Ujjivan Financial Services – An Overview

Ujjivan is a micro finance Institute (MFI) is at the cusp of turning into a Small Finance Bank (SFB). It provides loans to sections of the society that is often neglected by banks. Ujjivan started its operations in the year 2005 as a Non-Banking Financial Corporation (NBFC). Its operations are spread across 24 states and union territories covering more than 210 districts. As of mid-2016 it is the only MFI with a  pan India presence. Ujjivan has about 470 branches and is serving more than 30 lakh customers. The company has more than 8,000 employees spread across the country. As of 2016, the loan book of Ujjivan is about Rs. 5400 crores. The company prides in its customer stickiness which is reflected in the fact that 86% of its business comes from repeat customers.

Ujjivan has been funded predominantly by foreign investors. Ujjivan was planning to go for an IPO sometime in 2017. But in 2015, RBI came up with the concept of Small Finance Banks (SFB). Ujjivan saw an opportunity to transition itself from an MFI to an SFB. However, for an SFB, the pre-requisite is that the SFB has to be majority domestic owned. At that time Ujjivan’s foreign ownership was at 91%. This forced the company to go for an IPO in order to reduce the foreign shareholding to less than 50%. The IPO was restricted only to the domestic investors. 1,70,55,277 fresh equity shares and 2,49,68,332 shares from existing shareholders were put for sale in IPO aggregating to 4,20,23,609 shares. The pre-IPO and the IPO sales predominantly saw Insurance and Mutual funds participation. Post IPO, the company has brought down the foreign holding to 54% and plans to bring it down further to the stipulated levels of 49%. As a listed company, Ujjivan can now tap the large domestic capital market for its future capital needs and it no longer needs to depend on large institutional investors. Samit Ghosh is the CEO and MD of the company. Samit is the founder of Ujjivan and has been with the company since its inception. He has over 30 years of banking experience in Citibank, Standard Chartered Bank, HDFC Bank, Bank Muscat.

Business Model for Ujjivan:

The figure below shows how I visualize Ujjivan. This need not be the same as envisaged by the company or RBI or the government.

Let us now look at the business model diagram in detail.

1. Customer Segment: Ujjivan provides loans to customers who are unserved or under-served by the regular public and private sector lenders (like banks). People like Unskilled migrants coming from remote villages, construction workers, daily wage laborers, tailors, petty shop owners, dhobiwalas, dabbawalas, house maids etc form the core customers for Ujjivan. The company predominantly lends to Women.
2. Value Proposition: Currently the available channels for credit, i.e. public and private sector banks do not (or cannot) cater to this customer segment as most of them do not have regular source of income. This customer segment is left to borrow from friends and acquaintances who may charge a very high interest rate. This is where Ujjivan comes into picture. It provides credit at moderate rates of 22-24%. It has a well-defined EMI payment process and is professional enough to treat the customers with dignity and respect which they do not get from the private lenders (like acquaintances). The company also tailors the loans based on the needs of the customer. The loan amounts are tailored, the purpose of the loans are tailored based on customer segment and business needs of people. Additionally the company provides facility to get the loan amount being directly credited to the customer’s account. This eliminates any issues in disbursals. The customer in-turn can directly deposit the EMI. This eliminates issues with intermediates who may eat up the money.
3. Channels: Ujjivan reaches its target customers through its network of branches spread out across India. The employees also visit the customer premise for discussions, follow ups, collections, disbursements etc. Additionally the company has digital channels like phone based support and internet based support.
4. Customer Relationships: In Tier II, Tier III and villages, customers expect a more personal relationship with the company. They expect to be treated with dignity and respect. They also expect the relation to be long lasting as they take repeated small loans for their business needs. If the same employee handles their account then they would be comfortable in dealing with such a person for repeat loans.
5. Revenue Streams: Most of Ujjivan’s customers fall in the Group lending option. A set of people come together and take a joint loan from Ujjivan to meet a business objective. The group acts like a motivator and a collateral to each other in case one of them fails to repay back her share of loan. The second revenue stream is the interest from micro and small enterprise (MSE) loans. These loans are given to customer who have past/present relationship with Ujjivan (ex: they have completed one or two group loans with Ujjivan). MSE loans are more like individual loans given to customers to meet their business needs. The third revenue stream is the interest earned by giving housing loans to customers. There are secured loans backed by collaterals (the house itself). The final revenue stream is the interest earned from loans related to agriculture and animal husbandry. Loans to farmers, milkman, and cattle raisers etc. come under this segment.
6. Key Resources: The key resource required to support Ujjivan’s endeavor are the employees. They are an important link between the company and the customer. The CEO also forms a key resource as his experience, enthusiasm and connections are equally important. The second key resource is the low cost credit. If the company wishes to maintain higher NIMs it needs access to credit at low cost. The third key resource is the IT backbone. Strong hardware and software support is the key to ensure MFI operations are customer friendly, safe, error free, scalable, measurable and replicable across all its branches in India.
7. Key Activity: The key activity for Ujjivan to achieve its value proposition is to lend money to deserving customer. Period.
8. Key Partners: The key partners for Ujjivan are the banks that provide the credit required for lending. Additionally, the venture capitalists, private equity investors, foreign institutional investors are important source of credit. The third set of key partners are the IT vendors (both software and hardware vendors) who help in setting up the backbone of the entire lending ecosystem.
9. Cost Structure: Interest costs are the major operational expense for Ujjivan. Ujjivan takes credit from banks and returns it back with Interest. So the interest is a major expense. The other major expense is the employee cost that includes their salaries, perks, ESOP etc. The third major expense is the IT cost (both hardware and software cost). Additionally the infrastructure cost (branch related expense) also adds up to the cost. The CAPEX costs seem to be limited to branch expansion. These should be minimal as the company can take office space on lease/rent to reduce its CAPEX needs.

Product Categories

Ujiivan has a repertoire of financial products that have broadly been classified into 4 categories.

Category 1: Microfinance (Group Lending):

Among the four major categories, the Microfinance (or group lending) forms a major chunk of lending. The figure below shows the description of each of the lending options under microfinance/group lending. Group lending is like an entry point for any customer into Ujjivan’s world. A new customer has to take a group loan along with his set of trusted people. Based on the repayment record during his stay with Ujjivan, he/she can graduate to the next level which is the Individual Loan (IL) or MSE loans.

Category 2: Micro and Small Enterprise (MSE) Loans:

Once a customer under the “group loan” category shows maturity in repayment of loans, the customer might be promoted to the MSE category. In MSE category, the customer gets a higher loan amount because she has had a relationship with Ujjivan. Ujjivan wants to focus on this category going forward.

Since Ujjivan wants to focus on MSE going forward, it is innovating more products in this area. For unregistered micro enterprises they want to provide unsecured as well as business loans and to registered small enterprises they want to give Unsecured and Secured enterprise loans. A secured overdraft option is being planned as well for small enterprises.

Category 3: Housing Finance:

 Ujjivan provides both secured and unsecured housing finance loans. The loans are provided for home improvements as well as new house construction/purchase. The figure below shows the different options under housing finance.

Category 4: Agriculture and Animal Husbandry Finance:

Agriculture and animal husbandry loans are provided to marginal farmers who do not get loans from the normal credit system. These loans are used for growing crops as well as to buy livestock (like cows, buffaloes) and to construct/repair cattle sheds.

Small Finance Bank (SFB)

Ujjivan’s quest to be a Small Finance Bank was seeded sometime in November of 2014. This is when the journey started. The project might see its first major milestone by the end of FY17. The figure below shows the timelines for Ujjivan’s quest to become an SFB

A bank has many restrictions, for example, a bank has to maintain Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR). This is more or less dead money as it cannot be used for lending. Moreover banks are governed by the priority lending norms. As an MFI a company is not bound by all these rules. In spite of these issues, Ujjivan still wishes to be a Bank (Small Finance bank that is). In the 12th Annual General Body meeting, Samit made some very succinct points on why the company wishes to be a SFB.

• Each state has implemented money lenders act. This act is applied on all money lending institutions other than banks. Since these acts vary state-by-state, MFI business is constantly clouded with uncertainty due to this act.
• For an MFI, its funding is predominantly from banks (wholesale lending). During the Andhra crisis, banks simply stopped lending. This is a death knell for an MFI as they cannot survive without banks agreeing to lend them. So a secure source of money is needed for Ujjivan to sustain its operations.
• NBFCs can only give loans. They cannot take deposits. However banks can take deposits. Deposits act as a source of money. A bank can raise savings bank deposit at a rate as low as 6% and deploy the cash in the business. Since an MFI cannot take deposits, it makes sense to become a bank to tap the low cost funds.
• By becoming a bank, Ujjivan will be able to offer value added products like insurance policies, pension plans, remittances etc.
• By being a bank, Ujivan will be able to provide a deposit account to customers hitherto devoid of such a facility. This inculcates a habit of savings among its customers.
• NBFCs are known to provide innovative products. However banks liberally borrow the idea and ram the idea through their channels thereby high-jacking the idea and leaving the NBFCs in lurch.

The points listed above made me appreciate management’s forethought and acumen. The company has submitted its application to RBI in August 2016 and hopes to get an affirmative response from RBI in due course.  The company plans to start the bank operations by the end of FY17. Within five years Ujjivan wishes to convert itself into a full-fledged bank. Ujjivan shall provide regular features like ATMs, phone banking, internet banking as well as banking correspondents.

In order to satisfy the criteria to be an SFB, Ujjivan will have to open bank branches in many unbanked rural areas. This will require investment moneywise and time wise on these branches. I am expecting the cost to income ratio to shoot up from 53% to more than 60% (even the management is guiding cost to income to be around 61%). Additionally the company will be converting 200 of its 470 odd branches into SFBs. Rest of the branches will be converted into customer touch points.

IT Infrastructure: RBI mandates that a bank have sophisticated software.  Ujjivan has shortlisted the software providers for its SFB adventure. The core banking and treasury operations shall be handled by the trusted “Finacle” software from Infosys. The CRM solution shall be provided by CRM-Next. The mobility solution will be provided by I-Exceed. Comprehensive risk management system shall be provided by SAS. The human resource module is from RAMCO. Oracle is providing the Oracle accounting system where as the hardware is coming from CISCO. With such diverse software and hardware pieces, an integrator is required to piece these up together. Wipro will be the system Integrator who will integrate the entire system.

For its MFI activities, Ujjivan uses many other software. For example, it uses IBM’s Cloud virtualized service recovery software to ensure that its system is backed up and can be restored in minutes if there is a system failure. It also uses handheld devices like tablets and smartphones for customer acquisition, loan processing, repayment collection, fee collection. It uses a document management system called IBM Filenet to move the loan file from one department to another. This is a good thing as technology has replaced the manual file movement between departments. Other than this the company uses other software at different stages of loan processing for example it uses BR.NET for loan processing and disbursement and Indus IC4 for collections management system (to manage over-dues etc.).

Risks and Threats

All companies face risks and threats. Ujjivan is no different. Additionally, being a lending agency, it faces even higher risks. Below are some of the risks that I see for Ujjivan.

• Risk & Threat 1: Non-payment of Loans: Since Ujjivan deals with people of low income and irregular cash flows, the most obvious risk is the risk of non-payment of the EMIs by its customers. This will lead to rising NPAs.
  • A domino effect of this could lead to multiple people not paying back that could result in systemic problem. Ujjivan lends in Tier II, Tier III and villages. If Ujjivan writes off some of the loans and this news spreads in these towns and villages, it might lead to a situation where people will assume that it is OK not to pay and they may default. Since most of the loans by Ujjivan are unsecured loans, I don’t see a way in which the bank can coerce the customers to pay back other than going through litigations.
  • Acts of God: If there is a draught in a particular district and Ujjivan has exposure to farmers in that district then the customers might default even though the farmers are law abiding, well-meaning people. I don’t see any remedy to such acts of god. The company can counter this by saying that they are spread across India to diversity geographical risk, but it still does not solve the problem being faced in THAT district. The net NPA will rise and the company may have to write off these loans. (No wonder MFIs lend at such rates as a precaution for defaults!).
• Risk & Threat 2: Competition Risk: MFI is turning into a crowded places. Multiple agencies are entering MFI industry looking at the NIMs in this space. Now the company lends at a rate of close to 23-24% where as its cost of funds are around 12%. This NIM of about 12% will not be sustainable in the face of competition. The company may be forced to bring down its lending rates. If this is not compensated with a reduction in cost of funds this will result in a reduction in NIM which directly hits the PAT.

This is one reason why the company has applied for a Small Finance bank license. Being an SFB results in opening of liability accounts like CASA accounts which in-turn will lead to lower cost of funds. This gives Ujjivan the freedom to bring down its lending rates in order to tackle competition.

• Risk & Threat 3: Excessive lending: In its desire to grow at a higher than average pace, the company might end up in excessive lending. This could lead to the following:
  • Weak loan book: The type of customers who end up being part of Ujjivan’s loan book may turn out to be of poor quality. This is especially relevant in case of Ujjivan because it lends to people who do not have access to credit.
  • Defaults: Again, a side effect of weak loan book is the fact that there could be defaults in EMI payment by customers.

If you check the loan book growth you would be surprised and alarmed at the rate of growth. It led me to believe that the company is in an overdrive and might get into trouble. Then I read an interview with Raghuram Rajan where he provides a hint on why the MFIs (or the private lenders) are growing the way they are growing [2].

Even with respect to entities like micro-finance institutions (MFIs) getting small bank licenses, Rajan was asked about any possible red flags as there was an exponential growth even in their finances. “Remember that one of the factors in the economy today is that public sector bank loan growth is much weaker and as a result something else is filling the gap. Now, we have to be very careful that while the public sector banks are dealing with their balance sheet problems, we don’t completely shut off credit growth elsewhere. That is why private sector banks are also growing at 20-25 per cent,” he said

The RBI deputy governor R. Gandhi had the following to say in support of such institutions [3].

Reserve Bank of India Deputy Governor R. Gandhi on Wednesday chided banks for neglecting the small and medium enterprises (SME) segment and warned that if the lenders did not fulfil their social responsibilities, the very existence of banks would be in jeopardy. It is not that the SME segment has not been profitable, but banks have shown a lackluster attitude towards the “big area”. As a result, new generation financial technology (fintech) companies and non-banking financial companies (NBFC) have entered the space and have become “instant success,” Gandhi said.

• Risk & Threat 4: Multiple Loans by a Customer: Since there are multiple MFIs providing loans, a customer could be lured in to take more loans from various credit sources. This exposes him to repayment default risk as his source of income may not be sufficient to repay these loans. MFIs have a check for such scenarios where they do not lend to a customer if she has two loans from one or more MFIs. However MFIs cannot monitor loans taken by such customer from family members or acquaintances. This poses a risk to MFIs.
• Risk & Threat 5: Corrupt Employees: Employees might connive with the customers and provide loans to undeserving customers. This poses a risk to the company. However this is not unique to Ujjivan. This is a risk to any lending agency (be it a bank or an NBFC). Embezzlement from branches is also another possibility (again this is not an MFI company specific issue)
• Risk & Threat 6: Theft and Robbery: Few handful of employees have lost their lives in Northern India. They were attacked by miscreants when they were carrying the cash back to the branches. Since the job involves cash handling, theft and robbery are plausible. Theft and robbery is possible at the branches as well. Again this is not an Ujjivan (or MFI) specific issue.

In order to tackle this issue, the company is moving slowly towards digital platform. The company encourages its employees and the customers to complete all formalities and transactions digitally. This ensures physical handling of cash is avoided.

• Other risks: Equity dilution, Key employee attrition, Samit Ghosh leaving Ujjivan, company’s failure to obtain SFB license are some of the other risks for Ujjivan.

Financials

Let us now talk some numbers.

Loan Book:

The Gross loan book of Ujjivan has grown as shown in the table below. The year-on-year growth numbers are eye popping. On an average the company has grown its loan book at close to 60%. 2015 saw the loan book grow at 102%! Ujiivan is lending, and lending big time!

Year	Gross Loan Book (Crores)	Y-o-Y Growth (%)
2012	703
2013	1126	60.1%
2014	1617	43.6%
2015	3274	102.4%
2016	5389	64.5%

Segment Wise disbursements:

As expected, group lending forms a major chunk of the total disbursements over the past two years. For FY16 group lending formed 89% of all the disbursements. Ujjivan plans to reduce the dependency on group lending and concentrate more on Micro and Small Enterprises (MSE) as well as Housing finance. Ove the next five years the company wants the ratio between group lending and MSE&Housing lending at 50:50.

Year	Group Lending (Crores)	MSE (Crores)	Housing (Crores)	Others
2015	3943	195	121	69
2016	5919	290	238	172

Customer Retention Ratio:

Ujjivan is a micro finance lender. In micro finance business, people take small loans and repay in a year or two. Hence retaining customers is very crucial for the following reasons:

• Existing customers have a track record. If they return back for future loans then Ujjivan has past track record to bank upon before making the loans.
• A higher customer retention shows the stickiness of customers to the company. If a customer returns back for new loans it shows that the customer has faith in the company and has no issues with the lending rates of the company. That’s a sweet news!

The table below shows the Customer retention ratio over the past 5 years. The company seems to have managed a decent customer retention ratio. Over the past 3 years the company managed a retention ratio of 86% which according to me is fairly decent.

Year	Customer Retention Ratio
2012	78%
2013	70%
2014	85%
2015	87%
2016	86%

Staff Retention Ratio:

In Tier-II, Tier-III as well as villages, a company’s name has mirginal significance. It is the employees of the company who matter. The people who take loans from these far flung towns and villages trust the employees of the company more than the company itself. Hence the employees are a major contributing factor for MFIs. The table below shows the staff retention ratio over the past five years for Ujjivan. From the table it is clear that Ujjivan has managed to retain talent. By the way, Ujjivan was the third best company to work in the Great Place To Work (GPTW) survey for the year 2015.

Year	Staff Retention Ratio
2012	76%
2013	78%
2014	83%
2015	83%
2016	82%

Cost-to-Income ratio:

In order to achieve higher profits, the company has to have a tight rein over its costs. If the costs shoot up the profits nosedive. The table shows the cost-to-income ratio for Ujjivan for the past five years. For FY16 the cost-to-income ratio has come down to 51%. However the company may find it tough to maintain this ratio at these levels in future. As it transitions to an SFB, it will have to spend on upgrading the branches as well as on IT (new software and hardware). The company expects the cost-to-income to shoot up few notches above 60%.

Year	Cost-to-income ratio
2012	94.2%
2013	64.1%
2014	55.5%
2015	60.4%
2016	51.0%

Net Interest Margin (NIM):

Net Interest margin is an important metric for any lending institution. A higher net interest margin indicates that the company is able to lend at a higher rate compared to its cost of funds. The table below shows the NIM for Ujjivan over the past five years.

Year	Net Interest Margin
2012	11.3%
2013	13.8%
2014	13.6%
2015	11.6%
2016	12.3%

The Net Interest margin seem very high considering that regular banks have it anywhere between 3-5%. Couple of reasons for such high margins are as below:

• The customer who need these funds do not get loans from regular commercial banks as such customers cannot provide income proofs. In the past, these customers used to take loan from friends, acquaintances who used to charge higher rates. MFIs charge an interest of about 22-25% which is much less than the local moneylenders. Hence the customers are ready to pay these rates.
• From the company’s perspective these are risky loans as the chances of default are higher. Hence MFI companies charge higher interest rates.

But then as we saw in the “Risks” section, as new entrants come into this area, the lending rates may see a downward revision leading to lower NIM. Let us see how things pan out over the next two to three years.

Non-Performing Assets (NPA):

It is quite natural that some of the customers may not be able fulfill their repayment obligations and will default. In such a scenario, the unsecured loans (not backed by collaterals) turn into non-performing assets (it is another story that even if loans are backed by collaterals and there are defaults even then it is treated as NPA). The table below shows the Gross NPA and Net NPA. The Net NPA numbers are on the lower side which means the actual write-offs have been less and the company is able to recover most of the doubtful assets.

Year	Gross NPA	NET NPA
2013	0.08%	0.08%
2014	0.07%	0.01%
2015	0.07%	0.02%
2016	0.15%	0.04%

Auditors:

From shareholder point of view, one of the most important thing about a company is the Auditors. Shareholder does not get to see, review and evaluate all the documents pertaining to a company. This is where an auditor comes into picture. An auditor evaluates the books (as per laid out norms, rules and practices) and provides his opinion about the results declared by a company. Having a good auditor does not guarantee that a company does not do any fraudulent things, but it is always better than having a bad or incompetent auditor.

The Independent auditor for Ujjivan is Deloitte Haskins & Sells [5]. Deloitte is the second largest auditing firm in the world and is part of the Big Four auditing firms [5][6]. In India, revenue wise and audited company count wise, Deloitte is the largest auditing firm ahead of other global auditing firms like PwC, EY and KPMG who are part of the Big Four[4].

What Next

• The company currently provides 87% of its loan products as group lending solution. Ujjivan wants to move to Micro and Small Enterprises (MSE) segment as well as housing loan segment in a big way. In the next five years the company wants the split to be 50-50% between Group lending and MSE/Housing loans. To me this seems like a good path going ahead for the following reasons:
  • To avail MSE loans a customer has to have a past/present relationship with the bank. This ensures that Ujjivan knows the history of the customer.
  • To avail a moderate to high ticket housing loan, the house would naturally be a collateral. To a certain extent this buffers the company from loan defaults.
• Ujjivan wishes to convert itself into a Small Finance Bank. This will insulate it from money lenders act and at the same time provide access to low cost credit in the form of liability accounts like CASA (Curent Account and Savings Account). I hope that the company will be able to retain its NIMs post being a Bank.
  • Other than CASA product, it may also sell other products like Insurance, mutual funds and debt instruments resulting in diversified product portfolio and customer base.

Going forward, the above two factor are going to be the major growth drivers for Ujjivan. The company is planning to target a loan book growth rate of 35-40% for FY17 [7]. I assume the company will be able to retain this rate for the coming years.

References:

[1] Ujjivan Finance Annual Report FY16, FY15

[2] http://www.business-standard.com/article/finance/bigger-nbfcs-must-be-inspected-regularly-rajan-116081001386_1.html

[3] http://www.business-standard.com/article/finance/shape-up-or-lose-out-rbi-s-gandhi-to-banks-116081701242_1.html

[4] http://articles.economictimes.indiatimes.com/2016-01-21/news/69961008_1_130-crore-225-crore-audit-fee

[5] https://en.wikipedia.org/wiki/Deloitte

[6] https://en.wikipedia.org/wiki/Big_Four_accounting_firms

[7] http://www.moneycontrol.com/news/results-boardroom/ujjivan-fin-sees-loan-book-growing-35-40-for-fy17_7155201.html

Disclaimer:

I am not a SEBI registered research analyst. The information provided above is my subjective view based on what I have read on different websites, annual reports, and quarterly reports of various companies which I assume to be accurate. The above information should not be treated as an offer/advise to purchase a specific stock/investment instrument. Since these are my subjective opinions, I could be wrong in my understanding or presentation of information. I do not claim that the above information is complete or can be relied upon as such. I cannot be held responsible for any loss or damage caused due to any inadvertent error in the above information. I will not be liable for investment decisions made by readers of this article based on the above information. I am not an investment advisor. I may or may not have position in the above company. Please consult your investment advisor for all your investment needs.