From The CGAP Microfinance Blog
Risks Facing Indian Microfinance Companies and equity valuation of Microfinance Companies
By Xavier Reille who leads the CGAP’s Transparency Team
I was particularly interested in Intellecap’s December 2008 survey on the major risks facing the commercial microfinance sector in India. Overall, liquidity risks ranked first, over indebtedness due to multiple borrowing was second, and high cost of debts came in third. Investors and lenders emphasize internal risks (inadequacies of internal control, fast growth), and CEOs of MFIs emphasize external risks (refunding risk mainly)—a key risk to watch in the short term.
Why do CEOs of MFIs see over indebtedness as one of their main worries? India is definitely a large and young market, but MFI CEOs seem to be increasingly worried about the level of competition and indebtedness of their clients. Over indebtedness does not necessarily translate into credit risk because clients might need to borrow from several sources to get higher loans to fund their business. However, it is a source of concern in an environment without a credit information system, and it might be an early warning of upcoming credit risk. High-growth MFIs with substandard loan underwriting processes,and lax group formation and training policies may be particularly vulnerable, as we have seen in Morocco. This is definitely another topic to watch in 2009.
I didn’t have a chance to discuss the topic with commercial MFI CEOs but was surprised by the importance of group lending in India. While group lending is a good entry product, it has also shown several limitations in other markets. I would be like to learn more about MFI risk management techniques for group lending and product diversification plans.
Finally, I was not able to crack the equity valuation mystery. According to a soon-to-be-released survey conducted by CGAP and J.P. Morgan, the median price for private transactions is 1.9x book, but Indian MFIs are trading at 6x book value, 3 times more than the market median. What can justify such high valuation? While MFIs offer high growth potential, first-class management and systems, and attractive opportunities for IPOs on the local market, the earning prospects alone can’t justify such a level of valuation. Are MFI distribution platforms strategic acquisition targets for large equity investors ?