borrowings

 

Downward factors

• Continued deterioration in asset quality leading to weakness in overall profitability, as reflected in RoMA remaining below 2.5% for a prolonged period
• Moderation in capitalization, as evidenced by adjusted gearing remaining above 5 times commensurate to decline in tier I CAR below 18%
• Lack of smooth transition in the operations under new management, leading to adverse impact on the company’s overall credit profile

About the Company

Spandana is a public company in India, incorporated under the provisions of the Companies Act, 1956 on March 10, 2003. It was registered as a non-deposit accepting NBFC with the RBI and got classified as an NBFC-MFI effective April 13, 2015. The shares of Spandana were listed on the stock exchanges in India in August 2019 pursuant to the IPO of equity shares.

 

Spandana, together with its subsidiaries, is primarily engaged in lending, providing small-value unsecured loans to low income customers in semi-urban and rural areas. The tenure of these loans is generally spread over 1-2 years. While Spandana extends microfinance loans, its subsidiaries extend other services such as loan against property, gold loans, business loans and personal loans.

Key Financial Indicators: (Consolidated)

Particulars	Unit	Jun-22	Mar-22	Mar-21	Mar-20
Total managed assets	Rs crore	6,688	7,568	10,077	8,422
Total income	Rs crore	259	1,480	1396	1,240
Profit after tax	Rs crore	(220)	70	145	352
Gross NPAs (90+ dpd; excluding legacy Andhra Pradesh portfolio)	%	6.7%^	17.2%^	5.6% ^	0.27%
Gearing	Times	1.15	1.26	1.95	1.15
Adjusted gearing	Times	1.29	1.42	2.50	2.07
Return on managed assets	%	-12.3%	0.8%	1.6%	5.0%

^audited, including cross defaults

Any other information: Not applicable

Annexure - Details of Instrument(s)

ISIN	Name of Instrument	Date of allotment	Coupon rate (%)	Maturity date	Issue size (Rs.Crore)	Complexity Level	Rating assigned with outlook
NA	Proposed Long Term Bank Loan Facility	NA	NA	NA	3500	NA	CRISIL A/Stable

 

Annexure – List of entities consolidated

Names of Entities Consolidated	Extent of Consolidation	Rationale for Consolidation
Criss Financial Ltd	Full	Subsidiary
Caspian Financial Services Ltd	Full	Subsidiary