Ujjivan Financial Services Primary Offer: Lending a helping hand

After Equitas, Ujjivan, one of the other eight microfinance institutions that was awarded small finance bank licence, is tapping the capital market. The initial public offering (IPO) by Ujjivan is a combination of fresh issue of shares worth ₹358 crore and an offer for sale (OFS) for 2.49 crore equity shares.

Started in 2005, Ujjivan Financial Services is a microfinance NBFC, targeting the economically poor, but active women. The company’s business that is primarily based on the joint liability group lending model provides loans for agriculture, education, home improvement, home purchase and livestock. The company’s loan book has grown by a robust 51 per cent annually in the last four years. Ujjivan is well placed to transition into a small finance bank, to provide credit to small businesses and low income households.

But the real challenge, will be to garner low-cost retail deposits, to manage the adverse impact on profitability on account of costs involved in meeting the statutory requirements of a bank. The existing return on asset (ROA) of 3.6 per cent can go down to about 2.5 per cent in the next two to three years.

However, sound management team with extensive experience in the banking and financial services space, wide geographic reach and customer base are likely to facilitate a smooth transition into a small finance bank. Valuations too are comforting, below the asking price for the Equitas issue. At the upper band of ₹210, the valuation works out to about 1.4 times the FY-17 book value (post-issue) against Equitas’ 1.7 times (based on its issue price).

Ujjivan is now the third largest MFI (Equitas is fourth) in the country. With an outstanding loan book of ₹4,589 crore as of December 2015, Ujjivan commands about 11 per cent market share of the NBFC-MFI business in India. The company’s business can broadly be divided into group and individual lending. Unlike most other MFIs that predominantly lend through the joint liability group model, Ujjivan has also been extending loans to individuals — both secured and unsecured. While group lending loans constitute a chunk (88 per cent) of the total loans, the share has been coming down in the last few years. These loans contributed about 96 per cent in 2012-13.

Over the next couple of years, Ujjivan plans to focus on individual lending. This will help widen its offerings, as there are limits on loans extended to a borrower under the joint liability group. This however can increase the risk of defaults, which under the group lending, with a joint group guarantee, is well managed. The gross non performing assets (GNPA) are 0.15 per cent of loans as of December 2015.

The company has however been mitigating risks from individual lending through multiple safeguards. For one, majority of these loans are extended to its existing group lending customers, with a long track record. The company maintains a higher provisioning of 2 per cent of the outstanding loans for individual, against the 1 per cent for group loans.

Going ahead, the company plans to diversify its business beyond microfinance, into micro and small enterprises (MSE) and housing finance. While Ujjivan has been building these businesses over the last couple of years, meaningful diversification will happen in the next couple of years.

Ujjivan’s well-spread operations place it at a notch higher than Equitas, which is highly dependent on Tamil Nadu — contributing 62 per cent of the loan accounts. Ujjivan has no particular regional concentration. The four big States are Karnataka (15.3 per cent of loans), West Bengal (15.1 per cent), Maharashtra (13 per cent) and Tamil Nadu (12.3 per cent).

Small finance banks will have to comply with cash reserve (CRR) and statutory liquidity (SLR) requirements from day one of conversion into a bank. This will weigh on earnings, as it will not earn any interest on CRR, while SLR can earn interest of just 7-8 per cent as compared to the current loan yield of 22.7 per cent. The company’s plan to increase share of secured individual lending (lower yields) can also put pressure on profitability.

Garnering low-cost retail deposits can, however, cushion the erosion in profitability. But raising such deposits can be a challenge, particularly in the rural and semi-urban areas. In the urban market, there is already a scramble for deposits among existing banks.

Kotak Bank and YES Bank, which were awarded licences over a decade back, have taken quite some time to ramp up their low-cost deposits.

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