Microfinance mayhem: This MFI ​could have ​‘going concern’ issues

In August 2023, the stock peaked at Rs​ ​692​ per ​​​share.

As of the last closing, it was down 75% to Rs​​ 174​ ​​per ​share. Its current price-to-book value is 0.69X.

View Full Image

If having a well-reputed private equity player as promoter was any comfort that the business would do well, Fusion Microfinance would be among the lesser impacted MFIs in the recent MFI blowup. The opposite is true for Fusion Finance Ltd.

On 15 November 2024, Fusion’s auditor Deloitte Haskins & Sells said in a report that pointed to the “Existence of material uncertainty that may cast significant doubt on the company’s ability to continue as a going concern”.

​​It’s not news that the microfinance sector is in mayhem mode but players like Fusion are among the worst of the. ​​The gross non performing assets (GNPA) increased from 2.9% in March 2024 to 9.4% in September 2024. This is about two-three times higher than the top four players in the industry. ​​​

Major MFI players – Gross Non Performing Assets (%)

View Full Image

According to Crisil’s credit rating report, its annualized credit cost increased to 16.4% as of Q2FY25 from 3.1% in FY24. Even Icra downgraded the stock on November 26th 2024, because the company had breached loan covenants on Rs​ ​ 5618 crore worth of loans.

Loan covenants are rules or conditions a borrower agrees to follow when taking a loan from a lender. These include operating, financial and credit rating metrics that are included in the loan agreement to protect the lender.

Breaching loan covenants, the “material uncertainty event” alluded to earlier, gives lenders the right to demand repayment of loans earlier than required normally. Given the circumstances, raising additional capital was inevitable.

In October 2024, Fusion announced plans to raise Rs​ ​550 crore. However, in December the company announced that it will raise Rs​ ​800 crore, not ₹550 crore that it originally planned for, signaling increasing stress. But could there be a silver lining?

Also Read| Microfinance in doldrums. Will this company outperform, again?

A question of survival

Firstly, these technical breaches are ‘temporary in nature’. In Q1FY25, Fusion was granted “all the waivers” and the company “believes that similar waivers will be granted further too”.

Secondly, Fusion’s board has also approved an equity raise of up to ₹800 crore through a partly paid rights issue. This means subscribers to the rights issue are expected to contribute only a fraction of the total amount initially. Up to 20% of this amount, equalling ₹160 crore, can also be raised through a preferential equity route. The promoters, including Honey Rose Investments have expressed support and have “undertaken to ensure the success of the rights issue”. ​ ​​If this funding comes through, ​​​​it could ​ensure that the lender will not go belly up, at least for now.

Third, there’s been an improvement in the percentage of accounts​ at Fusion​ which had existing loans with over three lenders. In March 2024, 47.4% of the total customer​s​ had loans with four or more lenders, including ​ ​​Fusion​. This number has reduced to 31.4% as of September 2024 quarter end. On an absolute basis this is still high, but the downward trend is encouraging.

Fourth, a low price-to-book value of 0.7X may be attractive. If book value was stable, this would offer an attractive entry valuation, but the book value (the denominator in P/B) is itself in question. Since lending is a leveraged business, losses are magnified. At 3X leverage, a 10% AUM—assets under management turning into NPAs means 3X, i.e. 30% of the equity capital will get erased.

The fact that Fusion is raising ​ ₹​800 crore, that is approximately 30% of current net worth ( ₹​2​,​522 crore), signals that the MFI expects at least another 10% of loan book to slip into NPA. It’s always possible that the company is simply fortifying its balance sheet to signal strength. 

Also Read: Microfinance meltdown: Five stocks that could come out on top

Could this be an investment opportunity?

We have written earlier that in an industry fraught with frequently recurring risks, sticking to higher-quality players is key. ​As things stand now, ​Fusion does not qualify as ‘high quality’ in our definition. Despite that, more certainty on delinquencies and AUM growth pickup over the next few quarters might make this an interesting opportunity.

The reason is that most lenders follow a peculiar pattern. When bad loans rise, it creates uncertainty, which prompts most lenders to stop disbursals. Lower disbursals mean lower AUM growth. So, while bad loans are mounting, AUM growth is stagnant. This leads to an even higher GNPA ratio. It’s a vicious circle.

Also Read: Microfinance comes crashing again. Two stocks could buck the trend.

On the flipside, when the future looks more certain, lenders begin disbursing again and a high AUM growth combined with lower fresh NPA accretion leads to exponential increases in profits. This ensures that booms and busts are choppy and sharp. This is especially true for MFIs.

We believe the ongoing MFI crisis brought on by overleveraging is far from over. Fusion Finance Ltd is likely to see higher delinquencies over the next few quarters but promoter’s intention to support the rights issue offers reasonable comfort that the lender will survive, at least for now. ​It may be a good idea to ​​ ​wait and watc​h how this plays out​​ ​.

For more such analysis, read Profit Pulse.

Note: We have relied on data from www.Screener.in and www.tijorifinance.com throughout this article. Only in cases where the data was not available, have we used an alternate, but widely used and accepted source of information. 

The purpose of this article is only to share interesting charts, data points and thought-provoking opinions. It is NOT a recommendation. If you wish to consider an investment, you are strongly advised to consult your advisor. This article is strictly for educational purposes only. 

Rahul Rao has been Investing since 2014. He has helped conduct financial literacy programs for over 1,50,000 investors. He helped start a family office for a 50-year-old conglomerate and worked at an AIF, focusing on small and mid-cap opportunities. He evaluates stocks using an evidence-based, first-principles approach as opposed to comforting narratives.

Disclosure: The writer and his dependents do not hold the stocks/commodities/cryptos/any other asset discussed in this article.