Ujjivan Small Finance Bank Annual Report FY09 Notes

This is the third 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.

Letter from MD

Business Snapshot

Ranked 1st as the best co. to work for in MF Industry by the "The Great Place to Work Institute" and ET.

We achieved a month on month break-even in January 2009 and in the last quarter of the financial year. The major regions (South & East) have already broken even and as of May 31, 2009, 96 out of 145 branches (66%) were profitable on a fully allocated basis. We expect to clear our accumulated losses within the third quarter of the financial year 2009-2010.

Ujjivan has entered seven new states, started a new regional office in Pune, opened 90 branches all over India, acquired over 2,20,000 customers and disbursed about Rs. 250 Crores to the urban and semi-urban poor in India.

While our South operations are currently the largest, we have significantly expanded our operations in other regions so that our risk is diversified. We are now present in twelve states across India: Karnataka, Tamil Nadu, New Delhi, West Bengal, Rajasthan, Uttar Pradesh, Haryana, Jharkhand, Orissa, Maharashtra, Bihar, and most recently Uttarakhand.

Products

Ujjivan has successfully completed its one year-long pilot of the Individual Business Loan (IBL) with the guidance and support from Women's World Banking, and after review and revision, it has launched the product in 10 different branches across Urban and Semi-Urban Karnataka. Individual business loans ranging from Rs 10,000 - 50,000 are being offered to existing Ujjivan customers and their family members who have a running business and require funds for working capital and/or capital investment. Ujjivan intends on launching IBL in over 30 branches in the South region and 20 branches in the East region in the coming financial year.

Ujjivan launched the education loan nationwide this year to cater to the needs of our customers' children. There are typically three types of expenses that customers incur: annual/monthly education fees, uniforms, and textbooks.

For many of our semi-urban customers, our group loans are not large enough to cover the full outlay for purchasing cows/buffalo essential to their livelihoods and they resort to expensive borrowing for the remaining portion. We are conducting a pilot of the Livestock Loan, in which we evaluate the value of the animal they wish to purchase and give them a loan to buy the animal. We plan to roll this product out to all relevant regions in the coming financial year.

Life Insurance

It is mandatory for all Ujjivan's customers to be covered with life insurance. We were previously partnering with Life Insurance Corporation (LIC) to provide this coverage, but due to the high cost of servicing customers from beginning to end and negligible reimbursement, we found that this scheme was not sustainable given our expansive and rapid growth plans. After evaluating a number of options, we have moved forward and are now providing life insurance coverage through ICICI Prudential to all our customers with the option to cover their spouses. With minimal documentation requirements, quick turnaround time on claims, and reimbursement of expenses incurred, Ujjivan has started providing higher quality insurance services to its customers.

MF Plus

Ujjivan works with different NGOs to provide check ups, treatments, vocational training programs, childcare support, financial literacy and social development to bring these families to a more manageable level of poverty for the ultra poor beyond the scope of MF services. End goal is to migrate these families to MF services.

Processes and Procedures

Ujjivan was awarded the Microfinance Process Excellence Award in the South region in the mature company category after an extensive application and evaluation process.

Ujjivan has begun giving each individual customer a loan agreement outlining all of the terms and conditions of the loan they have availed per the RBI's Fair Practice Code.

One challenge Ujjivan faced in the last financial year was acquiring customers outside of our target profile. This year we focused on putting controls in place to ensure that we are acquiring customers who fit our requirements. We recognize that financial data can be very subjective when first meeting a customer, so we have begun using non-financial parameters like housing conditions, occupation, and lifestyle (assets) to assess both their need and repayment capacity. Using these parameters, our Distribution Supervisory Team approves first loans in the field. This also enables us to reduce our turnaround time, resulting in higher quality and faster service for our customers.

In an effort to maintain high levels of customer interaction, we have instituted bi-monthly center leader meetings across all branches. Every two months, all the center leaders are invited to the branch to meet with the CRM and departmental representatives from the Regional Office. This creates a forum for center leaders to meet each other, get updated on all Ujjivan news, policies and procedures, discuss any issues that have arisen in their areas and give feedback/suggestions.

Capital

Ujjivan completed its fourth round of capital raising, during which we brought in four new investors: Sequoia Capital India Investments III, Lok Capital LLC, Elevar Unitus Corporation and India Financial Inclusion Fund.

Originally planning for Rs. 75 Crores, we were oversubscribed and raised Rs. 87.8 Crores in total. Ujjivan's ability to attract high-quality investors and to be oversubscribed during a period when the world was going through one of the gravest financial crises of recent times is a testament to the future of microfinance in India. A unique feature of this deal was that Ujjivan, in collaboration with Bellwether Microfinance Fund and UEF, was able to give its individual investors the option of liquidity by offering to buy out part or all of their investment in Ujjivan. This is the first time a microfinance institution has been able to offer a market determined exit to individual investors, which will create a secondary market for shares of microfinance companies.

Human Resources

A total of 204 employees from all regions were eligible under the ESOP 2008 Plan. The total number of options granted under the ESOP 2008 Plan is 39,668. 1st batch of management trainees completed one year at the co.

Working on special training programs to improve managerial, leadership, interpersonal skills of employees.

MF Industry

Over 10,000,000 customers are served by MFIs. At least half a dozen NBFC-MFIs have a million plus customers, and two dozen NBFC-MFIs would be categorized by the RBI as 'systemically important' with an asset base over Rs.100 Crores.

Perversely, another acknowledgment of the coming of age of microfinance is the problems currently faced in Karnataka. The impact of microfinance is being felt among the poor Muslim communities where women have been extremely tradition bound. With half a dozen MFIs aggressively serving these markets in the silk growing districts of Karnataka, the women are not only freeing themselves from the clutches of money lenders but also from employers in the silk reeling business where working conditions are abhorrent. The vested interest is now striking back under the guise of communal threat, and confrontations like these will become the norm. It is important for the microfinance industry to keep the administration, press, politicians, regulators and society at large well informed and on our side.

Even though the un-served market is 80% or more, multiple MFIs are competing increasingly in narrow trenches. This is also leading to problems of over lending to customers. Additionally, the down turn in the economy will have a particular impact on the urban and semi-urban customers, leading to deterioration of portfolio quality. This calls for more disciplined growth in terms of branch expansion and credit extension. MFIs will have to look for virgin markets to extend their branch networks and they will need to put in place credit extension policies where they protect the customers in danger of over borrowing. Group liability, abandoned by Grameen Bank close to a decade ago, is religiously practiced by MFIs in India. This practice will come under severe strain. Unsavory collection practices will not be accepted and MFIs with these practices will be targeted by customers. MFIs will have to institute client protection measures as customers will also demand product differentiation and good customer service.

Finally, Sa-Dhan will have to evolve into an industry organization like the Confederation of Indian Industries or the Indian Bank's Association. Its role will have to be transformed to a Self Regulatory Organization and a full fledged industry organization that lobbies with other regulators and government.

Looking Forward

As microfinance has spread so quickly across India, one of the biggest challenges is multiple lending by aggressive microfinance institutions. As an industry, we are working to combat these problems through education of our customers and communication amongst each other. As a company, Ujjivan is putting in place strict controls with respect to area and customer selection to ensure that we are helping customers and not propagating over-indebtedness.

The largest need of our customers is a savings facility, which we are currently not allowed to provide them due to RBI Act Section 45 (bb). Ujjivan and other MFIs hope to work with the regulatory bodies to find a solution to this problem and begin providing a safe and secure vehicle for customers to make small savings of Rs. 10-20 per week.

Ujjivan recognizes that technology is important in increasing operational efficiencies and plans to introduce a variety of initiatives to enable field staff to serve customers more efficiently. We are implementing an ERP core banking system that is customized for Ujjivan's specific operations and in conjunction, implementing open source/Linux technology at all of our branches. We will be setting up a document management system incorporating scanning and digital imaging to increase work flow & storage/retrieval efficiencies. Also in the pipeline are SMS & mobile technology to accelerate operational processes as well as GIS technology to map and better manage our branches and centers.

Ujjivan believes that in addition to its financial shareholders, its customers and staff have a stake in the company. As a social enterprise, in addition to our 'financial' bottom line, Ujjivan has planned for a 'social' bottom line as well. After achieving annual financial break-even, we will provide 10% of Profit after Taxes (PAT) and dividends payable as a budget in the following financial year towards programs for poverty alleviation for customers and their immediate family members, which will be increased to 20% per annum thereafter. Given that many of our staff are from the same economic background as our customers, we will also set aside 5% of PAT and dividends payable for the staff (excluding officers) and immediate family members, which will be increased to 10% per annum thereafter.

Company Profile

Ujjivan is a Grameen replicator and applies the Grameen model that has been tried and tested over a period of almost 30 years. Ujjivan adopts the most effective microfinance and banking methodologies and modifies them to suit our operations.

Same goals as last year.

Customer Profile

79% self employed, 21 salaried.

Top 10 Occupations

Tailors, Maids, Flower Vendors, Vegetable Vendors, Embroidery workers, saree sellers, beedi rollers, factory workers, agarbatti worker and petty shop owners.

Average Loan Size:

FY06 - 8000, FY07 - 12000, FY08 - 14000, FY09 - 19000

Most customers fall in the 6000 - 10000 household income range with per capita income range of 1250 - 2500. Majority of customers are in 21 to 50 years old range.

AR is full of testimonials, life stories from customers and employees.

Loan book at 16.89 cr.

Ujjivan is proud to be the sole representative of the microfinance institutions in India on the international steering committee for the Campaign for Client Protection in Microfinance initiated by Accion International and CGAP (World Bank).

Risks: Portfolio quality under the present difficult economic environment. Portfolio quality under the present difficult economic environment. Cash handling.

Depreciation accounting policy changed from written down value to straight line method. Resulted in depreciation reversal of 30.618 lacs. D&A FY09 is lower by 40.7 lacs and loss this year is lower by 71.33 lacs.

No Contingent liabilities. Actuarial assumptions for employee benefit plans are not aggressive.

Auditor fee has doubled but so has the size of the organization.

ESOPS

The exercise price noted by the ESOP Committee is the par value of Rs. 100/- if the Company's net profit after tax is a loss number on the date of allotment. Thus there is no stock compensation expense under the intrinsic value method for the options granted.

The guidance note issued by the Institute of Chartered Accountants of India requires the disclosure of pro forma net results and Earnings Per Share (EPS) both basic & diluted, had the Company adopted the fair value method. Had the Company accounted the option under fair value method, amortising the stock compensation expense there on over the vesting period, there would have been no impact on the reported loss and the basic EPS and the effect on diluted EPS being anti-dilutive has been ignored. The fair value of the stock option granted during the period is calculated at Rs. 9.65 per option through the use of option pricing models, requiring subjective assumptions which greatly affect the calculated values

Company has changed its estimate with regard to provisioning for non performing assets, which has resulted in provision being lower by Rs. 487,565/- and loss for the period is lower to such extent.