Micro, small, and medium enterprises (MSMEs) are one of the backbones of economic development in India. There are over 6 crores of MSMEs in the country contributing roughly 30% to the GDP and employing over 11 crores of people. Unfortunately, these enterprises lack access to the right kind of debt.
As per World Bank and International Finance Corporation estimates, Indian MSMEs account for a credit share of 6%-7% and face a credit gap of nearly US$400 billion with formal lending sources addressing only ~US$150 billion of financing needs.
The credit gap can be attributed to the vicious cycle that MSMEs face. Many are reluctant to finance MSMEs because it’s difficult to assess their creditworthiness due to a lack of good credit history while they can’t establish a good credit history due to the reluctance of the lenders.
The huge credit gap is making debt expensive for MSMEs, which are lying between large corporates widely funded by formal lenders and bottom players being served by microfinance institutions. The reduction in the credit gap will not only help these enterprises scale up their businesses and increase their competitive edge but also lead to their formalization in the economy
Securitisation of Small Business Loans (SBL)
Securitisation of SBL could be an alternative and effective source of funding for small finance companies to reduce the credit gap in the MSME sector. The profile of borrowers in such ABS pools are small/medium industrial units mainly engaged in tertiary activities like auto ancillary, plastic makers, power looms, etc., and individuals running small businesses in essential services like medical shops, dairy units, Kirana shops, etc.
So far, the share of SBL securitisation volumes in the overall market has been minuscule due to difficulties in assessing the risk of the MSME portfolio for securitisation. Also, there has been a persistent decline in the share of SBL volumes from the onset of the pandemic in FY20, as the below chart suggests, due to rising perceived risk about the asset class.
As per Kiran Agarwal Todi, CFO, Ashv Finance, “The first wave in FY21 and second wave in H1FY22 have impacted securitisation volumes across the asset classes largely because there were concerns on the collection efficiency of these assets due to massive disruption in economic activities. However, the volumes have picked up starting Q3 of FY22 and consistently improved over Q4 FY22. There was almost a 50% rise in the volumes of securitisation of SBL pools in FY22 over FY21.”
Considering only PTCs, it is to be noted that pools in the upper band of the rating scale mostly comprise secured business loans, also known as LAP, as they are secured by either residential mortgages or business premises owned by borrowers. However, pools in the lower band of the scale predominantly comprise unsecured loans. “At A and BBB rating categories, the proportion of unsecured business loans could be anywhere in the range of 50%-70% and it is much higher in the below-rated pools. As this proportion reduces, the rating profile gets better for the pool. At AA rating and above, the proportion of unsecured business loans would be south of 25%”, said Todi.
The below diagram shows how the market is divided between the key players as per the nature of underlying loans and issuer ratings.
Considering only PTCs, SBL securitisation volumes stood at ~INR 2,000 crores during FY22 compared with the overall PTC volumes of ~INR 56,000 crores in the market during the same period.
When it comes to pricing, there is a wide disparity seen at the lower end of the rating scale than that at the upper end for pools during the settlement period of FY22. Deepak Goswami, CFO, NeoGrowth Credit, said “NeoGrowth has observed the disparity in pricing, which has so far been driven by the type of investor an NBFC can attract on the basis of the rating of the company and the pool.”
Performance of SBL pools
The performance of SBL pools remained largely stable before the pandemic. As the pandemic was hit, the cash flow cycle of underlying borrowers in the pools was disrupted leading to a dip in collections during the moratorium period of Mar-May 2020. As the lockdown was eased, a pickup in collection efficiency was noted over Jun-Sep 2020 as most of the borrowers were involved in the businesses of essential services in semi-urban and rural areas. The median collection ratio (MCR) was improved further and peaked at ~100% in Mar 2021, which is generally the highest month of collections in a fiscal year.
The MCR again got impacted during the second wave as both borrowers and employees of lenders got impacted hampering the collection efficiency. This led MCR to reduce to ~80% in Jun 2021. As the lockdowns eased, collections started improving and climbed to 90% and beyond after Aug 2021 finally hitting ~100% in Mar 2022. This whole trajectory of MCR has been captured in the image below.
“The quality of the portfolio originated during and post-Covid along with the macro-economic factors will largely determine the future performance of pools”, said Goswami. Although various government schemes like Emergency Credit Line Guarantee Scheme (ECLGS) and Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) have provided support to MSMEs in general to fix temporary cash flow mismatches, most of the rated pools possess inherent strength to sustain the stable performance unless black swan risks like Covid-19 strike. “The continued focus on collections, uninterrupted business activities, and continuity of stringent norms for onboarding the MSME customer will play a significant role in the future performance of SBL pools”, said Todi.
The views provided in this blog are the personal views of the author and do not necessarily reflect the views of Vivriti. This article is intended for general information only and does not constitute any legal or other advice or suggestion. This article does not constitute an offer or an invitation to make an offer for any investment.