Although a complete write-off is unlikely, and any potential losses would spread over several quarters, lenders are wary. Equitas Small Finance Bank estimates that around 50% of loans overdue by 90 days eventually become NPAs, though this figure varies across lenders.
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Additionally, a growing concern in the industry is that “this time it’s different,” as the Reserve Bank of India (RBI) has flagged a practice resembling “evergreening.” Here’s how it works: if a borrower owes ₹10,000 on a ₹50,000 loan and the lender senses repayment capacity is weakening, the MFI may issue an additional ₹50,000. The borrower then uses part of this amount to pay down the outstanding ₹10,000, bringing the net balance to ₹40,000.
This approach presents clear problems:
Concealed defaults: By rolling over loans, this tactic obscures the true rate of defaults.
Cascading defaults: If this practice is halted, it could trigger widespread repayment issues.
The fear that “this time it’s different” stems from this cascading effect, but estimating the extent of loans impacted by “netting off” remains challenging.
Additionally, borrower overleveraging has become a risk. Since FY22, the percentage of borrowers with loans from more than four lenders has surged, especially in states like Bihar, Uttar Pradesh, Karnataka, and Odisha, after the RBI removed the two-lender-per-borrower cap.
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From an investment perspective, this crisis presents selective opportunities. Players with robust fundamentals and a history of strong asset quality may be worth monitoring. Equitas Small Finance Bank, Ujjivan Small Finance Bank, CreditAccess Grameen Ltd, and Arman Financial Services Ltd have shown resilience, maintaining better-than-industry asset quality and adequate capital buffers to handle potential losses. Muthoot Microfin Ltd also looks promising, though it’s newly listed, and its resilience under stress remains to be seen.
There are three key metrics that make these companies worth adding to an Investors’ watchlist.
Key investment metrics
Lower NPA ratios compared to peers in FY22, the last crisis
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A key litmus test for lenders is how their NPAs fared in previous cycles. These four lenders have consistently outperformed the industry, as illustrated in the table above.
Healthy capital adequacy ratio (CAR)
Arman Financial, CAG, Equitas, and Ujjivan have CAR ratios of 40%, 26.1%, 19.4%, and 23.4%, respectively. A higher CAR signals a greater ability to absorb losses and lowers borrowing costs, supporting growth with less need for equity dilution.
Loanbook composition
Unlike traditional MFIs, Ujjivan and Equitas hold significant portions of non-MFI loans—50% and 85% of their loan books, respectively—providing some insulation from sector turbulence. CAG and Arman, however, remain heavily exposed to MFIs, with 90% and 80% of their portfolios, respectively.
Given these distinctions, Ujjivan and Equitas may not face the same risks as pure-play MFIs. For instance, Equitas’ book is diversified, with 41% in small business loans (SBL) and 37% in vehicle and home loans, both of which have shown better credit performance than group microloans.
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However, the SBL portfolio’s Micro-Loan Against Property (MLAP) subsegment has a slightly higher NPA rate, though the credit cost remains low due to its secured nature.
Valuations
The valuation gap among these stocks reveals an interesting contrast. CAG and Arman, with higher MFI exposure, trade at a premium compared to Ujjivan and Equitas, possibly reflecting their historical resilience in crises and higher profitability. However, the gap may also stem from the fundamental differences in loan book composition, raising questions about the appropriateness of these comparisons.
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For more such analysis, read Profit Pulse.
In summary, these four stocks—Equitas, Ujjivan, CAG, and Arman Financial—are worth tracking as the microfinance sector adapts in the coming quarters.
Note: This article relies on data from www.screener.in, www.tijorifinance.com, and www.tradingview.com. Where this data was unavailable, we used alternative, widely accepted sources.
The purpose of this article is to share insightful charts, data points, and thought-provoking opinions. It is NOT an investment recommendation. For investment decisions, please consult your financial advisor. This article is intended strictly for educational purposes.
About the author: Rahul Rao has been investing since 2014. He has conducted financial literacy programmes for over 150,000 investors, helped set up a family office for a 50-year-old conglomerate, and worked at an AIF, focusing on small- and mid-cap opportunities. His stock evaluation is grounded in an evidence-based, first-principles approach rather than market narratives.
Disclosure: The author and their dependents do not hold any of the stocks, commodities, cryptos, or other assets discussed in this article.
