ICRA Nepal assigns "Grade 3" rating to upcoming 50% right share of First Microfinance

ICRA Nepal Limited has assigned [ICRANP] IPO Grade 3 to the upcoming 50% right share of First Microfinance Laghubitta Bittiya Sanstha Limited (FMDBL), indicating average fundamentals. FMDBL is proposing to issue 22,81,313 units right shares, each to be issued at face value of Rs 100 per share. Currently, the process of issuance is awaiting approval from Securities Board of Nepal (SEBON). As per ICRA Nepal, the average fundamental grading factors in the strength of institutional promoters (15% stake of Global IME Bank rated at A-@ by ICRA Nepal, among others), experienced management team and comfortable capitalization profile (~15% as of Oct-17) which is expected to support FMDBL in maintaining healthy pace of growth reported so far (CAGR1 ~46% over last four years ending Jul-17, albeit on a small base vs. ~38% for industry). Incremental growth opportunities for microfinance business in Nepal also remains good given the large below poverty line population. The grading is further supported by FMDBL’s adequate loan underwriting and monitoring processes resulting in good assets quality indicators (0% Gross NPL so far) along with adequate profitability profile (RoA and RoNW stable at ~2% and ~20% respectively over last four years ending Jul-17) supported by healthy NIMs (3.76% for FY2017), low credit provisioning expense & moderate operating expense ratio. The grading also factors in the mandatory deprived sector lending requirements for banking sector (5% for commercial bank, 4.5% for development bank and 4% for finance companies) and relaxation on regulation requiring 2% direct deprived sector lending by commercial banks, which is expected to ensure adequate flow of funds for future growth of microfinance sector. Nonetheless, the grading is constrained by the regulatory risk in MFI industry which along with stiff competition from other wholesale lending MFIs and commercial banks pursuing direct deprived sector lending might impact funding profile of FMDBL that has remained solely dependent upon bank borrowings so far. While assigning the grading, ICRA Nepal also takes note of the lack of long term funding sources for FMDBL (~84% loans are revolving in nature as of Oct-17) for floating ~64% scheduled nature loans which might create liquidity management issues. Nonetheless, FMDBL’s revolving borrowings have been mostly renewed so far, given the deprived sector lending targets to be met by the banking sector, which provides some comfort. The grading is also constrained by higher portfolio vulnerability arising from large share of exposure to cooperatives (~36% of credit portfolio on Oct-17, however lowered compared to 60% in Jul-14) which lacks regulatory supervision and relatively high portfolio concentration (~43% among top-20 borrowers on mid-Oct-17). The grading is further constrained by limited track record of FMDBL (operating since 2010), lack of diversity in earnings, lower representation of institutional promoters in the board (one director out of six from institutional promoter despite ~38% shareholding) and uncertain operating environment that banks in Nepal are currently facing. Moreover, high portfolio vulnerability given unsecured nature of loans, high chances of over-leveraging in the absence of credit bureau in MFI sector and marginal profile of borrowers also remains a constraint; although mitigated to some extent through guarantee from board and right of lien on the assets of borrowing units. ICRA Nepal assigns IPO grading on a scale of IPO Grade 1 through IPO Grade 5, with Grade 1 indicating strong fundamentals and Grade 5 indicating poor fundamentals. For the grading categories 2, 3 and 4, the sign of + (plus) appended to the grading symbols indicate their relative position within the grading categories concerned. Thus, the grading of 2+, 3+ and 4+ are one notch higher than 2, 3 and 4 respectively.