Spate Of Defaults In Microfinance Securitisation Transactions Raises Concern
Defaults in microfinance securitisation transactions highlight the need for greater caution in evaluating them.
Recent defaults in seven microfinance securitisation transactions with an initial senior-class pass through certificate amount of Rs 849.34 crore and an initial rating predominantly in the ‘A’ category have again highlighted the need for greater caution in evaluating the microfinance loan securitisation, according to India Ratings and Research.
As the principal payment is promised on the final maturity date, losses were getting postponed. These losses accumulated in the range of 2.8-3.1 percent for senior class and nearly 100 percent for the junior class of Rs 45.73 crore, which was rated in the ‘BBB’/‘BB’ category.
Volatile Loan Performance Warrants Differentiated Treatment
The similarity of borrowers from microfinance institutions (MFIs), in terms of their vulnerability to socio political events, financial literacy and credit behaviour, renders the microfinance sector susceptible to any kind of adverse idiosyncratic event and more so in case of a system-wide event such as demonetisation.
Thus, the microfinance sector has shown a volatile loan performance despite a low average historical default rate. India Ratings highlighted the volatility in the performance of MFI loans compared with other asset classes in its report PSBs’ Reliance on Portfolio Acquisition from NBFCs.
India Ratings factors in the high volatility of the microfinance loan asset class in its model, reflected through the robust performance of India Ratings’ rated microfinance transactions, which have not experienced a default and have majorly retained their initial ratings, even after demonetisation.
Protection Against Defaults Dependent On Performance Of Underlying Pool Itself
In the case of the securitisation of a microfinance pool, internal credit enhancement (CE), which is a part of cash flows from the pool, forms 70-80 percent of the total CE. On the other hand, in the case of pools of other asset classes, internal CE is between 55 percent and 60 percent of the total CE.
However, the 70-80 percent internal CE is contingent on the robust performance of the securitised pool itself. Hence, in case of defaults in the underlying pool, it may be of little help to safeguard investors against losses.
Issuer-Specific Underwriting Quality Needs To Be Factored In Analysis
India Ratings, however, believes that demonetisation alone cannot be blamed for the defaults, as these defaults are largely concentrated to specific geographies and have not affected on-balance sheet liabilities of the issuers.
The sector was already facing challenges in terms of borrower overleveraging, which was highlighted in Microfinance: Borrower Over leverage Warrants Course Correction from MFIs. Moreover, demonetisation exposed the weaknesses in the underwriting standards of some issuers.
For the quarter ended September 2016, the aggregate gross loan portfolio of MFIs grew 84 percent YoY and the average loan outstanding per borrower increased 19 percent YoY. High growth in some of the MFIs’ loan book prior to demonetisation may have come at the cost of deterioration in underwriting standards.
India Ratings places utmost importance in understanding issuer origination experience through several cycles and suitably factors any negative deviation in underwriting standards.
On-Balance Sheet Debt Versus Securitisation
High capital buffers and the ability to raise capital to mitigate the impact of demonetisation enabled MFIs to maintain their ratings and led to no losses on the balance sheet debt. On the other hand, because of the bankruptcy remoteness of a securitisation transaction, any support beyond initially provided CE is not allowed in such transactions.
Hence, quite a few of them suffered losses. Additionally, balance sheet debt benefited from timely regulatory intervention by the Reserve Bank of India, which delayed the provisioning post demonetisation.
Securitisation transactions typically do not have such benefits. Hence,factoring in an extreme event risk in CE sizing becomes all the more important.
Direct Assignment Of MFI Loans Is A Riskier Affair
As on 31 December 2017, about 17 percent of the gross loan portfolio of NBFC-MFIs was classified as off-balance sheet items. About 27 percent of the off-balance sheet portfolio is in the form of direct assignment securitisation transactions.
Such transactions are without any CE. Hence, chances of realised losses in such transactions are quite likely to exceed the initial expectation, as is the case with the defaults observed in the seven transactions, which resulted in a loss given default of 8-9 percent of the securitised pools.
Delinquency Stabilising Post Demonetisation
As mentioned in FY19 Outlook: Structured Finance, weighted average 0+dpd for MFI loan pools dropped to 6.29 percent in December 2017 from the peak of 12 percent in December 2016 during demonetisation.
The collection efficiency for India Ratings-rated MFI transactions has improved since December 2016. India Ratings expects issuers to use this opportunity to tighten underwriting standards and investors to ask for deeper portfolio performance information and undertake greater due diligence.
India Ratings and Research, a wholly owned subsidiary of Fitch Group, is a SEBI and RBI accredited credit rating agency operating in the Indian credit market.