Ujjivan Small Finance Bank Annual Report FY11 Notes

This is the fifth post of the series, where I will share notes taken by me while reading the annual reports of this business. I will be sharing an excel sheet at the end of the series which will capture all the relevant data throughout the years of its operation. Notes will mostly contain intangible non-financial data which will reveal subjective characteristics of the business and management. I have restrained from adding my comments and recommendations on specific subjects as I do not want to introduce my biases in this exercise. Shorthand abbreviations are used from time to time and should be logical. For any clarification, please use the comments section. This is not a buy or sell stock recommendation, just an exercise in researching and understanding the business.

In India's top 15 as best companies to work for, no. 1 in MFI for 2011.

Letter from MD

Quotes WB - When the tide goes out we see who is swimming naked.

Was invited to FOROMIC, annual MFI conference in LATAM, where MF is over 40 years old. They were astonished at the magnitude scale achieved in 6 years in India. All hell broke loose in AP. Studying a report shared in the conference which explains root causes of our crisis and provides directions for the future. LATAM has been through and survived such events. Had written in the letter last year about poor business practices of MFIs.

There was a liquidity crisis as bank funding dried up. Prioritized outflows in OPEX, interest payments and serving good customers. SIDBI, Developing World Markets and IDBI provided fresh funding. Protecting portfolio from collateral damage was the 2nd priority though we didn't have any exposure to AP. Faced problems in some pockets in TN and WB. The problem was that excessive MFI competition evaporated and over-indebted customers started to default. We worked on a branch by branch recovery program.

3rd priority was managing the employees as major MFIs were struggling and negative publicity from media made our staff insecure about their future.

New regulations were being adopted from Malegam committee by RBI, Andhra Ordinance was a blow. Had to lobby so that over-regulation does not kill the sector.

Through the crisis continued our social development programs at the branch level. Our programs and initiatives with the Parinaam foundation have helped us develop a unique bond with the community where we work. This was in stark difference with what was evident in AP where MFI relationship with customers has reduced to that of just another money lender.

RBI regulations are better than the Malegam committee recommendations. New regulations will put a lot of pressure on margins and profitability. We need to bring our OPEX down significantly. Working on rationalizing branch structure and increase efficiency in field staff.

Customer dropout rates are at 20-25% pa at an industry level which is a setback to the viability and our mission. Have identified and instituted changes to cut the rate to 10%.

Days of easy money are over. Bank and PE funding are drying up.  Customer Security Deposit is now closed.

§Customer suicides resulting from over-indebtedness and coercive collection practices were the biggest reasons for the debacle of the sector. This is an area that needs to be urgently addressed if we are to survive. First, the 'joint liability group JLG system' creates enormous social pressure in higher loan cycles needs to be phased out. This is a lesson not only from India but also from Bangladesh where it was removed over a decade ago. We have already started working on phasing our the JLG system.

We are revising our staff incentive structure. Working with MFIN to share customer data with credit bureaus but it will take a couple of years to be effective. Over-indebtedness needs to be solved by the customer and MFIs. We have introduced financial literacy programs for the customer to manage their debt and even though it is very well received its impact will be in the LT.

Developing additional business channels which will allow us to serve our customers outside the purview of regulations. The individual lending business is one such major initiative to build over next few years.

MF can only succeed if it becomes a full-service provider to the poor segment. MFIs have to become self-funded through their customer deposits. In other countries where MF sector is more mature, this is the direction where it has evolved. Setting up of NBFC-MFI as a separate category by RBI and announcement by MoF for separate banking licenses with focus on financial inclusion are clear pointers. The path is littered with obstacles but the LT direction is clear.

Goals:

• Provide a full range of financial services required by the customers


• Build an institution which is best in class in all aspects: customer service, innovation, efficiency, workplace engagement, leadership, governance and reputation


• Operate a viable business to provide satisfactory returns for investors


• Provide professionally rewarding careers to employees and, attract and retain quality talent


• Holistically approach poverty reduction, in partnership with Parinaam Foundation, through social welfare; healthcare, education, vocational training, community development, shelter, and disaster relief, to enable customers to lead a “better life”.

Won the Srijan MFI Transparency Award 2010. Gold award for Social Performance Reporting from CGAP, MSDF, and SPTF. Awarded certificate of Recognition for being a global industry pioneer by participating in the India Transparency Pricing Initiative.

Credit policies were proactively tightened in the form of strict outside borrowing norms, lower loan and credit exposure limits in states where multiple borrowings were seen as a concern. Over-indebted customers who were revolving their loans faced a serious cash crunch as the number of active MFIs reduced. PAR grew rapidly in southern districts in WB, north TN, and some pockets in Odisha and Jharkhand. We have continued to lend to customers with strong credit discipline in these areas. A targeted rescheduling program has been launched to help needy customers overcome temporary financial setbacks.

With support from Parinaam Foundation, Ujjivan’s investments in local communities through social development programs, have helped it distinguish itself in the minds of the customer contributing to successful collection efforts.

The credit evaluation process includes an independent review of applications and a back-end credit check. Going forward, this process will be supplemented with a credit bureau check. Ujjivan is now a member of both Highmark and CIBIL. A pilot with three branches is currently underway in partnership with Highmark. This is expected to ramp up to cover all branches by the end of 2011. In addition, steps have been initiated to strengthen back-end data infrastructure, credit monitoring processes and analytical frameworks to detect trends in branch credit performance and initiate timely corrective action.

Credit write-offs during the year amounted to Rs. 7.4 Million. This includes accounts involving customers who are dead, absconding, facing serious financial hardships, or where all collection efforts have been exhausted. All write-off decisions are supported by comprehensive documentation of collection efforts by branch management and supervisors and independently vetted by credit and vigilance resources. The vast majority of these loans are overdue for more than 180 days. Ujjivan follows provisioning norms that are conservative relative to current regulatory requirements.

Our provisioning norms will continue to be in line with or more conservative than those proposed by the Malegam committee on the MFI sector.

Introduced a financial literacy program for debt management, with addresses end consequences of excessive borrowing, sub/ghost lending and future impact of the credit bureau.

Working on service quality programs, with one of them being CRM being a single point of contact for the customer at the branch. Average credit error rate with a CRM dropped from 18% to 5% this year. Introduced exit interview process for customers to get feedback. These feedbacks resulted in, bigger group sizes, reducing center meeting frequency and revising the joint liability model. Introduced dedicated help desks for each region to improve efficiency and time utilization of operating staff.

Instituted a Service Champion award for employees who did outstanding work.

Ujjivan is the first MFI to have undergone an in-depth Client Protection Assessment under the SIDBI and the Smart Campaign Partnership Project in India on Responsible Financing. We scored highly across the parameters. In the current market environment where there is a severe criticism of MFIs in public media, it was especially heartening to receive high scores on parameters of ‘ethical staff behaviour’ and ‘appropriate collection practices’. This is indeed a matter of great pride and satisfaction, for it reasserts that these principles are not just guidelines, but are actually reflected in the actions of each employee.

We are one of the very few MFIs who received funding and managed to maintain a sound liquidity position when the industry as a whole was facing a liquidity crunch.

Ujjivan enjoys a +ve ALM on account of its receivables tenure being of shorter duration than it borrowing tenure. Leverage ratio at 4.5x.

MD&A

Ujjivan is the only MFI which after its first year of profitable operations in 2009-10 voluntarily reduced interest rates by 1.9 - 2.9% p.a. across the board on all its loans effective July 1, 2010. The interest rates on our loan products for our group lending customers (99% of our portfolio) range between 22 to 25% p.a.

Endorses the view of the regulator that MFIs are social enterprises that should pass on the benefits of scale to customers in some way. Top 5 states contribute 67% of the loan book. Are the largest MFI in Mumbai.

Started the Mature Branch initiative for branches which cross 12 months of operations or 2500 customer base to groom them into a stable profitable business unit.

The microfinance sector faced its biggest crisis since inception, from October 2010. There was tremendous pressure due to the crisis in Andhra Pradesh and the harsh stance of the state government Ordinance. The entire industry received a backlash in terms of the ruthless media questioning the very sanctity of the microfinance and the banks shutting down funding. The political vulnerability was at its peak, affecting the entire sector.

In January 2011, the RBI-appointed Malegam Committee came out with a set of recommendations which again triggered a debate. During this entire phase, banks and financial institutions, with minimal sanctions/ disbursements, virtually shut the fund's flow. The Priority Sector Lending (PSL) status for their lending was also awaiting clarity and affirmation. The Monetary Policy released on 3rd May 2011 and the subsequent notification to Banks on PSL status for bank loans to MFIs has substantially eased the uncertainty for the sector.Although there are a lot of logistics issues in terms of uncertainty of implementation, review processes, confirmations, and verifications, the clear specifications on lending rates and processing fees have enabled MFIs to have greater clarity. Ujjivan has aligned itself on these key parameters of the RBI Regulations and is well set to ensure all compliances as may be relevant for NBFC MFIs. The next two years are going to be a period of consolidation for the sector. Institutions including Ujjivan will have to make a number of fundamental changes in the way we operate under the new regulatory environment.

Our priorities are to:

1. become more efficient and bring down our operating costs;

2. retain our customers;

3. phase out the joint liability system and develop the individual lending business;

4. develop better customer & community connect.

Introduced internationally practised Microsave's Loan Portfolio Audit Process. The audit also prepares a branch risk profile which helps set the periodicity of audits among other things as well.

Equity shares of FV 100 were subdivided into FV of 10.